Gold Standard: What is it and can we go back?

The gold standard is a monetary system that has long been the basis of the global financial system.

Currencies were directly linked to gold, which ensured stability, trust and discipline. But what exactly did the gold standard mean, why was it abolished and is a return still conceivable?

What is the gold standard?

Under the gold standard is the value of a coin directly linked to a fixed amount of gold.

Central banks promised that paper money could always be exchanged for physical gold for a fixed one. gold price. As a result, money creation was limited: a country could only issue new money if there was sufficient gold in return.

The advantage of this was monetary discipline. Governments were unable to print unlimited amounts of money, which greatly reduced the risk of high inflation. In addition, the gold standard ensured international trust, because currencies were interconnected via gold.

The gold standard after the Second World War

After the Second World War, the monetary system was redesigned during the Bretton Woods Conference in 1944.

It was hereby agreed that the US dollar would be at the center of the global system. The dollar was pegged to gold at a fixed price of 35 dollars per troy ounce, while other currencies were pegged to the dollar.

So, in theory, gold remained the ultimate basis, but in practice, a dependency on the United States arose. As the US spent more dollars (including through social programs and the Vietnam War), gold coverage came under pressure.

In 1971, the president withdrew Richard Nixon permanently unplug this system. With the so-called Nixon Shock the exchangeability of dollars for gold was ended. The gold standard was thus abandoned.

Why was the gold standard abolished?

The main reason was that the gold standard as too restrictive was experienced. Governments and central banks wanted more flexibility to absorb economic shocks.

In addition, a structural problem arose: more dollars were circulating worldwide than gold was available to cover them. Confidence in the fixed gold rate came under pressure, causing countries to massively exchange their dollars for gold. That was unsustainable in the long run.

What happened after the gold standard was broken?

After the abandonment of the gold standard, the financial system changed dramatically.

Currency became fiat

Money no longer acquired intrinsic value, but has since derived its value from trust in governments and central banks. We call this system fiat money.

More monetary flexibility

Central banks were given the opportunity to actively intervene through interest rate cuts, money creation and purchase programs, offering space to combat recessions but also associated with new risks.

Higher inflation

Without gold as a brake on money creation, the amount of money increased structurally. In many countries, this led to higher inflation. In the US, inflation rose to double digits in the 1970s and peaked around 13-14% (year-on-year) around 1980.

The United Kingdom also saw extremely high peaks. In 1975, inflation was around 24%. At 6% to 7% per year, the Netherlands was considerably lower, but still significantly higher than the desired 2% per year that central banks aim for.

More debt and credit growth

Governments, companies and consumers were able to borrow more easily. The global debt mountain grew because money was no longer scarce.

What are the chances of us ever going back to a gold standard?

A full return to the gold standard seems to be in the short term unlikely. The size of the global economy and the amount of outstanding money and debt make linking money to gold complex.

It is remarkable, however, that central banks worldwide their increasing gold reserves. This indicates that gold is still seen as the ultimate form of trust, especially in times of uncertainty.

At the same time, there are increasing doubts about the sustainability of the current fiat system. Should trust in paper money structurally decline, it is conceivable that gold will become another greater monetary role gets, although it will probably be in a different form than was the case in the last century.

Digital gold could be a possibility. This is gold that is traded via blockchain technology in the form of tokens that represent a claim on physically stored gold. This makes gold more easily transferable and more employable in a digital economy, without central banks formally returning to a gold standard.