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What is the gold standard? 

Gold Standard definition

The gold standard is a monetary system where a country’s currency value is pegged to a fixed volume of gold

According to Encyclopaedia Britannica’s gold standard definition, it is a “monetary system in which the standard unit of currency is a fixed quantity of gold or is kept at the value of a fixed quantity of gold”. 

How gold standard works

When a country adopts the gold standard as its monetary system, its currency is convertible at home or abroad into a fixed amount of gold per unit of currency.

The quantity and growth rate of a country’s money supply would also be regulated by the production of gold.

Adopting the international gold standard means that gold or a currency that is convertible into gold at a fixed price is used as a medium of international payments. Under the gold standard system, exchange rates between countries are fixed.

Gold standard history

Which countries use the gold standard? The UK formally adopted the gold standard in 1821, with Germany, France and the United States committing to the standard in the 1870s. Many more countries followed the suit as gold discoveries in western North America increased the supply of the precious metal. 

As major countries joined the gold standard in the 1870s, the common monetary system contributed to economic growth and facilitated free trade among the countries, and this was how the gold standard affected globalisation. The period from 1880 to 1914 is known as the classical gold standard.

However, the system collapsed during World War I, as the belligerent powers of Germany and Austria-Hungary abandoned the monetary system and resorted to inflationary finance to fund their war efforts.

The gold standard was reinstated from 1925 to 1931 as the Gold Exchange Standard, where countries could hold gold, dollars, or pounds as reserves. The US and the UK were the exceptions as both held reserves only in gold. 

The UK departed from the Gold Exchange Standard in 1931 because of the massive gold and capital outflows. In 1933, the US nationalised gold owned by citizens and repealed contracts in which payment was specified in the precious metal.  

By 1973, the direct convertibility of the US dollar to gold was no longer feasible because of the country’s depleted gold reserve. 

Is there still a gold standard? 

Is any currency backed by gold today? To answer simply – no. No currency in the world today is on the gold standard. Switzerland was the last country to abandon the gold standard in 1999, so the Swiss franc need not be backed by gold. 

Pros and cons of the gold standard

The advantages of the gold standard are the certainty brought about by the monetary system and the limit on inflation

The fixed exchange rates between countries creates certainty in international trade. The monetary system limits the power of the government or banks to issue excessive paper currency, hence the ability to curb inflation.

The disadvantages are the rigidity of the system and the increased risk of financial contagion among countries adopting the gold standard. 

The supply of newly minted gold is not closely related to the changing needs of the global economy, and the monetary system does not provide sufficient flexibility in the supply of money. Countries adopting the gold standard are exposed to economic conditions such as inflation or depression in the neighbouring countries.

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