The History (And Cryptocurrency Future) of the Gold Standard
Popular gold and silver coins from various civilizations often acted as a global means of exchange throughout history. Roman, Byzantine, Arab, Spanish, and Dutch coins all took turns as the most popular coin used in international trade over the centuries. Until relatively recently, there was little or no differentiation between money and gold: money simply was physical gold.
The Advent Of The Gold Standard
It wasn’t until the 19th century and the advent of modern banking institutions that a true gold standard came into effect. With international trade becoming more advanced, it was no longer always practicable to transact in physical gold coin. Paper notes, credit accounts, stock markets, and modern financial instruments required a more flexible unit of account and a more practical medium of exchange. National governments and private banks alike issued notes that could be converted to physical gold or silver on demand, assuming an adequate supply of the underlying metal was actually reserved. However, the temptation to issue more circulating notes in excess of actual gold reserves often led to crises of devaluation where paper notes became worthless.
Naturally, currencies that were perceived as being stable became popular in international trade. By the late 1700s, Great Britain had become one of the world’s dominant trading powers. Britain was forced to suspend convertibility of its notes in 1797 as the Napoleonic Wars began and demand for gold soared. But this was only a temporary measure – convertibility of British pounds to gold was restored in 1821, and faith in that currency led to greater demand for it in international trade. Britain further cemented its position as the world’s dominant political and economic power during this period. Ample supplies of gold from colonies in Australia and South Africa, inflows of gold from the export of manufactured goods, and political stability in Britain itself ensured that the pound had high demand and ample gold reserves backing it throughout the 19th century.
By the 1870s, a modern gold standard had emerged, whereby each nation’s currency was defined in terms of a quantity of gold. Virtually all Western countries adopted some form of the gold standard during this generally peaceful and prosperous era. As a result, relationships between international currencies were clear and generally stable, and international payments could be settled in gold. There was no questioning the value of a British pound, or the US dollar, or even a French franc because each was legally defined as a weight of gold and could be redeemed in gold from each nation’s gold reserves. This ability to redeem currency for gold ensured the security of the currency and financial accountability across borders.
The Decline of the Gold Standard
The dominance of the British pound was shaken during World War I, as the country once again suspended convertibility to gold under the pressure of financing its war efforts. Britain attempted to restore convertibility in 1925 at pre-war prices, but Britain had spent much of its gold reserves and the currency was significantly overvalued at this pre-war level. As the global economy soured during the Great Depression, all major European countries and the US were forced to devalue their currencies or abandon the gold standard entirely between 1931 and 1936.
The US devalued the dollar’s value relative to gold by nearly 40% in 1934 but still offered convertibility to gold at the new price of $35/ounce. Investors from Europe seeking a safe-haven investment in gold-backed US dollars took advantage of the higher price, resulting in massive gold inflows to the US during the 1930s. At the outbreak of World War II, Britain was forced to spend massive amounts for war materiel, thus depleting its own gold reserves and further bolstering American reserves. By the end of World War II, Britain’s economy was in shambles, the US held nearly three-fourths of the world’s gold reserves, and the US dollar had unquestionably supplanted the British pound in international importance.
Many economists saw the inflexible nature of the gold standard as a contributing factor in the Great Depression and the lead-up to World War II, as policymakers had not been able to expand the money supply to ease economic conditions. Seeking to avoid a repeat of the 1930s slowdown which ended in conflict, representatives from the US and 43 other nations met at Bretton Woods, New Hampshire in 1944 to plan the post-war monetary system. It was decided at this conference to establish a new monetary system based on the newly dominant US dollar.
The Bretton Woods system was a very tenuous gold exchange standard, rather than a gold bullion standard. While most currencies were pegged to the US dollar, the US dollar was in turn pegged to gold at a price of $35/oz, backed by American gold reserves. The advantage for policymakers, fresh from the experience of the Great Depression, was that this system was far more flexible should another economic contraction occur, but still retained the exchange rate stability of the gold standard. For other nations recovering from war, holding US dollars was the best of both worlds: dollars were stable like gold (and could be exchanged for gold) but were significantly more useful as they could be used to purchase goods and services from the US. Holders of dollars couldn’t capitalize on price changes in the value of gold, but there was a stable and reliable store of value behind the dollar, and the ability to redeem for gold inspired confidence in the monetary system.
The End of the Gold Standard
As other major economies recovered and increased their exports in the 1950s and 1960s, the US had to constantly intervene in the gold market to maintain the US Dollar’s peg of $35/ounce. This was often a drain on gold reserves as the US had to frequently sell gold into the market to keep the price down. In 1961, the US collaborated with 7 European nations to establish the London Gold Pool, wherein these countries contributed half of an initial $270 million reserve of gold for the purposes of maintaining gold prices in the London market (the largest gold trading center).
The $35/ounce peg was only supposed to deviate by less than 1%, but external pressures on the price of gold soon made this impossible to maintain. Events such as the Cuban Missile Crisis in 1963 sometimes drove the price up to $40/ounce (almost 15% higher). The situation became untenable in the late 1960s as increasing levels of US government spending and expansionist monetary policy decreased the real value of the US dollar, thereby pushing the price of gold higher in US dollar terms. The US lost more than half its gold reserves in this period through attempts to maintain the price peg. The London Gold Pool collapsed in 1968, with the US government requesting a temporary closure of the London gold markets to stabilize the situation.
With the US no longer able to defend the value of the dollar on the open market, it instead relied on other countries simply not exchanging their US dollar holdings for gold (as they were still entitled to do under Bretton Woods) or buying dollars on the open market to prop up the price. In May 1971, this arrangement collapsed when West Germany allowed the Deutschmark to float, effectively ending its support of the US dollar and Bretton Woods. President Nixon notoriously closed the “gold window” – i.e, convertibility of US dollars to gold – in August 1971. A conference in Washington held in December of that year attempted to reestablish the system at a higher dollar peg of $38/ounce with a looser 2.25% trading band, but the price of the US dollar continued to fall. A further devaluation to $42/ounce in February 1973 also failed, and the Bretton Woods system was formally ended by 1976. Since then, most of the countries which participated in Bretton Woods have allowed their currencies to float freely.
Even after the closure of the gold window, Switzerland continued to hold its own partial gold reserves. In fact, the Swiss franc was required by law to maintain a 40% gold reserve until pressure from international authorities led to a constitutional change in 1999. So why didn’t the Swiss franc become the world’s new reserve currency? The bottom line is that the US dollar had no serious competitor in terms of international trade. Though it was no longer convertible to gold, the US dollar still maintained its purchasing power after 1971 in relation to other floating currencies. Even more importantly, the United States remained a major economic power, dominating global trade. Many countries, such as Saudi Arabia and China, still maintain their own pegs to the US dollar to facilitate trade, securing high demand for US dollars around the world. These two factors ensured the US dollar remained as a global reserve currency. Today, the US dollar still makes up more than 62% of global currency reserves. The Swiss franc certainly maintained its value better, appreciating substantially versus the US dollar after 1971, but there was far less demand for it around the world. It’s simply not as useful to hold Swiss francs, even if they were still partially tied to gold.
And how has the global economy been progressing since dropping the gold standard? Seemingly pretty well, actually. Since 1971, worldwide GDP is up more than 400%, and the global economy has only contracted during one year since then (2009, during the Global Financial Crisis). While currencies fluctuate more often than they did under the classical gold standard, these fluctuations are less dramatic or sudden, and today volatility in currency markets is fairly low.
The Future Of The Gold Standard
Only time will tell whether that stability proves illusory, especially as much recent growth has been fueled by unprecedented levels of debt that many consider unsustainable. Many countries (especially the US) also stabilized their financial markets during the Global Financial Crisis through massive monetary expansion, effectively transferring risk from the equities market into the currency markets (reflected by a sharp rise in gold prices). Policymakers disliked the inflexibility of the gold standard, but without any tie to gold, there’s no longer any constraint on central banks to print money.
Talk of reviving the gold standard has been brought up by both mainstream and fringe actors alike since the Global Financial Crisis, but little movement has occurred in this direction. A 2014 referendum to restore a 20% gold reserve in Switzerland failed, and there have been no serious attempts at something similar in other developed countries. Given the well-established predilection among policymakers for monetary expansion as a response to economic angst, it is unlikely that we’ll see a return to gold in the traditional banking system.
Gold in the Cryptocurrency Space
Despite nostalgia on the part of some gold standard purists, the idea of a major fiat currency returning to an early iteration of the gold standard seems unlikely and such a movement has no serious momentum in any international economy. But in the new world of cryptocurrencies, technology is making financial innovation possible in ways that were previously unimaginable, and lessons can be learned from the gold standard to develop currencies that achieve many of the same benefits in emerging cryptocurrency markets.
Vault is the company that is reinventing the gold standard in the crypto space with its USDVault token, launching this upcoming Fall. Cryptomarkets are notoriously volatile, and so the competition to develop a reliably price-stable currency is fierce. While many tokens have emerged that attempt price stability through fiat-like price manipulation and/or fiat backing, no instrument has emerged that reliably maintains a USD peg through the most trusted methodology the world has ever known – backing by and redemption for investment-grade gold bullion.
Pegged 1:1 to the USD and backed by / redeemable for LBMA gold bullion stored in Swiss vaults, USDVault is the new gold standard for cryptocurrency. The USD peg ensures stability relative to a meaningful unit of account and is maintained via a robust hedging process to ensure gold price neutrality. The gold backing / redemption implements the best practices of gold standards that succeeded throughout history in the world’s most stable economies. And all of this is implemented using ERC20 tokens, introducing investment-worthy price stability in cryptomarkets. Combined with KYC/AML compliance and strict regulatory adherence in all relevant jurisdictions, USDVault just may be the stable cryptocurrency that cryptoenthusiasts and serious institutional investors alike have been waiting for.