The Gold Standard, Explained

03 Sep

The Gold Standard, Explained

You may have heard a spirited debate about the gold standard, fiat currency, and free-floating currency. If you’re familiar with Ron Paul or other free market advocates, the gold standard is likely to come up. 

So what is the gold standard, why are so many Americans up in arms about it, and how likely is it to come back?

What is the Gold Standard?

The gold standard is a system of currency where all of a country’s currency is backed by gold. The gold standard ensures money has a physical backing, as opposed to fiat currency, which has a free-floating value that is prone to inflation and eventual devaluation. With the gold standard, the price of gold is fixed, and the value of a country’s currency is determined by that fixed price.

Currently, no governments use the gold standard. The US Dollar has been officially divorced from the gold standard since 1971

The world runs on fiat currency

As opposed to currency backed by gold, the world operates on currency without intrinsic value, known as “fiat” money. Fiat currency relies on government regulation and intervention and gives central banks an enormous influence over the economy.

Fiat currency has plenty of outspoken critics, namely proponents of small government. Some disadvantages of fiat currency include:

  1. Economic volatility
  2. Currency devaluation
  3. Concentration of wealth
  4. Risk of hyperinflation
  5. Dependence on central banks

A Brief History of the Gold Standard

Gold has been the preferred currency for most of human civilization. Most currency was backed by gold from ancient Egypt to the Richard Nixon years, and precious metals still have an important place in the modern economy. Here is a brief history of the gold standard.

Gold before America

Gold was a fascination in the ancient world, and was integral in the development of currency. Ancient Egyptians topped the Pyramids of Giza with solid gold and precious metals played an important role in their mythology. By 560 B.C., Lydians (present-day Turkey) had developed the first pure gold coin, the Lydian Lion. Precious metals were the basis of currency exchange through the Bronze Age, Iron Age, Middle Ages, and the early modern period.

The American gold standard

Congress passed the Mint and Coinage Act in 1792, and established a fixed ratio to the US Dollar. In the early 1800’s, President Jefferson stopped the minting of silver coins, which established a derivative silver standard, since the Bank of the United States didn’t fully back its currency with reserves. America would eventually create a bi-metallic standard in the 19th century.

In 1862, during the Civil War, paper money was made legal tender. Known as “greenbacks,” this set a precedent as America’s first use of fiat currency.

The Great Depression & Franklin Delano Roosevelt

After a devastating market crash in 1929, America was sent into a crippling economic depression. In response to economic uncertainty during the Great Depression, President Roosevelt enacted the Gold Reserve Act in 1934. This act nationalized gold, and devalued the US Dollar by 40%. Executive Order 6102 put a prohibition on private ownership of gold (up to $100 worth), and coerced Americans to turn over their gold to the government. 

The Executive Order issued by the President yesterday amplifies and particularizes his earlier warnings against hoarding. On March 6, taking advantage of a wartime statute which had not been repealed, he forbade the hoarding “of gold or silver coin or bullion or currency,” under penalty of $10,000 fine or ten years’ imprisonment or both. 

The New York Times, April 6, 1933

By this time, the gold standard had all but been abandoned, and private ownership of significant amounts of gold was forbidden.

Nixon shock & decriminalization

In 1971, President Nixon officially divorced the US Dollar from the gold standard. At the time, unemployment had risen to 6.1%, at an inflation rate of 5.84%. In the years that followed Nixon’s decision, free-floating fiat currencies became increasingly unstable, and the dollar lost a third of its purchasing power.

In 1974, President Ford signed Public Law 93-373, which decriminalized the possession of gold. According to the law, “No provision of any law in effect on the date of enactment of this Act, and no rule, regulation, or order in effect on the date subsections… may be construed to prohibit any person from purchasing, holding, selling, or otherwise dealing with gold in the United States or abroad.”

Will the Gold Standard Return?

Since 1971, the National Debt held by the United States has grown from $398 billion to $22.3 trillion. Over the same time period, the U.S. deficit has risen from $232 billion to $1.12 trillion, and one 1971 dollar is worth $6.31 in today’s currency. Clearly, things have gotten out of hand since the gold standard went away.

President Trump on the gold standard

Donald Trump has weighed in on the gold standard numerous times in the past decades, but acknowledges how hard it would be to bring the standard back. 

“Bringing back the gold standard would be very hard to do, but boy, would it be wonderful. We’d have a standard on which to base our money.”Donald Trump, February 2017

Since then, Trump has remained relatively quiet about the gold standard.

In contrast to this, Trump’s Federal Reserve nominee, Stephen Moore, has recently denounced the gold standard after decades of supporting it. For the time being, the gold standard looks unlikely to return anytime soon.

Gold Maintains Its Value

Even when the dollar has lost about 95% of its purchasing power since 1913, gold still buys essentially the same products. An ounce of gold bought a well-made man’s suit ($20.68), and an ounce of gold still buys a designer suit. Though it experiences fluctuations in demand, the value of gold remains largely the same. The gold standard isn’t currently recognized by the government, but purchasing gold still has tremendous advantages.For expert insights on securing your financial future with gold and precious metals, get in touch with Republic Monetary Exchange today for a free consultation.