What is the Gold Standard? - Definition & History

Instructor: Mark Bound

Mark has taught graduate level political science and sociology and has a Ph.D. in International Conflict Analysis and Resolution

This lesson will give an explanation of the economic principle of the gold standard, and its differing variations. We will also conduct a brief history of the usage of the gold standard.

What Is the Gold Standard?

Gold Bars
Gold Bars

Have you ever traveled to another country where your money is no good until you exchange it with a bank? How does the bank know how much your money is worth? Historically, we used 'the gold standard' to address the problem of different sovereign nations issuing their own standard currencies.

Nations have traded with one another since ancient times; much of it under the barter system where goods were exchanged for equal value goods. Unfortunately, not all goods and services could be exchanged through the barter system effectively. Though paying for a ticket to the Colosseum with a chicken may be a fair exchange, all those chickens could become problematic.

To avoid problems like these, nations began issuing their own sovereign currency. But the problem with coin or paper currency is; what is its actual value? If a merchant is selling grapes to a foreign winemaker, she must know that the currency she accepts for her grapes allows her to buy supplies both in her country and abroad. A standard was needed.

Simply put, the gold standard is a system where nations agree on a common value of a commodity, in this case gold. Therefore, the more gold a nation had, the more valuable its currency.

Variations of the Gold Standard

Within the gold standard there are 3 different variations, all of which are based on the agreed upon value of gold.

Ancient Gold Coins
Gold Coins

In the Gold Specie Standard actual gold coins are issued. This system is based on the value of one of those coins, usually the one manufactured with the most gold. In this system, a coin made of 100% gold would have a value double a coin made of half gold and half silver.

In the Gold Bullion Standard, gold coins are not circulated. Currency can be made in metal coin form or paper currency. Within this system, a nation agrees to trade a fixed amount of the gold bullion it holds for the currency presented. In this system coins and paper money are equivalent to IOUs. If one unit of a nation's currency equals 1 oz of gold, then 10 units would equal 10 ounces of gold. This way, people could carry paper instead of pockets full of heavy gold. The Gold Bullion Standard required nations to maintain large reserves of gold, like in the United States' Fort Knox.

The final variation, the Gold Exchange Standard, is a bit more complicated. Iit does not set the value of the nation's currency to a fixed value of gold, but rather guarantees the value of another nation's currency (if that nation uses the gold standard).

In other words, a nation agrees to pay its merchants a fixed value for any foreign currency they may accept. This creates a condition of a de facto gold standard even within a nation that may not follow the actual gold standard. In the case of our grape merchant who only sells to foreign winemakers, her homeland guarantees the value of the foreign money received based on the reserves of gold held in the winemakers' nations.

The History of the Gold Standard

Many nations such as the United States still maintain a large stockpile of gold. In the 20th century however, many nations abandoned the gold standard as the basis for the monetary systems.

The use of gold as money can be traced back thousands of years. Many historians attribute civilizations within Asia Minor as some of the first cultures to use the relatively rare commodity of gold as a form of currency.

During the Middle Ages, the economic power of the Byzantine Empire dictated much of the world economy. But as the Byzantine Empire declined, many nations in Europe and the Mediterranean switched from the Byzantine standard of gold to the more available silver. The conversion to silver was promoted in the 16th century by the Spanish discovery of large silver deposits in what is now Mexico.

McKinley Campaign Poster Advocating the Gold Standard
William Mckinley

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