What is the 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 1/500 ^th 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 20 ^th Century by most nations, many still hold large gold reserves.

There are 3 well known types of gold standard:

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 19 ^th 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

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

Britain abandoned gold 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 hyper-inflation, which can effectively render money worthless.