The Gold Standard
Today, the U.S. dollar is a fiat currency, but this hasn’t always been the case.
Today’s topic is the gold standard.
In last week’s episode, I explained that the U.S. dollar, like most currencies throughout the world today, is a fiat currency, meaning that it’s backed by faith, rather than something physical of value.
But this hasn’t always been the case. There was a time when the U.S. dollar was backed by something more tangible than faith, and that something was gold.
After last week’s episode, a listener named Pam S. e-mailed me with this question: “Why isn’t the U.S. dollar still backed by gold and why did FDR recall all gold coins?”
A Brief History of the Gold Standard
To get to an answer to this question, let’s take a quick look at the history of the gold standard.
In 1900, the United States and most of Europe adopted a monetary system based on gold. The Gold Standard Act of 1900 made paper dollars convertible to 1.5 grams of gold. A troy ounce of gold (which is one-twelfth of a pound) was a little over $20. (1) In practice, most people used paper dollars because of their convenience, and didn’t often redeem them for gold.
If you take a close look at a U.S. dollar bill today, you’ll see the words “Federal Reserve Note” printed on it. You’ll also see the words “This note is legal tender for all debts public and private.”
When dollars were backed by gold, the words printed on bills were different. For example, in the case of a $50 bill they read, “This is to certify that there is on deposit in the Treasury of the United States of America $50 in gold coin payable to the bearer on demand.” These gold-backed bills were literally gold-backed: the backside of the bill was printed in yellow. For those of you who are curious to see what these gold-backed bills looked like, Here’s a linkopens IMAGE file to an image of one.
FDR Makes Owning Gold Illegal
Well, during the widespread bank failures of the Great Depression, many people and institutions both in the U.S. and around the world actually did redeem their dollars for gold, which drained the Federal Reserve’s gold supply. In response to this crisis, in 1933 President Franklin D. Roosevelt made private ownership of gold illegal and confiscated gold by executive order. U.S. citizens had to turn in their gold and gold-backed paper money to the central banking system and were paid a little over 20 paper dollars for each troy ounce of gold, which had been the official gold price since 1900.
After the gold confiscation, the U.S. government reset the price of gold to $35 per troy ounce, which, in one fell swoop, devalued the dollar by more than 40%.
The Dollar Becomes the Preeminent World Reserve Currency
During World War II, delegates from 44 countries signed an agreement called Bretton Woods that fixed the dollar to gold and fixed other nations’ currencies to the dollar. Under this agreement, the dollar was defined as 1/35th of a troy ounce of gold and could be redeemed for gold at this rate by foreign governments and central banks. This agreement established the U.S. dollar as the world’s preeminent reserve currency, replacing the British pound sterling. But private ownership of gold by U.S. citizens remained illegal.
This gold standard survived with variations until 1971. It was at this time that France and Britain wanted to redeem their U.S. dollars for gold at the defined rate of $35 per troy ounce, which President Roosevelt had set all the way back in 1933. But the U.S. Treasury’s amount of physical gold was far less than the amount of dollars held by the central banks of other countries. France’s and Britain’s requests would have depleted U.S. gold reserves.
The End of the Gold Standard
Since 1971, fiat money, rather than gold-backed money, has been the type of currency used in all major economies. Because a fiat currency is not backed by a resource that’s limited in supply, such as gold, there’s no physical constraint on the amount of money the Federal Reserve may print.
As the U.S. Federal Reserve prints more paper money and increases the money supply, the demand for gold tends to increase as more people and institutions buy it as a way to preserve the value of their money against inflation.
Next week, I’ll discuss some investing strategies for gold, so stay tuned.
OK, today I’m really excited because we have a special giveaway. Paul Grignon, the creator of the excellent animated video “Money as Debt,” donated two copies on DVD for today’s giveaway. The film has really great animation and explains how the monetary system works and why it may not be sustainable in its current form. The winners are Mike in Brooklyn and Tiffani in New York City. Congratulations and be sure to check your e-mail for instructions.
For those of you who want to watch the video, I’ve posted links to it at the bottom of this page.
-
Money as Debt video by Paul Grignon
-
The price of gold (1997 – present)
Â
Gold Bar image courtesy of Shutterstock