The gold standard was a monetary system tying the value of a country’s currency directly to gold. It helped countries maintain fixed exchange rates and facilitated international commerce. The Bretton Woods Agreement shaped its evolution, pegging major currencies to the U.S. dollar. President Nixon’s decision to end the dollar’s convertibility to gold in 1971 effectively ended the gold standard. This transition led to the modern fiat currency system, where money is backed by government trust rather than physical commodities, influencing today’s U.S. dollar value and monetary policy.
Key Takeaways
- The gold standard linked currency value to gold, with countries fixing their currencies to a specified amount of gold.
- The U.S. abandoned the gold standard in 1971, ending dollar convertibility to gold.
- The rise and fall of the gold standard affected global trade and economic stability, especially during World Wars.
- No country currently uses the gold standard; currencies today are fiat money, backed by government decree.
- A return to the gold standard could restrict monetary policy flexibility and lead to increased economic volatility.
Historical Use and Decline of the Gold Standard
No government uses the gold standard today. Britain abandoned it in 1931, and the U.S. followed in 1933, with final traces gone by 1973.12
Fiat money, which a government mandates must be accepted as payment, fully replaced the gold standard. In the U.S., for instance, the dollar is fiat money, and in Nigeria, the naira is.
The gold standard's appeal lies in limiting human control over money issuance. With the physical quantity of gold acting as a limit to issuance, a society can potentially avoid the perils of inflation.
The U.S. gold standard history shows that while it can prevent inflation, strict adherence can cause economic instability and political unrest.
Comparing the Gold Standard With the Fiat Currency System
A fiat system lets currency values fluctuate against others on foreign exchange markets, not relying on physical commodities.
The word "Fiat" comes from the Latin fieri, meaning an arbitrary act or decree. In keeping with this etymology, the value of fiat currencies is ultimately based on the fact that they are defined as legal tender by way of government decree.3
In the decades before the First World War, international trade was conducted based on what has come to be known as the classical gold standard. In this system, trade between nations was settled using physical gold.
Nations with trade surpluses accumulated gold as payment for their exports. Conversely, nations with trade deficits saw their gold reserves decline as gold flowed out of those nations as payment for their imports.
A Historical Overview of the Gold Standard
President Herbert Hoover said in 1933, "We have gold because we cannot trust governments," to Franklin D. Roosevelt. This statement predicted the Emergency Banking Act, which forced Americans to convert their gold into U.S. dollars.4
In 1934, President Roosevelt signed the Gold Reserve Act of 1934 which transferred the title of gold from private holders to the U.S. Treasury.5
While the legislation successfully stopped the outflow of gold during the Great Depression, it did not change the conviction of gold bugs, people who are forever confident in gold's stability as a source of wealth.
Gold has a history like that of no other asset class, in that it has a unique influence on its supply and demand. Gold bugs still cling to a past when gold ruled, but gold's past also includes a fall that must be understood to properly assess its future.
Rise and Adoption of the Gold Standard
The gold standard allows paper money to be freely convertible into gold. In other words, in such a monetary system, gold backs the value of money. Between 1696 and 1812, the development and formalization of the gold standard began as the introduction of paper money posed some problems.
In 1789, the U.S. Constitution gave Congress the right to coin money and regulate its value. Creating a united national currency enabled the standardization of a monetary system that had, up until then, consisted of circulating foreign coins, mostly silver.6
Gold and Silver: A New Standard
With silver in greater abundance relative to gold, a bimetallic standard was adopted in 1792. While the officially adopted silver-to-gold parity ratio of 15:1 accurately reflected the market ratio at the time, after 1793, the value of silver steadily declined, pushing gold out of circulation, according to Gresham's law.78
The issue would not be remedied until the Coinage Act of 1834, and not without strong political animosity. Hard-money enthusiasts advocated for a ratio that would return gold coins to circulation, not necessarily to push out silver, but to push out small-denomination paper notes issued by the then-hated Bank of the United States. A ratio of 16:1 that blatantly overvalued gold was established and reversed the situation, putting the U.S. on a de facto gold standard.9
Gold Standard Adoption
In 1819, England was the first to officially adopt a gold standard. The century's dramatic increase in global trade and production brought large discoveries of gold, which helped the gold standard remain intact well into the next century.10
As all trade imbalances between nations were settled with gold, governments had a strong incentive to stockpile gold for more difficult times. Those stockpiles still exist today.
The international gold standard emerged in 1871, following its adoption by Germany. By 1900, the majority of the developed nations were linked to the gold standard. Ironically, the U.S. was one of the last countries to join. In fact, a strong silver lobby prevented gold from being the sole monetary standard within the U.S. throughout the 19th century.11
From 1871 to 1914, the gold standard was at its pinnacle. During this period, near-ideal political conditions existed among most countries—including Australia, Canada, New Zealand, and India—that instituted the gold standard. However, this all changed with the outbreak of the Great War in 1914.12
Decline and Replacement of the Gold Standard
With World War I, political alliances changed, international indebtedness increased, and government finances deteriorated. While the gold standard was not suspended, it was in limbo during the war, demonstrating its inability to hold through both good and bad times.
This created a lack of confidence in the gold standard that only exacerbated economic difficulties. It became increasingly apparent that the world needed something more flexible on which to base its global economy.
At the same time, a desire to return to the idyllic years of the gold standard remained strong among nations. As the gold supply continued to fall behind the growth of the global economy, the British pound sterling and the U.S. dollar became the global reserve currencies.
Smaller countries began holding more of these currencies instead of gold. The result was an accentuated consolidation of gold into the hands of a few large nations.
The stock market crash of 1929 was only one of the world's post-war difficulties. The pound and the French franc were misaligned with other currencies; war debts and reparations were still stifling Germany; commodity prices were collapsing; and banks were overextended. Many countries tried to protect their gold stock by raising interest rates to entice investors to keep their deposits intact rather than convert them into gold.
These higher interest rates only made things worse for the global economy. In 1931, the gold standard in England was suspended, leaving only the U.S. and France with large gold reserves.1
Then, in 1934, the U.S. government revalued gold from $20.67 per ounce to $35 per ounce, raising the amount of paper money it took to buy one ounce to help improve its economy.13
As other nations could convert their existing gold holdings into more U.S. dollars, a dramatic devaluation of the dollar instantly took place. This higher price for gold increased the conversion of gold into U.S. dollars, effectively allowing the U.S. to corner the gold market. Gold production soared so that by 1939, there was enough in the world to replace all global currency in circulation.
The Relationship Between Gold and the U.S. Dollar
As World War II was coming to an end, the leading Western powers met to develop the Bretton Woods Agreement, which would be the framework for the global currency markets until 1971. Within the Bretton Woods system, all national currencies were valued in relation to the U.S. dollar, which became the dominant reserve currency.14
The dollar, in turn, was convertible to gold at the fixed rate of $35 per ounce. The global financial system continued to operate upon a gold standard, albeit in a more indirect manner.14
The agreement has resulted in an interesting relationship between gold and the U.S. dollar over time. Over the long term, a declining dollar generally means rising gold prices. In the short term, this is not always true, and the relationship can be tenuous at best, as the following one-year daily chart demonstrates.
In the figure below, notice the correlation indicator which moves from a strong negative correlation to a positive correlation and back again. The correlation is still biased toward the inverse (negative on the correlation study) though, so as the dollar rises, gold typically declines.
At the end of WWII, the U.S. had 75% of the world's monetary gold and the dollar was the only currency still backed directly by gold.
However, as the world rebuilt itself after WWII, the U.S. saw its gold reserves steadily drop due to its high demand for imports and as money flowed to war-torn nations. The high inflationary environment of the late 1960s sucked out the last bit of air from the gold standard.
Understanding the Gold Pool Agreement
In 1968, a Gold Pool, which included the U.S. and several European nations, stopped selling gold on the London market, allowing the market to freely determine the price of gold. From 1968 to 1971, only central banks could trade with the U.S. at $35 per ounce.15
By making a pool of gold reserves available, the market price of gold could be kept in line with the official parity rate. This alleviated the pressure on member nations to appreciate their currencies to maintain their export-led growth strategies.
However, the increasing competitiveness of foreign nations, combined with the monetization of debt to pay for social programs and the Vietnam War, soon began to weigh on America’s balance of payments.
With a surplus turning to a deficit in 1959 and growing fears that foreign nations would start redeeming their dollar-denominated assets for gold, Senator John F. Kennedy declared, in the late stages of his presidential campaign, that he would not attempt to devalue the dollar if elected.16
Fast Fact
Approximately 50% of all the gold ever mined was mined after 1971.17
The Gold Pool collapsed in 1968 as member nations were reluctant to cooperate fully in maintaining the market price at the U.S. price of gold. In the following years, both Belgium and the Netherlands cashed in dollars for gold, with Germany and France expressing similar intentions.15
In August 1971, Britain requested to be paid in gold, forcing Nixon's hand and officially closing the gold window. By 1976, it was official; the dollar would no longer be defined by gold, thus marking the end of any semblance of a gold standard.18
In August 1971, Nixon severed the direct convertibility of U.S. dollars into gold. With this decision, the international currency market, which had become increasingly reliant on the dollar since the enactment of the Bretton Woods Agreement, lost its formal connection to gold. The U.S. dollar, and by extension, the global financial system it effectively sustained, entered the era of fiat money.18
Who Still Has the Gold Standard?
No country currently uses a gold standard. As mentioned above, Britain terminated the gold standard in 1931 and the U.S. did the same in 1933. In 1971, the U.S. fully severed the direct convertibility of dollars into gold. In other words, no country backs its currency with gold. In the U.S., currency is backed by the government and its ability to continually generate revenue.118
What Are the Advantages and Disadvantages of the Gold Standard?
Proponents of the gold standard argue that it prevents inflation, as governments and banks are unable to manipulate the money supply, such as by overissuing money. The gold standard also stabilizes prices and foreign exchange rates.
On the other hand, under the gold standard, the supply of gold cannot keep pace with its demand, and it is not flexible under trying economic times. Also, mining gold is costly and creates negative environmental externalities.
Why Did the U.S. Abandon the Gold Standard?
The U.S. abandoned the gold standard in 1971 to curb inflation and prevent foreign nations from overburdening the system by redeeming their dollars for gold.18
What Would Happen If We Returned to the Gold Standard?
Though it is highly unlikely for the U.S. to return to the gold standard, the idea has drawn some attention and popularity. Most notably, Judy Shelton, an economic advisor to former President Donald Trump, is known for her support for a return to the gold standard. (In 2019, Trump nominated Shelton to the Fed, but she ultimately did not retain enough support.)
A return to the gold standard would limit the Federal Reserve's ability to print money and constrain its ability to enact monetary policy during critical economic events, such as recessions. Economists have also posited that a return to the gold standard would result in an economy that is more volatile, due to vulnerability to shocks in supply and demand for gold. Central bankers and economists are largely unanimous against the idea of returning to a gold standard.19
Did the Gold Standard Cause the Great Depression?
The Great Depression—the longest and most severe economic recession in modern history—was caused by a confluence of factors, with the gold standard being but one contributing element. Economists do not agree on a single explanation for the catastrophe but have noted that its key causes include the stock market crash of 1929 and protectionist trade policies. The gold standard also played a role in the Great Depression, as it limited the ability of monetary policy to stabilize the economy.19
The Bottom Line
Gold has fascinated humanity for 5,000 years, but its role as the foundation of the monetary system was brief, with the international gold standard lasting less than 50 years. The decline of the gold standard began earlier with the rise of paper money, offering a flexible tool for modern economies. Gold's price is now driven by demand and remains a significant financial asset for nations and central banks. It provides a hedge against government loans and is an indicator of economic health, making it a strategic component of national reserves. For individual investors, gold can diversify portfolios, often moves inversely to the U.S. dollar.