When and Why the Gold Standard Failed

Updated: Apr 29, 2024 | Published: Apr 29, 2024
Verified Investing
By Verified Investing
When and Why the Gold Standard Failed

The International Gold Standard was only fully in effect from the mid-1870s to 1914. Heavy deficit spending in WWI knocked most European countries off the Gold Standard. Attempts to revive it after the war ended with the Great Depression in 1931.

Billions of dollars in excess currency sloshing around after WWI gave nations two options to return to the Gold Standard. Either contract their economy to shrink the money supply or devalue their currency.

Britain took the first route, France the second. This resulted in gold flooding out of the UK. People rushed to convert their paper currency to gold, causing nationwide bank runs. It was feared that the gold runs would force the Bank of England to devalue the pound to match the franc. With the Bank of England days from running entirely out of gold, they were forced to do the unthinkable. On September 19, 1931, Britain abandoned the Gold Standard.

Britain was still the world's leading economic power when the Great Depression forced it to abandon the Gold Standard. Once everyone saw that it didn't cause the End of Western Civilization, the taboo was broken. Sweden, Norway, and Denmark all abandoned the Gold Standard within a week after Britain.

Finland followed suit, leaving the Gold Standard in October. Japan left in December. The United States ended the Gold Standard domestically in 1933. It confiscated privately owned gold and raised the official gold peg to $35 per ounce.

The rest of Europe held on until 1936, when the ascendance of Nazi Germany forced them to ramp up military spending.

After WWII, most of Europe was a pile of rubble, and the US owned most of the world's gold. Devastated European economies had no way to make export goods and thus no way to bring gold into the country. They had to rely on the US Marshall Plan to rebuild.

Gold certificates were used as paper currency in the United States from 1882 to 1933.Gold certificates were used as paper currency in the United States from 1882 to 1933. (Source: Wikipedia)

The Gold Standard ended for good in 1944 at the Bretton Woods conference. Bretton Woods established the US dollar as the replacement for physical gold going forward. Central banks could hold dollars as reserves, as they were "good as gold." And thus began the “Dollar Hegemony” of global trade.

Problems with the Gold Standard

Even if WWII had not ended the Gold Standard, it would have eventually fallen apart on its own.

On a macro level, the world’s economies grew much faster in the late 19th century than the amount of new gold mined. This was mitigated by nations moving to a fractional gold reserve standard, where each dollar, pound, or franc was only partially backed by physical gold. This made the public more apt to start bank runs during economic shocks, as everyone knew there wasn’t enough gold in their central bank to cover all the outstanding paper currency.

Another problem with the Gold Standard was that countries with large domestic gold production could issue far more currency than others, which allowed them to influence international trade. This extra money supply, compared to others, also allowed these countries to better match their economic expansion.

Even wealthy countries need to increase spending to combat recessions and high unemployment. This was basically impossible under the Gold Standard, which made market panics and recessions sharper and longer.

Lastly, the market price of gold was very volatile. The Gold Standard required that participating countries peg their currencies to a stable gold price. When the market price of gold exceeded that benchmark price, the country in question would see large gold outflows due to the ability to redeem unlimited amounts of paper currency for gold at the benchmark price. This would force them to contract the money supply, risking deflation and recession.

A Gold Standard Sounds Good on Paper

Decades of runaway government deficit spending make returning to the Gold Standard sound like a good idea. For the reasons stated above, it really isn’t. Without it, governments would not be able to rebuild after natural disasters, pay for infrastructure like dams and highways, fight high unemployment or inflation, or do everything people depend on the government for.