Gold Standard

Updated on January 29, 2024
Article byMilan Jha
Reviewed byDheeraj Vaidya, CFA, FRM

What is the Gold Standard?

The gold standard is a monetary term used for when there was a system of gold exchange instead of the paper currency. The paper currency holders converted their money in gold with proper authentication because gold was used in any monetary business.

Key Takeaways

  • Gold Standard refers to when gold transactions were utilized instead of paper money.
  • The Gold Standard aimed to create a monetary system where the value of a country’s currency was tied to a fixed quantity of gold.
  • The government set the price of gold, and residents may trade their paper money for gold at the time. The nation’s absolute economics were enforced based on gold prices.
  • This standard was abandoned mostly because the slightly restricted circulation of gold made it impossible to raise the value of money, which would have benefited the entire economy.

Explanation

Gold standards are considered to regulate the money outflow and inflow in the country. This is because the government had very strong control over the issuance of gold at the exchange time. In addition, the price levels were also checked and controlled by the government. Therefore, the monetary transactions were feasible if the transaction was happening in the country. But things were not the same when the monetary transactions were done with other countries. If so, the gold rates were fixed by the government of one country, which the other country’s government did not agree with. Therefore, the government witnessed the difference in supply and demand, and thus it is one of the reasons for the discontinuation of this system.

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History of Gold Standard

It is considered the most effective way to keep the economy intact. In 1900, an act passed, the Gold Standard Act 1900. It was mentioned that the gold could be exchanged for paper moneyPaper MoneyPaper money is a country's currency in banknotes that have a specific value and pay for goods and services. Paper money holds a country's government backing while the central bank controls the note's printing and circulation.read more. The government sets the value for the gold, and the paper currency can be redeemed with the exact valuation of the gold set by the government. It was adapted to control the economy and, thus, misuse resources because the gold’s issuance was authenticated and checked properly.

How Does it Work?

The gold standard was a standard price set by the government to control the money supply in the country. The government set the prices of gold, and the citizens could exchange their paper money for gold which was in the trend at that time. The gold prices set up the absolute economy levied in the country. This gold price was considered a standard, and therefore the country should follow the standard set.

Types of Gold Standard

Gold-Standard

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Source: Gold Standard (wallstreetmojo.com)

The types are:

  1. Gold Exchange standard,
  2. Gold Bullion Standard,
  3. Gold and Fiat Money standard, and
  4. Gold specie standard.

Abandoning Gold Standard

The countries abandoned the adequate standard of calculating the economy and an approved way of money exchange, i.e., the Gold standard. Presently, no government uses this method in economics. Many factors have led to the abolishment of this system. It was not a failure; rather, it was a good method for economists. The major reason for the abandonment of this standard was that it could not raise the value of money because the circulation of gold was somewhat restricted, which couldn’t reach out to the entire economy. Therefore, the US government started with Fiat moneyFiat MoneyFiat money is a currency that is declared by the government to be legal tender and has no physical backing such as gold; rather, the value of fiat money is derived from the market's demand-supply relationship. India's and America's fiat currencies are the India Rupee and the US Dollar, respectively.read more, and now it is doing well for them. The Fiat money system has also proved the equality in the economy of scales, and hence it was abolished.

Impact

When we talk about the impact of this standard on the economy, it is clear that the impact was a mix. It had a good impact on the limited crowd and a harmful impact on the rest. They were adopted to bring uniformity to the economy. The money was very well controlled, and no inflation could come in the country because the government could easily control the economy. Still, the country demands an increase in the economy, which was possible only if there was a fiat money policy.

Rise and Fall

The Gold Standard was the history of the economy in most of the countries. It was considered the safest and most prominent way of money exchange when paper currency was not evolved. The government used to rely on this method to control the flow of currency in the country and hence considered it very important. However, they started losing their impact after the government changed the mindset of equality. The paper currency can provide equality in the country, and therefore the government was forced to take up the change for the economy.

Advantages

  • This standard helped the government control the economy of the country.
  • The inflation in the country was managed to a greater extent.
  • The gold reserve was also maintained in the country because the export was done in gold, and the reserve was getting higher.

Disadvantages

  • The gold standard lost the opportunity to trade and export goods in any other country, which was not followed by the old standard.
  • They also discourage the country’s business growth because the norms of this standard are very rigid.
  • It also does not support inflation, and thus the recession is there in the market.
  • It has also caused some very serious economic stability.
  • It is also suggested that the countries should increase the gold reserve, which blocks the currency flow in the country, and hence it is said. 
  • Not to benefit the economy as a whole.

Conclusion

The gold standard was the monetary exchange method used by several countries, but because of its fewer benefits, the method is now changed to paper currency. Some countries still have some gold reserves, but the whole world is now using paper currency or fiat money policies to form equality.

Frequently Asked Questions (FAQs)

Why did the gold standard gets collapsed?

The gold standard was abandoned because of its volatility and the constraints it imposed on governments. Also, there were too many disputes between nations over the price of gold.

How did the gold standard work?

Under the gold standard, nations agreed to exchange paper money for a specified quantity of gold. In a country that follows the gold standard, the price of gold is set, and gold is bought and sold at that price.

Do countries still use the gold standard?

No large country now uses a gold standard. Nonetheless, a lot of countries do have gold reserves. While some states save sizable reserves, they cannot fully support their economies. For example, the United States, Switzerland, Germany, and Australia hold large gold reserves.

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