The Fall of the Gold Standard and the Road to Digital Money
Why hello, class 👋
Good of you to show up! You’re all on time.
Ready for the exam?
Naaah, the exam’s only at the end of the semester. You still have some time.
In the meantime, let’s talk about how the gold standard imploded.
What even is the gold standard?
We’re picking up where we left off on the previous chapter, regarding banknotes. Banknotes are the necessary first step towards a gold bullion standard. Because, yes, there are several kinds.
- Gold specie standard is the basis for most metal coin economies until the 19th Century. The value of all standard coins (silver, copper, bronze, what have you) would be defined in relation to that of the circulating gold coin.
- Gold bullion standard is what we mean when we speak of the gold standard. When banknotes replaced gold coins as the preferential currency, governments accepted the responsibility of exchanging them for gold bullion whenever someone desired it. Every banknote was valuable because it represented a certain value in gold.
- Gold exchange standard is when a government won’t exchange your banknotes for gold but for another nation’s currency (one that does have a gold standard). This way, you have a de facto gold standard.
Gold standards, if we take the term literally, have existed for as long as there were gold coins. They have always been the standard in the regions where they were in circulation.
What we mean by gold standard is gold bullion standard
This is why it’s important to make that distinction. The idea that banks, namely national banks, would ensure that all banknotes in circulation could be exchanged for gold, is a lot more recent. And, politically, a lot more significant.
It meant that states (via their national banks) had to accumulate enough gold to make up for all money in circulation. The landmark legislation that created this standard is British, and it was passed by Parliament in 1844. It’s called the Bank Charter Act and what it effectively does is make the Bank of England the only bank capable of issuing paper money, which would replace the gold pound as legal tender. Before this, any bank could issue banknotes. Businesses could take them or not. The legal tender was gold coins.
There were other (not so famous) standards
Most countries in the world, however, had gold exchange standards. This means that the value of their currency wasn’t backed by their own gold reserves, it was backed by (usually) either the US Dollar or the UK Pound Sterling.
Why didn’t this work?
Having a gold standard, and a tight control on how much money the government can print, has some virtuous effects. It keeps inflation under control, for one, by keeping the government from fixing problems by throwing money at them. It also provides a measure of certainty to international trade because it puts a stopper to price volatility.
It does, however, have a huge downside.
And that’s deflation.
Deflation is the gold standard killer
What you’re doing with a gold standard, essentially, is limiting the amount of money available.
When the economy is booming (see the Roaring Twenties) this isn’t much of an issue. Money is circulating, most people don’t care about gold, and the government can easily buy it. This means the amount of money in circulation increases in a steady way, the government is increasing its reserves, and everyone is happy.
The problem is when a crisis happens. Such as, say… a war?
Imagine something happens that costs governments a whole lot of money unexpectedly (like a war, say, a big one. A World one. Like in 1915–18). The government will never be able to pay for the war without depleting its reserves, which means abandoning the standard. It’s the only option.
And that’s what Britain, and plenty of other European nations, did.
So what happens if you try to get back to a gold standard and fixed gold prices? Like Churchill did in 1925, in the midst of the great depression?
Well, as the 20s progressed, these European nations were seeing slower growth, because the government had trouble injecting money into the economy. This means they had trouble paying their debts. With low reserves, for there to be more money in circulation, the governments would have to mine more gold.
This is not possible.
So most nations started having trouble paying their debts. Banks started failing. The US economy started seeing the results of this. People, scared, started hoarding gold, which means the government has trouble keeping its reserves up.
This leads to very slow growth, because money just isn’t circulating anymore. This means salaries stay stagnant. This means if companies want to continue selling, they need to lower prices. Lower prices means fewer profits. Fewer profits means people lose their jobs. Higher unemployment means slower growth.
I think you see where we’re going with this.
There’s a lot of reasons why the Great Depression became the behemoth it did, but the return to the gold standard by governments, namely the UK’s and the US’s, is certainly one of them. When the gold standard was revoked in the 30s, it would never come back.
Welcome to fiat money
Money that is backed by nothing. Its value is purely determined by the market and government assurances. There’s no gold (no grain, either).
Isn’t that wonderful?
Can you imagine what computers could do to that? We’ll be delving right into that in the next chapter.