Gold Standard

  1. Evolution of International Monetary Systems

Before the Gold Standard (550 BC - 1870 AD)

In the 1870s, America entered the modern age with significant technological changes: light bulbs and phonographs had been invented.

  (a) Gold Standard (1870 - 1914)
(b) Bretton Woods System (1945- 1971)
(c) Contemporary Monetary System (1973 - )
  2. Before the Gold Standard

About 600 BC, Spartans (Lycurgus, the lawgiver of Sparta) banned the use of gold and silver, and adopted iron discs as currency. But they were heavy (difficult to handle), and rusted (not a good store of value.). Plutarch: "Who would rob such a person with heavy iron money? Who would take money as a bribe?"

Gold and silver are easy to process
(melting point: G =1064o C, silver = 962o C, platinum = 1768o C).
Gold has one electron on the 6th circuit.
Silver has one electron on the 5th circuit of electrons.
Platinum has one electron on the 6th circuit
(but the 4th circuit is more dense)

(original artwork by Greg Robson).

The single electron on the outermost orbit may ensure stability (nonoxidization) Gold does burn at 1943 degree F.

Sixth Century BC: Period of Economic and Religious Awakening

Travels of Confucius (551 - 479 BC)

The world in the Sixth Century BC

The ruins of the Temple of Artemis in Sardis ©

According to Graham Levy, the earliest known coins were changing hands in the 6th century BC in Anatolia, in the kingdom of Lydia. Around 550 BC, King Croesus minted gold coins , made from electrum, a natural alloy of gold and silver found in the River Pactolus that flowed past Sardis, Lydia's capital. This electrum was 98% gold. A punch and anvil die was used to stamp the coins with the Lydian emblem of a lion, or a lion's paws, cutting the metal to reveal its consistency. (If iron was inside, it would be difficult to stamp the coins.)

Gautama Siddharta(b. in 563 BC)

Siddharta, Confucius, Lao Zi, and King Croesus were contemporaries.
Confucius' travel (12 years, 501 - 489 BC).

Why invade Britain?

Gold was a primary medium of exchange in the Roman Empire.

Roman invasion of Britain (55 & 54 BC): Caesar was initially looking for gold. Cicero reported he found none. This is the beginning of British history. (No alphabet, no kings yet.) Britain had people who could become slaves, wool (needed to make Roman togas), tin and lead, but Caesar failed to conquer Britain.

In 43 AD, Claudius appointed Aulus Plautius as the first governor of Roman Britain and built Londinium.


British Museum


Historic Gold Coins
The original gold coins of Croesus and other historic gold coins. This is a gold medallion of Constantine, who founded the Byzantine Empire (May 11, 330 AD).

Soldier: one who gets solidus.

Salary of Roman legionary, 225 denarii (75 denarii in Jan, May and September) for serving 25 years. They received land in a Roman colony plus a pension of 3000 denarii.

  British pound: pound refers to the amount of silver coined into money.

lira : pound in Italian
peso: weight in Spanish
mark: 1/2 pound
Why weigh coins? Gresham's law: Bad money drives out good money (Sir Thomas Gresham, 1519-1579).

Economic reason for the Dark Age (5th - 13th century)


Due to trade deficits with Asia, Romans gradually began to neglect to support the Roman troops. From the 3rd century AD, Roman soldiers were replaced by hired foreign mercenaries, and financial support was insufficient.

Solidus of Constantine minted in 325 AD (Wikimedia). Solidus replaced aureus of Augustus, and is the origin of "solid" and "soldier" (one who is paid in solidus).

Production of gold was suspended throughout Europe after the fall of the Roman Empire. This suspension of gold production was a primary cause of the great recession in the Western Europe for about a thousand years . After the fall of Constantinople in 1204 AD, the Byzantine empire was almost broken. It was reestablished in 1261, and lasted for two more centuries until 1453 AD.

Frescoes of Capella Brancacci, Florence show the Renaissance architecture and the bankers wearing silk clothes and turbans, indicating trade with the Middle East.

Due to massive expansion of trade, Venice suddenly became a major power, competing with Genoa, especially after Arsenale Nuovo (shipyard) was built in 1320. Arsenale served not only as a shipyard, but also was responsible for maintenance of 3000 galleys.

Florence minted the florin in 1252, which was the most trusted currency in Europe. 25% of Florentines were engaged in the wool industry. Cosimo Il Vecchio (the elder/reign: 1434-1464) supported Baldassare Cossa, who became the (anti)pope, and the Medici bank began to handle the Vatican's finance throughout Europe. Moreover, two of Lorenzo Magnifico's grandsons became a pope. It took a century for Florence to develop the silk industry. Florence became a major exporter of wool and silk to Europe. As the bank handling the Vatican's finance in Europe, Florence emerged as the banking center. Venetian Ducat (coins issued by a Doge/Duke) was minted in 1284, but gold was not produced again in significant quantities until the 20th century. (1 florin = 1 ducat = 3.5 g of gold = $150, $1350 per troy oz)

2% before 1492, and 6% (1492-1800) of the total amount of gold minted (6 billion oz in 2017, worth $7 trillion). One ton (32000 oz) of gold is worth about $40 million.

From the end of the 15th century, navigation skills were gradually developed, and the Portuguese and Spaniards began to explore other continents.

Renaissance Florence

Massolino and Masaccio (1401-1428, Early Renaissance)

Available evidences suggest that by 1400, Europe surpassed China and Japan in terms of per capita GDP.

The wage rose after the Black Death in 1348. This may have been a major cause of the industrial revolution that was taking place in England. Firms began to explore various means of replacing workers with machines.

City states such as Florence, Pisa, Genoa and Venice were engaged in trade, which may have been the source of abundance of gold. Florin was struck in 1252. (1 florin = 120 soldi = 6 lira.) Venetian ducats soon followed suit (1284). Lorenzo's (Il Magnifico) grandson Giovanni became Pope Leo X. His sale of indulgences triggered the Reformation.

The middle class (artisans and common laborers) became wealthier. In 1388, the vanity of the common people in dress was so great that it was impossible to distinguish the rich from the poor, the high from the low, or the clergy from the laity by their appearance. (Wealth and Progress, George Gunton, 1890)

After the fall of the Roman Empire in 467 AD, Constantinople was the only city that minted gold coins for 900 years.

daily wage of skilled labor = 10 soldi, in 1400.

food cost per day = 2 soldi. 720 soldi or more = 6 - 12 florins.

annual income of masters in a guild = 30 gold florins = roughly $4500

rent: a small cottage on the city's outskirts = 1 or 2 florins.

a house = 20 - 50 florins per year.

Brunelleschi's salary = 400 lire = almost 70 florins = about $10,000.

Gold market in Venice


Venice accumulated a large trade surplus, which was held in gold.

Rialto Bridge today (May 2003). The price of gold was fixed on this bridge during the Renaissance period.


  3. Gold Standard
The world in the 1870s

In the 1820s, the industrial revolution spread throughout Europe.

gold bullion, Shutterstock

In the United States, the Civil War (1861-1865) ended.

In Japan, the military rule of Tokugawa shogunate (1603-1867) was just over, some ports were opened to trade with European countries, and Emperor Meiji was instituting a major change in Japan (Meiji Restoration).

Admiral Perry of the United States came to Uraga, Japan and forced Japan to open up to trade, causing the fall of shogunate and triggering the Meiji Restoration (1868-1912) (15th shogun, Yoshinobu returned the power to the Emperor).

Europe's trade deficit with China ⇒ Opium Wars. The second Opium War (1856-1860) was just over and imports of opium was legalized in China.

A typical religious painting in the 15th century

Increases in the supply of gold ⇒ The Renaissance

Constantinople, Venice's arch rival, was conquered in 1204 after the 4th crusade war. After the fall of Constantinople in 1453 AD, the majority of intellectuals moved to the city states of Venice, Milan and Florence. By the early 1500s, Venice built a large shipyard, constructing many ships and thereby accumulating a huge trade surplus (in gold).

Also, Genoa became its rival, amassing enough wealth to compete with Venice (Christoforo Colombo was a Genoese). Florence became the center of the textile industry and banking. In the process the Catholic church amassed enormous wealth from religious donations and indulgences. For example, bishops and cardinals during this Renaissance period commissioned many paintings to show their power.

As illustrated in this painting, many donors and influential people are represented in the corners.

1870 - 1914

The gold standard has no precise date of origin. It gradually emerged around 1870-1880 when most of the industrial nations of Europe adopted the gold standard. (Great Britain adopted the gold standard in 1821, Australia in 1852, Canada in 1853, France in 1878, Germany in 1871, the US in 1879)

This period is also marked by the end of private bank notes in the US. (Private banks used to issue private bank notes to reduce coin debasement, e.g., shaving off, clipping and sweating (shaking coins in a bag)).

The gold standard lasted until 1914, before the outbreak of World War I. During this period, most of the industrial nations linked their currencies to gold and inflation rates were about 0.1 percent.

No treaty or agreement

When these nations were on the gold standard, there were no formal agreements with other nations. No treaty was signed . Each nation defended its currency in terms of gold. Its treasury or central bank was required by law to buy and sell gold without limit at the stated price. The public had complete confidence in the convertibility of its currency into gold.

Some policymakers feel nostalgic and want to restore the gold standard. For example, BRICS is planning a reserve currency based on gold and rare earth elements.


Jagiellonian University, Krakow, was the second oldest university in Europe (after University of Bologna). In the Austro-Hungarian empire, Poland was allowed to teach courses in Polish..



  4. Process of Adjustment


By the Gold Standard Act, 1900(copy) The Coinage Act of 1872 demonetized silver.

One dollar was defined to be equal to the value of 23.22 grains of pure gold (1 troy ounce = 480 grains of gold).


The gold content of pound sterling was fixed by Coinage Act of 1816 (copy) at 113 grains of pure gold.

Britain adopted the gold standard in 1821. By 1833, Bank of England was obligated to redeem its notes in gold and silver coins. (Bank of England Act, 1833 (copy)


Thus, the par exchange rate between the dollar and the pound was

p£ = 113/23.22 = $4.866


The cost of shipping gold from London to New York was $0.026 per pound. So the exchange rate was allowed to fluctuate within the limits of $4.866 ± 0.026. Thus,

$4.892 = gold import point for UK

$4.840 = gold export point for UK

If the spot price of pound fell below the gold export point, it is cheaper for Britons to convert £ into gold, export gold, convert gold into $ and make $ payments.

Gold export point
Why actual gold movement was negligible

During the period of gold standard, (i) prices were stable, and (ii) so little gold actually moved between countries. This was because central banks were not passive, but they adjusted the interest rates to prevent the gold outflow.

For example, when the exchange rate approached the gold export point, the Bank of England raised the bank rate (the interest rate the central banks charge commercial banks, equivalent to the discount rate in the US). This caused investors in New York to shift funds to London, because they could earn higher interest.

  Long term capital movement also lessened the need for current account adjustments. Current account adjustment requires drastic price changes under fixed exchange rate system. Without long term capital movement, price adjustments could have been deflationary.


  4. Problems with the Gold Standard

Quantity Theory of Money


QTM: When the economy is fully employed, one cannot manipulate money supply to coax more output. P = price level, V = velocity of money.

Price level is directly related to the amount of money in circulation. Velocity and GDP are fixed in the short run. An increase in M only raises the price level.

For the world as a whole, the growth of money supply is constrained by the flow of newly produced gold. Thus, the economic growth rate of a country or the world is limited by the growth of new gold production.

No new gold production ⇒ no growth!

Three Problems

(1) The gold standard is deflationary. In a closed economy under the gold standard, a country's money supply is determined by its stock of gold. To increase its money supply, the government must mine more gold. ⇒Economic growth is constrained by the gold supply. Limited supply of gold stifles economic growth and causes deflation. True, inflation is bad, but deflation is even worse. Firms had to lay off workers as price declined.

According to the World Gold Council, annual production of gold is about 2,500 metric tons or 80 million troy ounces . This implies that gross world product (GWP) cannot grow much. Had the world been on the gold standard today, this amount would accommodate the GWP growth of only $400 billion (M1 is roughly 5 × GDP). Thus, the gold standard would cause a severe deflation in the world economy. US money stock (M1) was $3.6 trillion in 2017, about 20% of US GDP.

Had the world been on the gold standard today, GWP would grow by only $.4 trillion, rather than $3 trillion (3.6% of GWP).

Unless more gold is mined, the economy cannot grow. When the monetary gold stock is fixed (nonmonetary gold stock as jewelry does not count), an increase in real output only causes deflation. (^M = 0 = ^P + ^Y). The velocity of money does not change. If the gold supply is fixed, then money supply and PY are fixed as well. Thus, in a growing economy, the gold standard is deflationary and retards economic growth. The Fed was required to hold 40% of money in gold. Almost 2/3 of gold was stored in the vaults of central banks.

(2) Inability to control money supply . Gold production is limited. Also, in an open economy, a balance of payments deficit causes a gold outflow and money supply shrinks. Thus, a single country's ability to expand money supply is limited by its balance of payments position. A fiscal expansion causes a trade deficit. A gold outflow would set off deflation.

(3) Difficult to insulate the domestic economy. A country cannot insulate its economy from external shocks. The discovery of a new gold mine increases the local supply of gold, but does not affect real outputs in the short run. Thus, an increase in gold supply raises domestic prices. Due to the fixed links between currencies, inflation or depression in one country is directly transmitted to other countries. (The Great Depression started by the Wall Street crash of 1929 was quickly transmitted to Europe and Asia.) While inflation rates were low during the period of the gold standard, prices could have been unstable.

Recession in Western Europe

After the collapse of the Roman Empire in 476 AD, gold mining stopped. There was no gold to pay soldiers (root = solidus) or to mine gold and mint gold coins. (Gold mines in Spain and Dacia were almost exhausted.) This decline of gold production and continued gold outflow to China caused a decline in Western Europe.

No significant amount of gold was produced until the age of Renaissance. ⇒1000 year-long recession in Western Europe. This was the main economic cause for the advent of the Dark Ages.

The total amount of gold mined from the earth to the end of 2014 is about 6 billion troy oz. (about 190,000 tons) According to Rafal Swiecki, of this amount,

2% was produced prior to 1492,
6% during the period 1492-1800, (due to navigation skills and trade, this period begins with the fall of Byzantine empire and the Renaissance.)
15% during the interval 1801-1900, and
52% from 1901-1985 (All these figures are adjusted in 2017, taking recent gold production into account)

(US: 8000 tons, IMF = 2,800 tons)

Annual gold production is about 80 million ounces (2500 tons) worth about $80 billion (at $1000/oz). GWP grows about $3 trillion each year today. Velocity of money (M2) is roughly 1.5 in the US. This amount of gold can sustain the annual GDP growth of $120 billion. This amount is not enough to accomodate even China's growth.

US owns 8000 tons or 0.25 billion oz (worth $250 billion at $1000/oz). Total stock of gold is about 190,000 tons, only a quarter is held by governments. (Bullionmark). This amount can be fit into a cube with sides of 20m (67 ft).

US 8000 tons
Germany 1800
IMF 2800
Italy 2450
France 2400
China 1800


  5. Fluctuating Exchange Rates, 1919-1925

During World War I the international gold standard ceased to function. Its operation was suspended with the outbreak of war in August 1914 when Archduke Franz Ferdinand, the heir to the Austro-Hungarian Empire (June 1914), was assassinated in Sarajebo. Consequences: Monarchies in Russia (1917), Germany (1918), UK (1918) and China (1911) were replaced by republics/democracies, and the Austro-Hungarian empire was split into many small republics.

European economies had been interlocked closely, but they were suddenly cut loose from the connective mechanism by war.

Countries diverged and developed in different directions during the war. By the end of war in June 1918, inflation rates varied greatly, because nations printed more money to finance war. Russian revolution occurred in 1917. The structure of world economy was profoundly altered by 1918.

Adjust gold parity?

It was clear that prewar exchange rates could not be restored. Thus, many countries delayed and were hesitant to fix official par values of their currencies. They allowed their currencies to float more or less freely in the foreign exchange market.

These countries did not realize that floating rates were the only viable solution. Instead, there was a universal expectation that floating exchange rates regime was temporary, and that countries would soon return to the gold standard. The main question was not whether to restore the gold standard, but at what parities to restore the gold standard.

at what parity?

Some urged that prewar parities should be restored.

others argued that economic conditions had changed equilibrium exchange rates between national currencies, and hence gold parities should be adjusted.


If 1914 is taken as the base (= 100), wholesale prices in December 1918 were as follows:

US 202
France 355
UK 246

Germany was off the gold standard at the outset of WWI. Germany agreed to pay £6.6 billion. By the end of 1919, $1 = 9 marks. By November 1923, $1 = 4.2 trillion marks.

US After the war in 1918 (President Wilson), US immediately announced that it would maintain the dollar price of gold at its prewar level. That is, it is willing to export gold at $20.67 per ounce.
Great Britain

It was thought that Britain's national honor was at stake. Failure to restore the prewar parity of pound would undermine confidence in pound. Accordingly, Britain resorted to a deflationary policy (1920-1925). During the Asian Financial Crisis of 1997, South Korea followed the same deflationary policy, causing a spectacular increase in the unemployment rate.

Gold Standard Act, 1925 (copy)

During the war, UK's money supply more than doubled. By April 1925, Winston Churchill announced that the Bank of England would again redeem its notes into gold. Britain was back on the gold standard in 1925 at its prewar parity.

Instead of doubling the price of gold, Winston Churchill, Chancellor of Excheqer, cut the money supply in half, which caused a depression in 1926 , three years ahead of the Great Depression in the US in 1929.

John Maynard Keynes wrote The Economic Consequences of Mr. Churchill, arguing that this policy would lead to a world depression. Churchill, then the Chancellor of the Exchequer (equivalent to the Treasurer), later acknowledged that this was the greatest mistake of his life.


Contraction of money supply and unemployment.

France French Franc dropped from $0.18 in 1918 to $0.0392 in 1926, which stopped gold outflow from France. After the depreciation, France returned to the gold standard in 1928.
  6. Gold Standard Restored (1925-1931)
Gold Exchange Standard

Under this system, each country holds gold or dollar or pound as a reserve asset.
(This system was invented due to the limited supply of gold. The scheme was designed to reduce the amount of gold needed for the reserve country.)

(i) The United States and Great Britain were to hold only gold as a reserve asset.

(ii) key reserve currencies: dollar and pound . (Due to an absolute shortage of gold, countries were discouraged to use gold in international payments.) Nonreserve countries were asked to hold dollar or pound (rather than gold) as reserve asset (Hence, gold exchange standard. Dollars and pounds were gold substitutes.) Other currencies are convertible into reserve currencies at fixed parities.

(iii) The Dollar and the British pound were freely convertible into gold between central banks, but not for the general public.

(iv) Most countries that had been on the silver standard also pegged silver to the dollar by 1890s, except China and Hong Kong.

At restored parities, the British pound was somewhat overvalued at $4.866 = 1, whereas FF was undervalued at $0.0392 = Fr 1.

  Britain had a BP deficit (and a gold outflow followed), but Britain did not have enough gold. France had a BP surplus.

Under the gold exchange standard, a country has to resort to the classical medicine of deflating the domestic economy to cure chronic BP deficit.

Deflationary policies (monetary or fiscal) stifle growth.

Before World War II, European nations often resorted to this policy, in particular the Great Britain. Even though few currencies were convertible into gold, policy makers thought that currencies should be backed by gold and willingly adopted deflationary policy after WWI.

Policy options

During this period (1925-31), these countries had 3 options to prevent gold outflow:

(a) countries tried to manage or stabilize the flexible exchange rates - by raising interest rate, but it did not prevent capital outflow.

(b) Some countries devalued their currencies, but many countries already did this without success. Nevertheless, this would be the best option.

(c) others imposed exchange control when faced with capital flight.

End of Gold exchange standard (1931) UK Gold Standard (Amendment) Act, 1931 copy
On September 21, 1931, Britain suspended gold payments. This put an end to the vain attempt to restore the gold standard. Many countries followed Britain's lead and abandoned the link to gold. For example, Japan also abandoned gold convertibility in December 1931, after its invasion of Manchuria.

Devaluation of the dollar

In April 1933, President Franklin Roosevelt suspended the gold standard.

Gold Reserve Act of 1934 (copy)
(i) GRA prohibited gold exports . In 1933 gold trade of US citizens were outlawed. Now, private possession of gold and gold export are outlawed. Citizens were required to sell gold to the Treasury.

(ii) It allowed the President to change the gold content of dollar. In January 1934, President Franklin Roosevelt raised the price of gold from $20.67 to $35.00 per ounce. ⇒ This resulted in a gold inflow into the US.

(40% devaluation of dollar, or 69% increase in the price of gold)

France devalued Franc in 1936. Europe was in a turmoil by the outbreak of WWII in 1939.