The gold standard is a system where the nation’s money supply is determined by the supply of gold that is mined. Over time we have had different types of gold standard economies and countries have even suspended the gold standard during wars (e.g.: WWI). Until WWI the world had the international gold standard. Under a gold standard, paper money like $ and £ are not money- they are simply substitutes for a specific weight of gold.
History of Gold:
Mankind has used gold for thousands of years as money. However, the modern gold standard system is the most important.
International Gold Standard system (1870-1914) (Classical Gold Standard)
This was when money was redeemable for gold and there were few interruptions. This was the most stable monetary order in the history of gold. Every major currency such as the £, US$ and Franc were all redeemable for gold. Gold was the real money. £ is simply a name to define a weight of gold. Under this system, exchange rates were fixed based on how much weight of gold equalled 1 unit of currency. £1 was 1/4th of an ounce and $1 was 1/20.67th of an ounce, resulting in an exchange rate of $4.86/£.
In the long run, the money supply growth was extremely limited. Money supply could only grow if the amount of gold mined was increased. As a result, this made the value of money very stable. For example, after the 1848 California gold rush, inflation averaged 1.5% per year (according to Larry White), but as the amount of gold mined slowed, then there was gentle deflation. The net result is that between 1800 and 1900, the price level fell slightly. The reason is because as saving and investment increase and technology improved, the output of goods and services grew faster than the money supply, resulting in deflation. However, since 1971, when Nixon ended Bretton Woods, the dollar has lost 82% of its value.
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