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What is the Gold Standard?

The gold standard is a gold-backed system developed to regulate the value of various paper currencies used by different countries around the globe. To put it simply, it is:

“The monetary system within the value of the currency or paper money of a particular country that is directly linked to gold.”

Initially, countries backed their paper money by a fixed amount of physical gold. For countries following the gold standard, it is necessary the price of gold is fixed against a specific value. A good example of this is the gold sovereign - today, and 100 years ago, a gold sovereign could and can buy you a nice suit. Its purchasing power has remained constant.  The price of gold that is set by a country determines the international value of that country's fiat currency. The higher the price of gold in a currency, the lower the value of that currency and vice versa.

For example: if the US sets the price of one ounce of gold to $1000, the value of a dollar would be 1/ 1000th of an ounce of gold. Simple, right?

Advantages of the Gold Standard:

The gold standard has various benefits for a country's economy - that’s why it was used for such a long time. It decreases the impact of human error in the economy. The ultimate advantage of the gold standard is that you have a fixed asset which backs the economy of your country and the value of your currency. When a country is allowed to print paper money based on the amount of gold it has, not only is its economy stabilized, but this also prevents inflation. It prevents bureaucrats from being able to print more money to their own agenda. The purchasing power retained in gold remains consistent. The budget deficit of a country will never exceed the available amount of gold as long as the Gold Standard is being followed.

Of course, more productive and exporting countries are more likely to benefit from the gold standard. They explore new markets, access new consumers and compete with other exporters to increase their gold reserves so they may print more and more money and become richer.

Disadvantages of the Gold Standard:

One problem with the gold standard is that it can limit the economic growth of a country depending on its gold reserves no matter how much the rate of local growth increases. And what about countries with little or no gold? They will never be able to print sufficient money to support the exports. And then hyperinflation happens. So, these countries are at a competitive disadvantage.

For example, in the 1700's industrialization occurred in the United Kingdom, and as a result the country increased its production levels of goods, increased trade, and as a result the country became richer. Spain, on the other hand, focused its resources instead on accumulating gold and silver from its colonies in Central and South America. The problem with this however is that there was no increase in production or output to compensate for the increase in gold. As a result, the gold devauled, and Spain entered a period of economic crisis. Increasing a country's gold reserves does not necessarily make it richer unless it correlates with an increase in production, output or trade.

The United States was never running out of gold; it is still the second biggest miner of gold after South Africa. But it still ended the gold standard to free its economy of any limits.

With the gold standard established, countries only focus on saving the gold more than anything else. 

Replaced by fiat money:

Due to the drawbacks it had, the gold standard is now a thing of the past. Britain and the US stopped using this standard in the twentieth century followed by the rest of the world. The alternative to the gold standard is the fiat money system. We can describe it as the currency used in a particular country because of a government’s order, or fiat. Everyone who wants to trade in that country must accept that currency as a means of payment. For example, fiat currency for the US is the dollar, and for Norway, it’s the Norwegian Krone.

Can The Gold Standard Return?

How can gold affect the economy of a country that decides to establish a gold standard once again? Well, it will surely decrease the government’s ability to manage the economy, because the value of a currency will no longer be directly in the government’s hands. The fixed currency supply will limit the growth of the economy. Lack of money can, in turn, easily hinder the funding process for new businesses and startups.

Moreover, it would be very difficult for a country to return to the gold standard.  If it was able to, other countries would demand to redeem owed debts in gold. This makes paying the debts a complicated process. It is very likely that we will not see a return to the gold standard. Governments prefer to regulate the value of their currency themselves. This gives governments greater economic control. That’s why the chances of gold standard returning in the global economy are negligible.