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Question:


What is the “gold standard”?
-KansasCitySir


Answer:


The gold standard is the monetary system in place during much of recorded history, ever since the Greeks (whose ability to manage financial affairs seems to be waning) first made gold coins 2,600 years ago. Under the gold standard, a unit of currency is simply defined as a certain weight of gold. At first that meant carrying around gold coins, but then as economies grew more complex and banking systems developed, gold coins came to be replaced by paper currency that served as an IOU – a promise to hand a specified amount of gold to the bearer on demand.

For much of the history of paper money, it was printed by private banks, not governments. Because a banknote is nothing more than a promise, it’s only as good as the bank that issues it. The soundest banks were the ones with the most gold in their vaults, and they were seen as the ones most likely to keep the promise. Theirs was the money that commanded the highest value in the economy, while merchants and others would require greater amounts of other banks’ paper in payment for the same amount of goods. That may have been the birth of inflation.

Over time, governments took over the duty of printing money, but they maintained the gold standard and the convertibility of paper into gold – right up until they didn’t. In the United States that happened in 1971, when President Richard Nixon declared that the dollar would no longer be backed by gold. That marked a sudden end to the Bretton Woods system, in which the world’s major economies pegged the value of their currencies to the dollar, effectively tying them to gold too. The system was set up near the end of World War II to manage trade and capital flows among nations. With the gold standard gone, money is backed only by the faith that people have in the issuing Treasury.

Would the world economy be better under a gold standard again? Such a system would tie the hands and printing presses of governments and central banks, limiting their ability to respond to extreme economic conditions such as the credit crunch in 2008 or the European debt crisis today. Some would argue that their policies haven’t been spectacular successes in responding to those crises, so maybe such restrictions wouldn’t be so bad. But it’s also possible that less flexibility would make it more difficult for crises to develop in the first place. Either way, we’ll probably never know.

-Conrad de Aenlle



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