Gold: A Glittering History
After the war, many countries returned to the gold standard. But this was a different kind of gold standard: the U.K., for example, went back on the gold standardin 1925, but this time there were no circulating gold coins. In 1931, as the worldwide Great Depression worsened, the U.K. saw large outflows of gold to the U.S. Since the supply of money was tied to the amount of gold they held, the U.K. could not stimulate its economy by expanding the monetary supply.
Forced to choose, the U.K. abandoned the gold standard.
Germany could not go back to the gold standard since it had used all its gold in the war and for reparations. Instead, the Germans began printing money. That, too, would prove to be disastrous; it led to hyperinflation of the 1920s, and the rise of Hitler.
Unlike the U.K., the U.S. maintained its commitment to the gold standard. Gold coins continued to circulate, but the U.S. had a problem similar to the U.K. By law, the Federal Reserve was required to have gold backing 40 percent of its Federal Reserve notes. It, too, could not expand the money supply.
But this was the Great Depression, and Americans were cashing in their dollars for gold. To increase demand for dollars and defend the gold standard, the Federal Reserve raised interest rates.
This was a disastrous course of action since it likely exacerbated the Great Depression. How much it exacerbated it is one of the great questions of 20th century economic history. At any rate, the strategy was unsuccessful. The supply of money in circulation dropped as Americans cashed in their dollars for gold, leading to deflation. Even foreign investors withdrew money from U.S. banks and converted to gold.
President Franklin Roosevelt took gold coins out of circulation; holders of gold were required to turn in their supplies at a rate of $20.67 per troy ounce. In 1934, that price was raised to $35.
This was the beginning of the end for the gold standard. Gold no longer circulated as money…now the only legal tender was paper money and silver (and base metals used in coins). Most of the rest of the world followed.
What about the gold? It was stored in vaults to back up the paper that was printed. One dollar worth of gold, theoretically, could buy so many dollars worth of paper. But demand for money continued to outstrip the supply of gold. Still, the U.S. continued on the gold standard.
After World War II, the devastated countries of Europe rebuilt their economy using U.S. dollars; they paid for those dollars in gold. Backed by gold, the dollar became the strongest currency in the world.
The new gold standard
Under the Bretton Woods Agreements, a type of gold standard was maintained. Many countries fixed their exchange rates relative to the U.S. dollar. The U.S. government, still maintaining convertibility of its currency into gold, continued to promise to fix gold at $35 an ounce.
By the 1960s the European economies had recovered. The United States was embroiled in a costly war in Vietnam. There was a serious negative U.S. trade balance, and the government was printing money.
The large supply of overseas dollars began coming home: European countries redeemed their dollars for gold at the price of $35 an ounce. The U.S. gold supply dwindled, and the dollar weakened. In August 1971, President Nixon stopped accepting dollars for gold.
As a result, the special role of gold in the world monetary system was ended. The Federal Reserve was not obliged to tie the value of the dollar to gold, or anything else. Most of the currencies of the world now float freely against each other.