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Gold Standard

Gold Standard

Author: Kate Eskra
This lesson covers the Gold Standard
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Hi. Welcome to Macroeconomics. This is Kate. This tutorial is on the Gold Standard. As always, my key terms are in red, and my examples are in green. In this tutorial we'll look at why gold was chosen as a standard. We'll talk about when the gold standard was formally adopted. We'll see the impact that the Great Depression had on the gold standard. And we'll talk about when the gold standard was abandoned.

So if someone asked you what is money, most of us would respond that we think of it as dollar bills, or coins, or checks or something like that. But is that really what money has always involved? If we define it broadly, money is really anything that lets us get what we want. And so the three functions of money are that money has to serve as some kind of medium of exchange allowing us to get what we want; some kind of store of value, meaning that it doesn't lose value over time that we can access it later; and a unit of account to help in comparing values of things and to record financial transactions.

So people used to barter, exchanging one thing for another. But at some point in history that became really inconvenient for a lot of people. And many economies shifted to using commodity monies. So people were wasting time trying to find someone who has what you want and also wants what you have. We call that the double coincidence of wants. That's when people started trading commodities.

And a commodity is something that has value in and of itself, because of how useful it is, and it makes it then very easy to trade. And so some examples of early commodities were things like salt, and shells, and large stones, cigarettes and alcohol, barley, even cotton, cocoa beans, gold, silver, and copper.

If we look at this list, which of them are a good medium of exchange? Which of them would make it easy to take it and get what you want? Which of them would be a good store of value and retain their value over time? Some of them are pretty good in those things. And some of them aren't so good. I don't know about you, but I wouldn't really want to lug around large stones. I don't think that barley would last a very long time, and be a good store of value.

So why was it that gold was chosen? Well unlike other commodities like salt or cotton, it really doesn't have much practical value. So why was it chosen? Well the fact of the matter is it is easy to transport. It's divisible. It's durable, it lasts a long time. And it's difficult to replicate. This last one is really the key here. When people can't easily replicate something. It has a really stable value over time. And that's what made it really attractive as one of the commodities to become a source of money.

So it met all three functions of money-- the medium of exchange, store of value, and unit of account. And it started becoming the most common medium of exchange we had. But the question then became how safe would it really be to carry around and store a whole lot of gold, or hold it at home.

So what started happening is intermediaries popped up. And by an intermediary, an example of that would be a bank. So banks really allowed people to store their gold safely, and then make it easy. They could then write checks on their gold deposits without actually having to physically remove the gold from the bank.

So banks then started to print paper money, and this is where I'm saying paper money, gold certificates. They started printing these gold certificates. And what they represented was a designated amount of gold. And this is when gold then became a representative form of money. It was no longer just a commodity. A commodity is when that item has value in and of itself. Well the paper money, in and of itself, no longer had-- it doesn't have value. Paper is worth fractions of a cent. But it is valuable, because it represents something of value.

So what made this really attractive was that this paper money then was even easier to trade than gold itself. When things are easy to go out and spend them right now and get what we want, we call that liquidity. So when a form of money is liquid, it's very easy to access. It's easy to use as a medium of exchange.

But what actually gave these gold certificates, these pieces of paper, what actually gave them their value? Well it was the belief. People believed that they could actually convert them to gold, and that's what gave these value. That's why our money is becoming a representative form of currency.

So banks were then able to make loans and start earning interest. This is where the banking system becomes similar to what it is today. So people would deposit money into an account, banks would pay them interest to do that. And then banks could use those deposits to make other loans, charging a higher interest rate than they paid to the depositor. And that is how still today banks make revenue.

So a Deposit Account, as one of your key terms, is an account typically held at a financial institution that allows the owner to deposit and withdraw his or her funds. So when you deposit money into an account, it's just called a deposit account, also sometimes called a checking account.

So now we have the gold standard. There was a time in our country's history in the 1800s, where people could exchange this paper money for either gold or silver. It was much more common for gold to be used. But technically we had a bimetallic system for a little while. And then the gold standard came into place. So this was gold backed currency such that paper currency exchanges for a set weight of gold. And gold then is the intrinsic value of the currency.

So in 1900, the Gold Standard Act was passed and signed by President McKinley. And this is what makes gold the only thing then that could be redeemed for paper money. And what it did was it defined a dollar as about 1/20 of an ounce of gold. So I know it's hard to see, but I put this 1928 US dollar on here. Because this really fine print, I couldn't get it bigger than that, states basically that the US Treasury will present gold to the bearer of the note on demand. So this obviously is a dollar printed back during the time when we are on the gold standard.

So I just have some pictures of early notes. It's kind of interesting to see what they looked like. This one dates back to 1882. You can see it's a gold coin. Thomas Hart Benton is pictured here. It looks kind of similar to our money today. This one is again from 1882, but has Alexander Hamilton on it. This one is from 1900, had has Andrew Jackson. This one's a $10,000 note. And this one is from 1934 with Benjamin Franklin pictured on it. And again, you can see this indication here. It's a gold certificate.

So when the Great Depression hits, we have some changes that go on though. When the stock market crashed, investors started trading in gold and their other commodities. And this is going to cause the price of gold to go up. People then flocked to start trading in their dollars for gold. They didn't trust the banks, and they began hoarding gold. Because they knew that if they had that physical gold that that was worth something.

So this has a serious impact on things. And how Roosevelt responds is by outlawing the private ownership of gold. He basically passes an order that is forcing people to bring back their gold, to turn it into the Federal Reserve in exchange for dollars at the current rate. And this was really to prevent hoarding and to protect our currency. And so at this time the gold standard was in fact suspended. Because it was illegal to hold the gold.

FDR also ends up increasing the price of gold to $35 an ounce, or $1 equaling 1/35 of an ounce of gold, instead of 1/20. But again, he makes it-- it's no longer redeemable for gold.

When the Great Depression ends, countries could go back to some kind of modified type of gold standard. Most countries ended up actually valuing their currencies based on our dollar. Since at that time, we owned most of the gold in the world. But as countries started to recover from World War II, like Germany and Japan, our share of economic output in the world started to drop. And because of that so did our stock of gold.

We had some issues in our country, especially in the late '60s and early '70s, where we start having a negative balance of payments, increasing debt in our economy, and inflation. And in an effort to really stabilize things in the early 1970s, Nixon completely ends the convertibility between US dollars and gold. And this completely suspended the gold standard.

So in this tutorial we looked at why gold was chosen as a standard, when the gold standard was formally adopted, the impact that the Great Depression had on the gold standard, and when Nixon finally took us off of the gold standard completely. Thanks so much for listening. Have a great day.

Notes on "Gold Standard"

Terms to Know

Gold Standard

Gold backed currency such that paper currency exchanges for a set weight of gold -- gold is the intrinsic value of the currency.

Deposit Account

An account typically held at a financial institution that allows the owner to deposit and withdraw his/her funds.


Image of Gold Standard dollar, public domain, http://en.wikipedia.org/wiki/File:One_dollar_1928.jpg, Image of Early $100 bill gold certificate (1882), public domain, http://en.wikipedia.org/wiki/File:US-$100-GC-1882-Fr.1207.jpg, Image of Early $100 bill gold certificate (1934) depicting Benjamin Franklin, public domain, http://en.wikipedia.org/wiki/File:US-$100-GC-1934-Fr.2406.jpg, Image of Early $1000 bill gold certificate (1882) depicting Alexander Hamilton, public domain,http://en.wikipedia.org/wiki/File:US-$1000-GC-1882-Fr.1218g.jpg, Image of Early $10000 gold certificate (1900) depicting Andrew Jackson, public domain, http://en.wikipedia.org/wiki/File:US-$10000-GC-1900-Fr.1225.jpg