What Would Happen If We Returned to The Gold Standard?

The value of gold is a hotly debated topic in economic circles, and I can see why. The United States’ economic system was originally based on the gold standard, and, in a time of intense economic crisis and uncertainty, lots of people question why we haven’t reverted to that system.

The gold standard system for currency directly related banknotes with a specific amount of gold. This system, though still used in some parts of the world, fell out of favor in the late 1900s and has since been replaced. Re-introducing the gold standard would be possible, but difficult, and may not be ultimately worth it.

Here’s what you need to know about the gold standard, and what it would look like today.

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What is The Gold Standard?

Very simply put, a gold standard monetary system means that the value of a nation’s currency is determined by the amount of gold they have in reserve. What I mean is that our money would be considered valuable because it would be a direct voucher for a certain amount of gold.

It might be easier to understand in an example. In the United States, gold is valued at $500 per ounce. In a gold standard system, this would mean that an American dollar is and will always be worth 1/500th of an ounce of gold.

In classical gold standard systems, nations would settle debts with each other by trading in physical gold. If you had more gold, then more currency was put into circulation.

If you had less, some was taken out of circulation.  This system was put into place to limit inflation and give a physical, real value to money so that governments couldn’t solely control the value of currency.

It gave average citizens more power to control their wealth.

Why Did We Stop Using the Gold Standard?

The United States stopped using a pure gold standard system in 1933, following Great Britain’s abandonment of the system in 1931 in the wake of the first World War and the advent of credit systems. 

This was because the stock market crash of 1929 came with a major crash in the currency value of many nations, leading the USA and Great Britain as the standard for currency around the world.

As more countries started collecting dollars and pounds sterling, gold started to flow out of the two nations at an alarming rate, stopping only when the US increased the value of gold so that you could get more paper money per ounce.

This deflated the value of the dollar dramatically, but let the USA corner the gold market.  One of the big moves that forced the United States away from a gold standard system was the Emergency Banking Act

This act, which took effect during the Great Depression, forced all Americans to convert their gold holdings – in the forms of coins and bullions, as well as certificates – to dollars. 

It was an effort to stop the flow of gold out of the country and, again, build the USA’s reserve of gold.  The extreme limitation of gold, coupled with massive inflation rates as nations attempted to reset their economies through World War II, led to an all-time high of inflation in the 1960s and 1970s, which caused the crash of many nations’ currency systems, which in turn caused them to ask for payment in gold from the USA. 

The USA stopped paying in gold in August of 1971, and with this, the dollar was official severed from direct gold trade.  Currently, most nations work on a fiat currency system.

This means that the currency’s value is determined by the government, and is set because the government mandates that it should be accepted as payment. 

So, the value is relatively arbitrary.

What Would Happen If We Returned to the Gold Standard?

So, if the gold standard worked so well before the crash, why haven’t we gone back to it? What would happen if we returned to the gold standard in today’s economy?

It’s an interesting question that economists and “gold bugs” have been asking for decades, and the answer is far from simple.

recent report in Forbes stated that going back to the gold standard system would be not only possible, but practically unnoticed if done today.

Economist Nathan Lewis posits that “many of the things that supposedly justify floating currencies, are also possible with a gold standard system,” and explains that banks would still be able to expand loans and cut interest rates during times of crisis, such as with the current pandemic, as long as they still adhered to the value of gold.

In this sense, we could definitely return to the gold standard. By reducing their bonds by the amount they intend to give in loans, banks could remain stable and on track with the Treasury while still offering aid to businesses and individuals in need.

It would also mean a cessation in the intensity of inflation, which has been a growing problem since the depression of the stock market in 2008.

Unfortunately, the strongest issue in opposition that I can find is the removal of control from the Central Banks. If the value of money is set to gold, the Central Banks can’t offer arbitrary stimuli (like the ones we received in 2020) in times of trouble.

They would also be extremely tied in terms of fiscal policy, being unable to counter intense economic cycles – similar to the issues happening right now in Greece.

It would require placing a lot of trust in the government to accurately and safely report and store the gold reserves of the nation, and to trade them fairly with the average citizen.

With the current climate of distrust in the central government, I’m not sure going back to the gold standard would be smooth sailing.

Conclusion

Investing in gold has always been a strategy for investment, even after the collapse of the gold standard. If we were to reinstate it today? Well, I couldn’t tell you what would happen.

I can tell you that there are benefits to consider that might outweigh the risks of returning to a fixed currency system. I can also tell you that, in the short term at least, returning to the gold standard system would be both confusing and extremely risky for both the Central Banks and average citizens.

The gold standard was a fascinating system, and is still used in some nations today. It would be an adjustment, but I believe it would be possible to fall back on in the modern age.

Would it be a good idea? Only time would tell.

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