For almost 200 years after the founding of the United States, the value of the U.S. dollar was officially backed by gold. This was called the gold standard. In 1933, in partial response to the Great Depression, Congress enacted a joint resolution nullifying the right of creditors to demand payment in gold. In other words, a person could no longer insist on being paid in gold. For a while, at the time, it was illegal for Americans to own gold. Our leaders were worried that citizens were hoarding gold during the Depression, worried about bank runs on gold, and concerned that these behaviors would further slowdown an already wounded economy. This was the beginning of taking the U.S. off of the gold standard. Individuals were able to exchange dollars for gold until the late 1960s.

In 1971 the U.S. “closed the gold window.” This was the last link that the dollar had to gold. Foreign countries’ reserve banks and treasuries could redeem their U.S. dollars for gold until that point. President Nixon closed the gold window because too many other countries traded their dollars for gold, depleting U.S. gold reserves.

We now have a “fiat money” system, as do most countries. The currency in circulation has value because the government forces people to use it. The word “fiat” means “an order or decree.” The dollar bill itself has no intrinsic value. The “promise” behind it is the value.

The price of gold in 1970 was $35 per oz. Gold is now just over $1800 per oz. This price change is not because the value of gold is going up; the value of the dollar, and most other world fiat currencies, are going down. As stated above, an ounce of gold can purchase about the same amount of goods and services now as it could 1000 years ago. A U.S. dollar can’t even buy the same amount of goods as it could a year ago.

A gold standard forces a nation to limit the increase of currency in circulation, limiting inflation. Central bankers and politicians can only increase currency with a gold standard when more gold is mined/purchased. This helps to keep the value of the currency stable. The gold standard constrains politicians and banks from inflating or deflating the amount of currency in circulation. That’s the positive side of a gold standard. On the negative side, it decreases the ability of politicians to react in a crisis, limiting the tools available to them.

What made gold and silver the perfect form of money for many centuries? It is scarce enough to have value but not so scarce. There is enough available to make coins that could circulate as money. These metals don’t degrade as other metals can, and both have non-monetary use, such as in jewelry and electronics. That gives them value outside of money. Gold and silver are perfectly and evenly divisible, unlike diamonds. Gold and silver are chemical elements and impossible to counterfeit perfectly. There is a fixed amount in the earth’s crust, and it costs work and energy to take it out of the ground, giving it value from that requirement as well. The inflation of gold and silver is limited by the ability to mine it. These reasons are why we relied on gold and silver for centuries as a form of currency.

Today, many pundits refer to gold as a “relic,” a “pet rock,” and the gold standard as antiquated. Could the U.S. ever go back on a gold standard? It would be very difficult and cause a great deal of economic disruption. There is no political or central bank appetite to do that at all. So probably not.

Why did we get off the gold standard? Politicians don’t like to be constrained. That is one reason. As the U.S. dollar became the world’s “reserve currency,” that status gave the dollar clout and value as the world’s leading currency, making it easier to get away from gold backing the U.S. dollar. In the current fiat system, currency can be printed to stimulate the economy, without restraint, as we are doing now with Quantitative Easing.

We may not ever go back to the gold standard, but it will forever be an important part of our history and the history of money.

Categories: MoneyWellth