In Lydia, a kingdom in Asia Minor, the first minting of pure gold coins began around 560 BC. In 50 BC the Roman Empire began issuing a gold coin called the Aureus, which comes from the Latin word for gold, Aurum. This is where the gold chemical standard of Au comes from to represent gold on the periodic table of elements. A little over a thousand years later, in 1066 AD, William the Conqueror of Normandy became the first Norman King of England, and with his conquest of goldfields began a new metallic coin-based-system of currency in England.
With the discovery of gold, a coin-based-system of currency came the establishment of the familiar “pounds,” “shillings” and “pence” with pounds literally being literally a pound of sterling silver. By 1284, about one hundred years later, Great Britain issued its first gold coin, the Florin while across Europe in modern-day Italy, the Republic of Florence issued the first gold Ducat, which soon became the most popular gold currency in the world and remained so for another five centuries.
In 1787, the first United States gold coin was struck by a goldsmith named Ephraim Brasher and a few years later in 1792, the infant U.S. government passed the Coinage Act, placing the country on a bimetallic silver-gold standard, which stood in one form or another until 1976 when the United States finally abandoned the gold standard to be entirely based on flat money. Backtracking a bit to 1848, a man named James W. Marshall found gold nuggets during gold fever panning in an American river in California thus beginning the California Gold Rush with the Forty Niners.
The California Gold Rush with John Sutter at Sutter's Mill in Sacramento, Northern California hastened the settlement of the American West. Then followed the prospectors of the Klondike gold rush during placer mining with regular sluice and in Coloma. From Nevada to Alaska the gold rush spread. A few short years later in 1868 George Harrison from South Africa discovered gold in his backyard and since then 40% of the world’s mined gold has come from the African nation and the gold rush began.
History of the Gold Standard
Clearly pure gold has a long and storied history of an obsession for over 6,000 years. The interesting thing about gold is that for reasons unknown its mysterious ability to attract people all over the world allowed it to become a medium of exchange accepted anywhere in the world from the United States to Mexicans and Egyptians. At various points throughout history, gold coins were minted however many coins were not minted by any central authority but were simply hammered by regular people. This ability to make homemade coins that were accepted as legal tender made them irregularly shaped.
Obviously, this homemade coinage was hard to regulate and a method called clipping was a common issue with gold and silver coins. The irregular shapes allowed people to clip small bits off of the coins and eventually accumulate enough to melt the bits down to create more coins. Unfortunately, the clipping of hammered coins made it so that the weight of the coin was less than the actual value of the coin making it no longer valuable tender especially abroad. Another issue was that the minted coins which were protected from clipping by special engraving were easily counterfeited by casting with counterfeit molds or stamped with counterfeit dies.
The Great Recoinage of 1696 was an attempt by the English Government to fix the issue with new minting technology. This was largely a failure. Issues like this were what led to the adoption of paper money. Also known as flat money which actually began earlier in the 16th Century and was based on the gold standard. The complete history of gold would not be possible without a discussion on the gold standard.
Rise of the Gold Standard
The gold standard was a monetary system in which the standard economic unit of example the U.S. dollar was based on a fixed quantity of gold. With this monetary system, an individual holding some paper money could go to a bank and exchange that money for a fixed amount of gold. The gold standard has been abandoned completely by all countries. A process of abandonment that began gradually around the end of World War I.
Issues such as the coinage problem described above and the introduction of paper money began to create problems for nations especially since many were based on a bimetallic standard of gold and silver. Paper money began to be valued too highly in gold while there were also constant problems of supply imbalances between both gold and silver to back the money. As a result, one metal was chosen to back the value of money which was gold. Thus, beginning the gold standard.
The process of colonization and globalization of other parts of the world by the developed world made new discoveries of gold commonplace. That brought a great supply of gold meaning that the gold standard was able to flourish. In 1871 a new international gold standard began with England and Germany officially adopted the gold standard and by 1900 most developed nations had followed suit. The period from 1871 to 1914 was a fairly stable period in the world politically which enabled governments to work very well with each other in establishing a stable gold standard. It was the golden age of the gold standard. But it all came crashing down starting with World War I in 1914.
The Collapse of Gold Standard
Under the gold standard, the money supply is tied directly to the supply of gold. Meaning that during World War I many nations decided to temporarily suspend the gold standard so that they could print money to pay for their military involvement in the war. This wild printing of money created hyperinflation.
Once the war ended countries began to appreciate the stabilization that the gold standard had provided for their currencies and international trade. Once strong political ties between nations had changed international indebtedness skyrocketed and government finances were strained. It became apparent that the gold standard was unable to hold up during tumultuous times which created the negative sentiment and low confidence in it going forward. This worsened economic conditions. Nations were still unwilling to abandon the gold standard altogether reinstating while holding out hope that a renewed era of international gold standard stability would return. It never really happened.
The Great Depression was the straw that broke the camel’s back for many countries. After the stock market crash in 1929 European countries’ currencies were misaligned completely while some especially Germany was still recovering from World War I. As people began to lose confidence in banks and paper money gold hoarding became common and the prices of commodities such as gold prices were rising. Bank rushes and gold hoarding eventually meant that banks had to close.
Countries began to raise interest rates in an attempt to entice people to keep deposits intact rather than converting their fiat currency into gold. Eventually, this led to many nations finally suspending or abandoning the gold standard altogether in the early 1930s including Great Britain. Interestingly many of the countries that left the gold standard earlier were able to recover from the depression sooner than those that stayed under the gold standard.
At this point, the only other major nations still under the gold standard with major gold reserves were the United States and France. In the United States, President Franklin Roosevelt instituted a number of measures in an attempt to prevent the hoarding of gold including making banks turn all their gold holdings to the Federal Reserve not allowing them to redeem dollars for gold and also prohibiting any exporting of gold. In 1934 the Gold Reserve Act was instituted which prohibited the private ownership of gold. All gold was given to the government which is where much of the gold at Fort Knox came from. This allowed the United States to pay off its debts with dollars instead of gold. Eventually, the United States basically cornered the global market for gold.
Finally, with the outbreak of World War II the depression had ended and some countries eventually went back on the gold standard again. In an attempt to create a framework for all international currencies backed by gold the Bretton Woods Agreement was created in 1944. Soon after the United States dollar became the de facto currency for the rest of the world as the United States held most of the world’s gold reserves. Most countries’ central banks began pegging their own currencies to the United States dollar instead of gold buying and selling their own currencies in the foreign exchange market to maintain their exchange rates stable.
By the 1960s inflation was high and United States gold reserves and hydraulic mining had been heavily reduced to help pay for the rebuilding of Europe and other parts of the world after the destruction of World War II. In 1968 a number of countries that dominated the global supply of gold decided to stop selling gold on the London Market which allowed the price of gold to be determined by the market. In 1971 U.S. President Richard Nixon changed the price of an ounce of gold to the United States 38 and no longer allowed the Federal Reserve to exchange dollars for gold. This was essentially the end of the gold standard but it wasn’t until 1976 that the gold standard was abandoned completely and gold was officially free.
Would The Gold Standard Work Today?
Although the gold standard seems as though it were largely a failure there are advantages to the system. The inability of governments to inflate the value of money because it is tied to the supply of gold made it difficult for inflation to increase significantly. A globally accepted gold standard fixes exchange rates reducing economic uncertainty. However, high inflation can occur when war destroys large parts of economies which were exemplified in the aftermath of World War II.
The inability to increase the money supply is often cited as the key issue under the gold standard. Many blamed the gold standard for prolonging the Great Depression as the money supply was unable to be increased to mitigate the effects of the depression. As mentioned earlier this led many countries to finally abandon the gold standard together and never look back.
Some economists also believe that the inability to increase the money supply under the gold standard puts a limit on the amount an economy can grow. This is because as an economy’s productive capacity grown then so too should its money supply but since the money supply is limited by the amount of gold that the economy has then the ability for an economy to produce more and grow is also constrained.
The gold standard tends to resist central banks for taking measures to correct issues within an economy. Some have cited that another disadvantage of the gold standard is that countries with less reserves are at a significant disadvantage to those with more gold reserves. That the gold standard always leaves the door open to a potential gold run which can lead to massive problems and ripple effects if those countries don’t have enough gold to exchange for paper money.
There are still advocates for the gold standard. Many coming out in New York, San Francisco and Australia during the global financial crisis citing among other advantages that the gold standard would create greater price stability than issuing flat money based solely on confidence.
Austrian Economic Theory is famed for favoring the gold standard. Proponents of Austrian economics believe that manipulating the money supply after the global standard abandonment is what has actually led to instability in global financial markets over the years.
The Mises Institute which describes itself as the “worldwide epicenter of the Austrian economic movement” states that restoring the convertibility of the dollar for a fixed weight in gold would be a move in the right direction and would help to remove the monetary policy from politics to “reduce special-interest” corruption.
The purpose of pegging the dollar to gold would be to remove what is euphemistically called monetary policy from politics and special-interest corruption as much as possible. People laud the current United States Fed as being independent. The Fed as it operates is clearly a cartelization device that pushes new money into the pockets of bankers and that allows the government to finance massive deficits much more cheaply than would otherwise be possible.
Having represented the advantages and disadvantages above there is no doubt that the mainstream economic view is that the gold standard is not a feasible way forward. However, it must be said that there are two sides to every coin.
If you have made it this far you will know that gold has a long history of human obsession dating back over 5000 years. From the very first time that mankind laid eyes on gold as bullion, it has led to an insatiable desire for the metal that has never wavered. That mutual desire for gold that captivated civilizations all over the world independently of each other facilitated the global adoption of gold as a medium of exchange and of course later the gold standard. Since the end of the gold standard the price and production of gold have skyrocketed globally and along with it so has the demand. Judging by the last 5000 years or so it seems unlikely that our obsession with the precious metal will change any time soon.
Now we can finally delve into gold as a traded commodity. Gold no longer backs any currency however it is still vital to the global economy which is demonstrated by the fact that almost all central banks hold substantial international reserves in gold. Gold has many similarities with other commodities but it also behaves similarly to currency and can be thought of as a monetary asset. Even today after the abandonment of the gold standard if you went anywhere in the world you could probably exchange for goods and services. One probably wouldn’t be able to do that with most other commodities. However, like most other commodities taken from the earth and it has an inverse relationship with the United States dollar.
Although gold shares some characteristics with other commodities it certainly stands out from the rest for a variety of reasons. According to the World Gold Council gold truly is a commodity like no other stating that “Gold is less exposed to swings in business cycles, typically exhibits lower volatility and tends to be significantly more robust at times of financial duress.” Its role as a monetary asset also differentiates it from most other commodities. Gold’s long history of prospecting as a lode as a standard of value in monetary systems and its history of an obsession for over 5000 years has left a lasting legacy and relevance in today’s international monetary system.
Not only is gold mining not subject to many of the supply side risks that most other commodities are subject to it is actually safer than most currencies and asset classes and used by investors as what is called a safe haven. At times of political and economic uncertainty investors usually buy gold to preserve their wealth. Historically speaking it has been the case that those that have survived economic and political shocks were those that had gold. When the economic landscape becomes a bit rocky values of currencies tend to fall and gold mines grow. One thing that remains constant is the purchasing power of gold.