Definition of The Gold Standard

The Gold Standard, 1876-1913

Since the days of the Pharaohs (about 3000 B.C.), gold has served as a medium of exchange and a store of value. the Greeks and Romans used gold coins and passed on this through the mercantile era to the nineteenth century. The great increase in trade during the free-trade period of the late nineteenth century led to a need for a more formalized system for settling international trade balances. One country after another set a par value for its currency in terms f gold and then tried to adhere to the so-called “rules of the game”. This later came to be known as the classical gold standard. The gold standard as an international monetary system gained acceptance in Western Europe in the 1870s. the United States was something of a latecomer to the system, not officially adopting the standard until 1879.

The “rules of the game” under the gold standard were clear and simple. Each country set the rate at which its currency unit could be converted to a weight of gold. The United States, for example, declared the dollar to be convertible to gold at a rate of $20.67 per ounce of gold (a rate in effect until the beginning of World War I). The British pound was pegged at £4.2474 per ounce of gold. As long as both currencies were freely convertible into gold, the dollar/pound exchange was:

Because the government of each country on the gold standard agreed to buy or sell gold on demand with anyone at its own fixed parity rate, the value of each individual currency in terms of gold-and therefore exchange rates between currencies- was fixed. Maintaining adequate reserves of gold to back its currency’s value was very important for a country under this system. The system also had the effect of implicitly limiting the rate at which any individual country could expand its money supply. Any growth in the amount of money was limited to the rate at which official authorities could acquire additional gold.