The Gold Standard: What it is and How it Relates to the Dollar Crash

In the last century, the value of precious metals like gold is what gave currencies their value. This was a system known as the „Gold Standard“.

Over time, a concern was the restriction that the gold standard placed on the flexibility of monetary policy, particularly for private banks which were unable to create money as needed. This was a factor that led to the abandonment of the gold standard in 1971 and the transition to a fiat currency system. 

A public belief in government economic policies and the status of a fiat currency as legal tender gives it the illusion of value, rather than backing from tangible assets like gold or silver. The use of fiat currencies also gives central banks much more control over monetary policy. 

People, businesses, and investors agree upon the value of a given fiat currency by trusting in the intermediary that controls its wider management as a currency.

However, fiat currencies do not convince everyone. One reason for this is the amount of money in circulation, which is greater than ever before thanks partly to U.S. and European banking deregulation – money printing seemingly without an upper limit can devalue a currency over time. 

Even though it’s the Federal Reserve’s role is to regulate the money supply, private banks now create nearly all new money. That money bears interest that people, businesses and governments need to repay. On the other hand, asset-backed money doesn’t bear interest since they are non-debt-based.

In this article, we examine what the gold standard is as well as its pros and cons. We also cover how modern asset-backed cryptocurrencies represent a partial return to the Gold Standard.

What is the gold standard?

The Gold Standard is a monetary system in which a country’s currency has a value directly linked to the value of gold. Under this system, the value of gold also pegs the exchange rates between participating countries.

For example, let’s say that one ounce of gold is worth 20 US dollars and 10 British pounds. This establishes a fixed exchange rate where two US dollars are worth one British pound.

Under the previous Bretton Woods system, U.S. monetary policy was to tie the value of the U.S. dollar to gold. The rest of the world then set their exchange rates in relation to the US dollar. If you wanted to, you could swap your notes and coins for gold at the central bank. 

However, this was not possible for U.S. citizens as their government outlawed the private ownership of gold.

Countries could stick to the Gold Standard, leave it and come back to it. The system offered flexibility, just like the flexibility countries have now to adjust their exchange rates.

In its simplest form, a cryptocurrency backed by gold or silver is the modern interpretation of the gold standard. That’s because it’s a monetary system where a currency is directly linked to physical precious metals.

What are the benefits of the gold standard?

Understanding the benefits of the Gold Standard points to why governments put so much faith in it. It also helps explain why belief in the Gold Standard is re-emerging today. Let’s look first at the pros.

Stable value

One of the primary benefits of the Gold Standard is that it ties a currency’s value to a tangible, finite asset. The backing from a physical asset such as gold provides stability because they are less subject to the volatility that fiat currencies experience due to a lack of tangible backing. Gold finds stability in the continual price appreciation over time, compared to the devaluation threat that fiat currencies experience. 

Self-regulation

The Gold Standard has a self-regulating effect on economies. The levels of gold reserves determine how much money governments and central banks can print. This limit discourages excess inflation and encourages fiscal responsibility.

Discourages debt and budget deficits

Gold is a finite, physical reserve. By tying a currency’s value to it, it discourages governments from excessive debt and focuses attention on closing budget deficits. This is a financial environment where actual assets back real money.

Benefits productive nations

The Gold Standard benefits productive nations because they amass more gold when they export goods and services. This system can encourage trade surpluses and a long-term building up of reserves.

Potential drawbacks of the gold standard

Despite its benefits, there are drawbacks to the Gold Standard that may discourage its adoption.

Limits governmental economic management

The Gold Standard can limit a government’s ability to manage the economy. For instance, central banks lose the flexibility to adjust the money supply or interest rates. These are important tools when battling inflation or other economic challenges.

Disadvantages countries with low gold reserves

Countries with little or no gold reserves can be at a competitive disadvantage under the Gold Standard. The lack of ample reserves means they struggle to support their currency and stimulate their economy.

While governments may not yet be ready to take the step back to the Gold Standard, many investors are. They’re doing so in the form of asset-backed currencies like gold and silver-backed cryptocurrencies. 

The debate over the pros and cons of the Gold Standard goes to show that it is far from over.

The dollar and the gold standard

The use of the Gold Standard in the US goes back to the Coinage Act of 1792. It was not formally adopted until 1900 though. 

The Gold Standard is an expensive system to maintain and it caused U.S. lawmakers a lot of problems from its original introduction. Many economists believe that the Gold Standard made the Great Depression worse.

The problem is that when government deficits grow quickly, faith in a country’s ability to repay in gold wanes. This happened in America in the 1960s when the market price of gold had begun to diverge from the official U.S. conversion rate. 

As a result, confidence in the USD gold standard-based international system started to falter

This divergence posed a risk to what was a fixed-rate commodity-backed system. For example, if the market price of gold was higher than the U.S. conversion rate, someone could buy gold from the U.S. government and sell it for a higher price. 

This is „arbitrage“ and the danger was it would reduce the amount of gold the U.S. had, putting further pressure on the conversion rate.

International trade continued to increase in the post-war period. The tension caused by the difference between market rates and fixed conversion rates escalated over time.

As a result, France and other countries holding U.S. dollars wanted to convert their dollar reserves. These central banks worried that, as America’s gold stock depleted, they’d have less chance of getting their gold back.

Central banks have an obligation not to lose money. With pressure on U.S. gold reserves, asking for their gold back made sense.

When did the dollar leave the gold standard?

The U.S. officially abandoned the gold standard on August 15, 1971. This was part of a larger economic plan announced by President Richard Nixon.

Nixon unilaterally cancelled the direct international convertibility of the U.S. dollar into gold. This was to stop other dollar holders from following France’s example. If they did, this would severely deplete the U.S. gold reserves.

This move marked the end of an era, but it was not the first time the U.S. had adjusted its relationship with gold. During the Great Depression in the early 1930s, the U.S. faced severe challenges. High unemployment and deflation were badly dragging down the economy.

President Franklin D. Roosevelt detached the dollar from gold in 1933, four years into the Great Depression. This allowed the government to introduce more money into the economy at favourable interest rates.

The price of gold was set at $20.67 per ounce (rising to $35 in 1934). The government ordered all American citizens to return all gold coins and certificates to the Federal Reserve. 

This would prevent them from redeeming their dollars for gold. Americans had to wait until 1974 to be legally permitted to own gold bullion again.

Right up until the end of the gold standard, the U.S. allows other countries‘ governments to exchange dollars for gold.

The U.S. departure from the gold standard happened decades ago. Yet, gold remains a valuable asset, providing a means of protecting investors‘ assets even in a world of fiat currencies.

Does any government still use a gold standard?

As of today, no countries in the world currently operate under the gold standard. But the gold standard still impacts modern finance and that impact has implications for the future.

The recent surge of gold-backed cryptocurrencies is a reincarnation of sorts for the gold standard in the digital age. 

They offer the promise of stability and intrinsic value. They can provide a hedge against inflation similar to gold bullion. The value of gold combined with a decentralised, secure and easily transferable digital asset

It’s uncertain whether a new global gold standard will re-emerge. However, investors want to build gold and silver back into modern financial innovations.

It’s clear that gold still holds considerable sway in the financial world. Its enduring value makes it a preferred asset during economic uncertainties. The rising interest in gold-backed cryptocurrencies indicates that their role as a standard of value is far from over.

The reintroduction of a gold standard or similar system could bring significant changes to global finance. It would affect banking, businesses, and investment strategies.

Some sectors may benefit from such a system like this while others may experience challenges. As a result, investors and businesses need to monitor these developments. They should prepare to adapt their strategies to new financial innovations.

Any transition to a new monetary system will likely present challenges. There will be risks, particularly if the result is a depreciation of existing fiat currencies.

In short, the gold standard is still a factor in modern financial practices and innovations. As these trends evolve, the gold standard’s role in shaping the future of global finance may become even more important.

Why was the gold standard abandoned? 

The gold standard was a pillar of international financial stability. However, built into it were limitations that made it increasingly untenable over time. 

It’s impossible to adjust the money supply quickly to respond to external emergencies. During periods of economic turmoil, this can worsen the situation.

Reliance upon the supply of gold, finite and irregularly distributed, is also a problem. Countries that have large gold reserves wield massive influence. This imbalance creates instabilities on the global stage. The discovery of large, easily-recoverable gold deposits can cause inflation.

It’s costly too. Gold is expensive and labour-intensive to mine, store, and transport. Fiat currencies do not have this problem.

As we read earlier, the system came under strain in the 1960s with a growing U.S. balance of payment deficits and dwindling gold reserves. The dollar was the peg for all other currencies creating wider economic instability around the world.

How is the gold standard used today?

As we’ve seen, the gold standard is no longer officially in use. However, its principles continue to inspire modern financial systems. One such example is the gold and silver-backed monetary system that is Kinesis.

In a volatile economic environment, asset-backed currencies offer a unique form of financial security. In the event of a crash in fiat currencies like the U.S. dollar, Kinesis provides a strong means for people to hedge against their devaluation.

Should economic catastrophe strike, holders of Kinesis would be significantly protected. If the dollar collapses, the value of gold would likely surge as investors rush to safe-haven assets. The ripple effects of a dollar crash would extend past just gold. Silver, another precious metal backing a Kinesis cryptocurrency (KAG), would likely see a boost in value as well.

Kinesis gold and silver currencies are digital assets, backed by physical gold (KAU) and silver (KAG), stored securely in Kinesis‘ global vaulting network.

We built Kinesis on the legacy of the gold standard, adapting it to the digital age.

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This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis.