Gold is one of the oldest forms of money used by individuals and societies. A gold standard is a monetary system where the money in circulation, often paper money, has a value directly linked to a store of gold. Currencies fixed to this standard also become fixed relative to each other, allowing predictable currency exchanges. The opposite is a fiat currency, meaning that central banks have the ability to increase or decrease the money supply without regard to any fixed standard.
When economic historians refer to the gold standard, they are generally referring to the International Gold Standard established in the late 19th century. Precipitated by a silver currency crisis in England which culminated in the United States suspending all payments of silver, this standard began in 1871 when a unified Germany established the Reichsmark as a strict gold standard currency. By 1900, virtually all global economic powers had followed suit.
This initial system reached its first crisis with the onset of World War I. The incredible expense of waging this war forced Britain to move to fiat currencies. The Treaty of Versailles, setting conditions for surrender, forced Germany to turn over much of its gold supply as reparations. Ostensibly, this was to bolster the gold supplies of the winning nations. A side effect, however, was that Germany did not have enough gold to remain on the gold standard. Despite remaining a major industrial power, Germany had no choice but to move to a fiat currency.
By the time Germany and the UK managed a temporary return to the gold standard in the mid-1920s, other major economies, including the US, were leaving it. The International Gold Standard officially died at the 1933 London Conference when participating nations could not agree on the value of gold itself. After World War II, influential economists such as John Maynard Keynes successfully argued against a return to this standard, and currencies began trading under the Bretton Woods agreement. The collapse of Bretton Woods in 1972 ushered in the era of free-floating currencies, and gold lost even its status as the basis for central bank reserve accounting.
While having a system of fixed currencies allowed tremendous expansion in global trade, the gold standard was not without significant problems. Because gold supplies grow more slowly than economies, the standard is highly deflationary. The United States, for instance, underwent periods of deflation lasting as long as 14 years after switching to it. Enormous local distortions of value can also occur; during the Great Potato Famine, for example, it was more profitable for the Irish to export potatoes to England than to sell them to starving locals. By making international trade more predictable, the gold standard puts pressure on taxing authorities to move away from import tariffs and towards income and sales taxes imposed on its own citizens. Credit becomes very tight in economies based on a this standard as governments do not have the ability to print more money when the economy needs it.
