Gold has been used as the currency of choice throughout history. The earliest known use was in 643 B.C in Lydia (present-day Turkey). Gold was part of a naturally occurring compound known as electrum, which the Lydians used to make coins. By 560 B.C., the Lydians had figured out how to separate the gold from the silver, and so created the first truly gold coin.
In those days, the value of the coin was based solely on the value of the metal within. Therefore, the country with the most gold had the most wealth. That's why Spain, Portugal and England sent Columbus and other explorers to the New World -- to get more gold so they could be wealthier than each other.
Introduction of the Gold Standard:
When gold was found at Sutter's Ranch in 1848, it inspired the
Gold Rush to California. This helped in the exploration and unification of western America. In 1861,
U.S. Treasury Secretary Salmon Chase printed the first U.S. paper currency.
In fact, by the mid-1800s, most countries wanted to standardize transactions in the booming world trade market. They adopted the gold standard, which guaranteed that any amount of paper money could be redeemed by the government for its value in gold. This meant transactions no longer had to be done with heavy gold bullion or coins. It also increased the trust that was needed for a successful global trade since paper currency now had guaranteed value tied to something real.
This worked so well that, by World War I, most countries were on the gold standard. Despite a few recessions, it worked pretty well until the costly war began. Between 1914-1919, most countries suspended the gold standard so they could print enough money to pay for their military involvement. Unfortunately, printing money created
hyperinflation. So much money was printed that it devalued each dollar, and prices skyrocketed. After the war, countries realized the value of tying their currency to a guaranteed value in gold. For that reason, most countries returned to a modified gold standard.(History.com, "Gold Standard")
The Gold Standard Made the Great Depression Worse:
Once the
Great Depression hit with full force, countries once again had to abandon the gold standard. When the stock market crashed in 1929, investors began trading in currencies and
commodities. As the
price of gold rose, people traded in their dollars for gold. It worsened when bank began failing. The
Federal Reserve kept raising
interest rates, trying to make dollars more valuable and dissuade people from further depleting the U.S. gold reserves. These higher rates worsened
the Depression by making the cost of doing business more expensive. Many companies went bankrupt, creating massive
unemployment.
The outbreak of World War II ended the Depression, allowing countries to go back on the gold standard. Most countries adopted the
Bretton-Woods system, which set the exchange value for all currencies in terms of gold. It obligated member countries to convert foreign official holdings of their currencies into gold at these par values. However, since the U.S. held most of the world's gold, many countries simply pegged the value of their currency to the dollar, thus making the dollar the defacto
world currency. Gold was set at $35 per ounce. (Source: National Mining Association,
History of Gold)
The
Bretton Woods agreement meant that
central banks had to maintain
fixed exchange rates between their currencies and the dollar. They did this by buying their own country's currency in foreign exchange markets if their currency became too low relative to the dollar. If it became too high, they'd print more of their currency and sell it. Even though the dollar was still worth 1/35 of an ounce of gold, most countries no longer needed to exchange their currency for gold. The dollar had replaced it. As a result, the
value of the dollar increased --- even though its worth in gold remained the same.
The End of the Gold Standard:
The strong dollar led to inflation and a large balance of payments deficit in the U.S. which in turn helped to create stagflation. The U.S. started to deflate the dollar in terms of its value in gold to curb double digit inflation.
In 1971, gold was repriced to $38 per ounce, then again to $42 per ounce in 1973. As the dollar devalued, it motivated people to sell their greenbacks for gold. Finally, in late 1973, the U.S. government decoupled the value of the dollar from gold altogether. The price of gold quickly shot up to $120 per ounce in the free market. (Source: Time, Fuss Over Dollar Devaluation, October 4, 1971)
Once the gold standard was dropped, countries began printing more of their own currency.
Inflation usually resulted, but for the most part abandoning the gold standard created more economic growth.
However, gold has never lost its appeal as a currency of real value. Whenever recessions or inflation looms, investors return to gold. By 2011, the price of gold was over $1,600 an ounce. It reached its record high of $1,895 on September 5, 2011.(Article updated December 16, 2011)
