What is the Gold Standard?

Gold Standard

A gold standard, or a gold standard currency, is a monetary system in which the monetary
unit is supported by the value of physical gold bullion. While the money in circulation is
not necessarily made out of precious metal, the idea is that the unit of currency can be
exchanged for a fixed amount of gold. For example, if the British government were to set
the price of gold at £500 an ounce, the value of the pound would be 1/500th of an ounce
of gold.

Thanks to its scarcity and natural beauty, gold bullion’s timeless appeal allows it to maintain
a high value. It is no surprise then that different civilisations have used gold as currency for
thousands of years.

Although gold standard currencies were abandoned in the 20th Century by most nations,
many still hold large gold reserves. When most people ask what the gold standard is, they
will be referring to this monetary system, but their actually three different ways a gold standard
can work, as discussed below.

Gold Specie Standard

In this system the unit of currency is either based on the value of a gold coin that is in
circulation, or has the same value as that gold coin. This doesn’t mean that all coins in
circulation are necessarily made out of gold, but it guarantees that the nominal value
of the currency is fixed by the intrinsic value of the gold coin being circulated.

A gold specie standard was adopted in Britain in the 19th Century after The Royal Mint
began to circulate gold Sovereigns, Crowns, Half-Crowns and copper Farthings. It lasted
for nearly a century, before the British Empire abandoned it during World War 1.

Gold Bullion Standard
Bullion Standard

A gold bullion standard system is different, then, as it doesn’t actually involve the circulation
of gold coins. Instead, gold bullion is available on demand at fixed price in exchange for
circulating currency.

An advantage of this is that it is difficult for currencies based on it to be devalued by inflation.
The value of the money in circulation is fixed by the amount of gold bullion that it can by,
making it difficult for governments to print more money.

However, this also means that it is very difficult for a government to stimulate a slowing economy through quantitative easing, as the amount of money in circulation is dependent
on the gold supply.

In 1925 this replaced the gold specie standard in Britain, before it was abandoned altogether
in 1931.

Gold Exchange Standard

A gold exchange standard is a monetary system where a government guarantees a fixed exchange rate to a foreign currency that uses a gold specie or gold bullion standard.

It is a way for countries without large gold reserves to fix the value of their currency in terms of gold, regardless of its own intrinsic value.

In the 19th Century it was a common phenomenon for countries who were still on silver standard, and who didn’t possess large gold reserves, to peg their currencies against the American or British gold-backed systems.

Gold vs Fiat Money
Gold Standard vs Fiat Money

Britain abandoned the gold standard in 1931 after the Great Depression severely threatened its gold
reserves. The rest of the world soon followed and gold-backed currencies have now been replaced with
‘fiat’ systems.

A ‘fiat’ system is a monetary system where a specific currency’s value is not based on a physical
commodity, gold or otherwise. Instead, the value of the currency fluctuates against other currencies
on foreign-exchange markets.

They essentially have no intrinsic value, unlike gold bullion, and are only worth the arbitrary value
assigned to them. The fact that a fiat currency is unattached to a finite amount of a valuable
commodity affords governments the power to print money in order to stimulate the economy by
increasing the cash supply. While this can be useful, there is also an element of danger involved.
While gold’s intrinsic value means that it will always be worth something, fiat currencies are
vulnerable to hyperinflation, which can effectively render money worthless.

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