Gold standard – definition and meaning
The Gold standard is a system of controlling and providing the exchange of money. The country fixes the value of its currency (money) against that of gold. In other words, it is a system of backing an economy’s currency with gold reserves. You can convert the currency of a country on the gold standard into gold at a fixed price.
Put simply, each unit of currency is worth a certain weight in gold. You can only add more money to the system if you also add the corresponding amount of gold.
Countries that use the gold standard use gold to settle all their international trade transactions.
The term also refers to the quality of something that is first class. For example, if I say “XYZ Newspaper is the gold standard for investigative journalism,” it means we measure other newspapers against XYZ. In other words, XYZ is so good that all other quality newspapers measure themselves against it.
This article focuses on the term when talking about a country’s currency.
According to ft.com/lexion, the Financial Times’ dictionary, the gold standard is a:
“Monetary system adopted during various periods of the 20th Century under which participating currencies were backed by gold reserves and exchange rates were fixed in terms of their value in gold.”
Gold is a precious metal. It serves as a store of wealth as well as a form of investment. In fact, we have been investing in gold and using it in coin-making, jewelry, and art for thousands of years.
Gold standard was once the norm
The world’s major economic powers were on the gold standard from 1900 to 1914. However, they were unable to maintain it from 1914 to 1918, i.e., during World War I.
Most major powers, except for the United States, abandoned the gold standard during the Great Depression. The Great Depression lasted during much of the 1930s.
In 1971, the United States also abandoned the gold standard and adopted a floating exchange rate system. The current international monetary system, in fact, consists mostly of floating exchange rates.
In a floating exchange rate system, the forex market sets currency prices. In other words, supply and demand for a currency on the foreign exchange market determine its value. Forex stands for the Foreign Exchange market.
Even though most countries abandoned the gold standard during the 20th century, today they hold substantial gold reserves.
Gold standard – origin
The gold standard evolved from the widespread acceptance of gold as a form of payment, i.e., currency. In fact, humans have been using many different types of commodities as money for a very long time.
A commodity is a raw material, such as gold or silver, or an agricultural product, such as coffee or wheat. Today, we buy and sell commodities in the commodity market.
Historically, the commodity that maintains its value the best over time becomes the currency people like the most. According to Wikipedia, “Chemically, gold is of all major metals the one most resistant to corrosion.”
Gold – Asia Minor then Europe
Humans started using gold as a currency in Asia Minor thousands of years ago. In Europe, the bezant, a Byzantine gold solidus, became a common currency during the Middle Ages. It was also popular during this period throughout the Mediterranean.
However, as the Byzantine Empire and influence declined, Europeans began choosing silver as their currency. This subsequently led to the development of silver standards.
Gold standard – British West Indies
In 1704, British West Indies was the first region to adopt the gold standard as we know it today. The Caribbean islands used the Spanish gold doubloon.
In 1717, Sir Isaac Newton established a new silver-gold mint ratio which effectively drove silver out of circulation. At the time, Newton was the master of the Royal Mint. Subsequently, Great Britain entered the gold standard.
It was not long before other major European economic powers, plus Canada and the USA also adopted the gold standard.
Germany introduced the new gold mark while the US used the eagle as its unit. Canada adopted a dual system – the US gold eagle and also the British gold sovereign.
At the end of the nineteenth century, Japan also chose to back its currency with gold. Japan’s main reason, in fact, was to gain access to Western capital markets.
Video – The Gold Standard
This One Minute Economics video explains what the gold standard is and how it emerged. It all started a few thousand years ago when people started using gold for purchases. They then started hoarding the precious metal.