What were the reasons for the decline of the gold standard? Was it caused by the violation of the ownership of gold? What other unique factors contributed to this shift? If you are out to get the answers to these questions, then I believe you will greatly benefit from reading this article, so read on to find out more:
What is the gold standard?
What exactly is the gold standard, and how does it function? Simply put, the gold standard is a monetary system in which a country’s currency’s value is closely linked to the yellow metal. The gold standard establishes a fixed price for buying and selling gold in order to determine the worth of a country’s currency. If the United States returned to the gold standard and set the price of gold at $500 per ounce, the dollar would be worth 1/500th of an ounce of gold. This would ensure consistent price stability.
Transactions are no longer required to be made with heavy gold bullion or gold coins after the introduction of the gold standard. The gold standard also boosts the level of confidence required for effective global trade; the assumption is that paper money has real-world value. This style of monetary policy aims to prevent both inflation and deflation while also promoting a stable monetary environment.
When did the gold standard become popular?
The gold standard was established in Germany in 1871, and by 1900, most industrialized countries, including the United States, had adopted it.
For decades, the system was popular, with governments all around the world cooperating to make it a success, but when World War I broke out, it became difficult to maintain. A widespread lack of confidence in the gold standard resulted from shifting political alignments, increased debt, and other issues.
**Also read: Gold in War | What is it good for?
The decline of the gold standard, what were the reasons?
Gold Standard Rules Violation
The gold standard’s successful operation necessitates adherence to the following basic rules:
- Gold should be free to move between countries;
- With the inflow and outflow of gold, currency and credit should automatically expand or contract; and
- Governments in different countries should help facilitate gold movements by keeping their internal price systems flexible in their respective economies.
Following World War I, governments in gold-standard countries did not want their citizens to be subjected to the inflationary and deflationary tendencies that would arise from adhering to the gold standard.
The gold standard’s successful operation necessitates unrestricted and uninterrupted trade between countries. However, throughout the interwar period, most gold-standard countries abandoned their free-trade policies in the face of narrow nationalism and embraced import-restrictive policies. This resulted in a decrease in international trade and, as a result, the demise of the gold standard.
Inelastic Internal Price System
The gold standard prioritized external price stability over internal price stability. During the interwar period, however, monetary authorities attempted to maintain both exchange and price stability. Because exchange stability is usually accompanied by internal price volatility, this was impossible.
Unbalanced Gold Distribution
The availability of appropriate gold stockpiles and their proper distribution among member countries is a necessary prerequisite for the gold standard’s success. However, throughout the interwar period, countries such as the United States and France collected too much gold, whilst Eastern Europe and Germany had very low gold holdings. The gold standard was abandoned due to a scarcity of gold reserves.
The smooth operation of the gold standard necessitates the use of gold for trade rather than capital movement. However, enormous international debt contributed to the demise of the gold standard during the interwar period.
The excessive movement of capital across countries had three key causes:
- Following World War I, the victor nations forced Germany to pay gold war reparations
- Large amounts of short-term capital (often referred to as refugee capital) were moved from one country to another in search of security, and
- Underdeveloped countries borrowed heavily from developed countries for investment purposes.
Excessive Use of Gold Exchange Standard
Excessive use of the gold exchange standard contributed to the gold standard’s demise. Many small gold-exchange-standard countries retained their reserves in London and New York. The depositing countries, however, were forced to remove their gold stockpiles due to rumors of war and unusual conditions. As a result, the gold standard was abandoned.
Lack of an International Monetary Center
Moving gold costs money. Before 1914, such movements were ignored because London served as the international monetary center, and countries with deposit accounts in London banks used book entries to rectify their negative balances of payments.
During the interwar period, however, London’s status as an international financial center was rapidly eroding. In the absence of such a center, each country was forced to hold significant gold reserves and conduct large gold transactions. This was neither proper nor manageable. As a result of the lack of an international financial center following World War I, the gold standard failed.
Lack of Cooperation
The success of the gold standard depends on economic cooperation among the participating countries. However, following World War I, there was no such cooperation among gold standard countries, resulting in the gold standard’s demise.
The downfall of the gold standard was also due to political instability among European countries. There were reports of war, uprisings, political unrest, and the dread of monies being transferred to other countries. All of these issues jeopardized the gold standard’s viability, eventually leading to its demise.
The Great Depression, which lasted from 1929 to 1933, dealt the gold standard its fatal blow. The essential aspects of the depression were falling prices and widespread unemployment, which drove countries to adopt high tariffs to restrict imports and hence international trade. The flight of capital was partly a result of the Great Depression.
Economic Nationalism’s Rise
Following World War I, a wave of economic nationalism swept through Europe. Protectionism was used by each country to ensure self-sufficiency and hence imposed restrictions on foreign trade. This was direct interference with the gold standard’s operation.
- Thus, both endogenous and exogenous factors contributed to the breakdown of the gold standard:
- some factors pointed to the gold standard’s internal flaws;
- others pointed to the monetary authorities’ failures to assist the system’s smooth operation; and
- still, others pointed to the gold standard’s adverse external circumstances.
There is little possibility of the gold standard being revived in the foreseeable future under current conditions, which are motivated by economic nationalism and dominated by selfish commercial systems.
Frequently asked questions on “the decline of the gold standard?”
What if the United States went back to the gold standard?
Returning to the gold standard would have a significant influence on the American economy. For one thing, it would prevent the Fed from providing fiscal assistance. After all, the Fed’s power to print paper currency would be severely curtailed if the US had to maintain sufficient gold reserves to trade for dollars on an as-needed basis.
Is the United States’ currency still backed by gold?
Gold, silver, or any other commodity cannot be used to redeem Federal Reserve notes. Since Congress revised Section 16 of the Federal Reserve Act on January 30, 1934, Federal Reserve notes have not been redeemable in gold.
Is Russia currently using the gold standard?
The Russian central bank has declared that the currency would be pegged to gold. A gram of gold is worth 5,000 rubles, according to the bank. That means that a troy ounce of gold, or 32 kilos, now costs 1,60,000 rubles in Russia. In Russia, 32 grams of gold would cost around $1,600 at the current exchange rate (As of April 2022).
What Is the alternative to the use of the Gold Standard?
Prior to gold, silver was the primary medium of exchange. Following the demise of the gold standard, fiat currency became the preferred method of payment.
That will be all for this post on what the main reasons for the decline of the gold standard were. I hope that you gained something from it, and you can contribute to conversations pertaining to today’s topic. You can also share it with a few of your colleagues and peers, so they can also understand why the gold standard is no longer in use. Let me know if you also have any questions or concerns about this post by dropping them in the comments section and I will get back to you ASAP.
I wish you well,
Eric, Investor and Team Member at Gold Retired!