The Gold Standard and Its End in 1971

In the earlier essays we saw a recurring problem. Whoever has the power to issue money also has the power to issue too much of it. Song emperors, Yuan khans and French regents all discovered how tempting paper could be. The gold standard was the most ambitious attempt in modern history to solve that problem by tying the hands of the issuer to a metal that no one could print.

Newton’s accident

Britain did not set out to adopt a gold standard; it drifted onto one. In the late seventeenth and early eighteenth centuries, the country used both gold and silver coins, at an official ratio fixed by the Mint. Isaac Newton, the physicist, became Warden and then Master of the Royal Mint and took his duties seriously.

In 1717 Newton reported on the relative value of the gold guinea and silver coin, and the government fixed the guinea at twenty-one shillings. At that rate, silver was undervalued compared with its worth abroad, so silver coin tended to be melted or exported, while gold stayed in circulation. Without anyone quite planning it, Britain came to run on gold.

The arrangement was suspended during the wars with revolutionary and Napoleonic France, when from 1797 the Bank of England was allowed to stop paying its notes in gold. Payment in gold was restored in 1821. An act of 1816 had already made gold the formal standard, and the gold sovereign coin was introduced the following year.

Peel’s act and the rules of the game

The Bank Charter Act of 1844, associated with the Prime Minister Robert Peel, strengthened the link. Beyond a fixed amount, every Bank of England note issued had to be matched by gold held in its vaults. The aim was to make the quantity of paper money follow the quantity of gold automatically, without depending on anyone’s judgment.

The Scottish philosopher David Hume had described, in an essay of 1752, how a system based on precious metal might correct itself. If a country’s money became too plentiful, its goods would become dearer, it would import more from abroad, metal would flow out, and the supply of money would shrink again. Nineteenth-century central bankers added their own tools, especially the interest rate the Bank of England charged, to speed up this adjustment. Later writers called the conventions that grew up the “rules of the game”.

A promise printed on every note

For people in Victorian Britain, the gold standard was not an abstraction. Gold sovereigns and half-sovereigns circulated as everyday coins for larger payments, and a Bank of England note could be taken to the Bank and exchanged for gold coin on demand. The notes said so in words: the Chief Cashier promised to pay the bearer on demand the sum written on them.

That printed promise still appears on Bank of England notes today, although it has long since ceased to mean payment in gold. It is a small survival from a time when the value of paper rested visibly on metal. Under the classical gold standard, the promise was real, and the Bank’s whole policy was organised around keeping it. When gold flowed out of the country, the Bank raised the interest rate it charged, making it more attractive to hold money in London and drawing gold back.

The classical gold standard

Between about 1870 and 1914, most of the major economies joined Britain on gold. The new German Empire adopted it in 1871 to 1873, using the indemnity paid by France after the Franco-Prussian War. Other European countries followed. The United States restored gold convertibility in 1879 after the Civil War and made the gold standard formal law with the Gold Standard Act of 1900.

The decision was not uncontroversial. In the United States, farmers in debt and miners in silver-producing states argued that tying money to gold alone kept it scarce and made debts harder to pay. In 1896 the Democratic candidate for president, William Jennings Bryan, ended a famous speech at his party’s convention with a line that was remembered for generations.

“You shall not crucify mankind upon a cross of gold.”

William Jennings Bryan, Democratic National Convention, Chicago, 1896

Bryan lost the election. For the moment, gold prevailed.

War, restoration and collapse

The First World War broke the classical system. Governments needed to pay for the war and suspended the convertibility of their notes. After the war, many tried to restore the old arrangements. Britain went back to gold in 1925, at its pre-war rate, under Winston Churchill as Chancellor of the Exchequer. John Maynard Keynes opposed the decision in a pamphlet, The Economic Consequences of Mr. Churchill. Two years earlier, in his Tract on Monetary Reform, he had already called the gold standard a “barbarous relic”.

The restored system proved fragile. When the Great Depression struck after 1929, countries on gold found that defending their currencies required them to keep money tight just when their economies most needed relief. Britain left the gold standard on 21 September 1931. The United States, under President Franklin Roosevelt, took a series of measures in 1933 and 1934, including requiring private holders to deliver gold coin and bullion to the Federal Reserve and changing the official value of the dollar in gold.

The economic historian Barry Eichengreen, in Golden Fetters (1992), argued that the gold standard was a central reason why the Depression spread so widely and lasted so long, and that countries recovered sooner the earlier they left it. That interpretation is now widely held among economic historians, although the details continue to be debated.

Bretton Woods

In July 1944, while the war still continued, delegates from forty-four Allied nations met at a hotel in Bretton Woods, New Hampshire, to design a post-war monetary order. The leading figures were Keynes for Britain and Harry Dexter White for the United States. The conference created the International Monetary Fund and the International Bank for Reconstruction and Development, the core of today’s World Bank.

The system that emerged was a gold standard at one remove. Other currencies were fixed to the US dollar, with the possibility of adjustment in serious cases. The dollar, in turn, was convertible into gold, but only for foreign governments and central banks, not for private citizens.

Triffin’s dilemma

The design had a weakness that the Belgian-American economist Robert Triffin set out in 1960 in Gold and the Dollar Crisis. For the world economy to grow, other countries needed more dollars to hold as reserves. That required the United States to send dollars abroad year after year. But the more dollars accumulated overseas, the less believable became the promise that all of them could be exchanged for the gold in American vaults. The system’s success undermined its foundation.

15 August 1971

By the late 1960s, the strain was obvious. Arrangements among central banks to manage the gold market broke down in 1968. Foreign governments increasingly asked to convert their dollars. On Sunday 15 August 1971, after a weekend of meetings at Camp David, President Richard Nixon announced in a televised address that the United States would suspend the convertibility of the dollar into gold.

The suspension was presented as temporary. It was never reversed. A new set of fixed rates agreed at the Smithsonian Institution in December 1971 lasted little more than a year, and by March 1973 the major currencies were floating against one another. The Jamaica Accords of 1976, which amended the IMF’s articles, formally ended the official role of gold in the international monetary system.

After gold

Since 1971, the world’s major currencies have not been convertible into any metal. Their value rests on law, on the institutions that issue them and on the policies those institutions follow. Independent central banks with legal mandates, and public targets for keeping the value of money stable, became the main answer to the old question of how to restrain an issuer.

Not everyone found that answer convincing. Some economists argued for rules rather than discretion; others wanted to restore gold. In the 1990s and 2000s, a small group of cryptographers began to ask a different question: could the restraint be written into software? The schedule of issuance in the Bitcoin design of 2008, fixed in advance by its rules, is one response to that question. It belongs to a long argument about trust in issuers that the gold standard, in its rise and its end, did more than anything else to shape.