What was the gold standard, and why did countries abandon it?

The gold standard was a system in which countries fixed the value of their currencies to a specified amount of gold, or linked their currency to that of a country that did. There was no single exit. World War I broke the classical system, the Depression-era version collapsed between 1931 and 1936, and the US ended the last dollar-gold link in 1971. [1] [2] [3]

Under the classical gold standard, domestic currencies were freely convertible into gold at a fixed price, and gold could be imported and exported without restriction. Because each currency was fixed to gold, exchange rates between participating currencies were fixed too. Central banks had to maintain convertibility and defend the exchange rate. [1]

England adopted a de facto gold standard in 1717 and formally in 1819. The United States moved to gold de facto in 1834 and by law in 1900. Other major countries joined in the 1870s, and the period from 1880 to 1914 is known as the classical gold standard, a time of strong growth and relatively free trade. [3]

Combatant countries suspended the gold standard during World War I, issuing inconvertible paper money to pay for the war, and prices rose sharply. After the war many governments wanted to restore it, but wartime inflation meant the available gold supply had shrunk relative to the money value it was meant to support. The restored version, the Gold Exchange Standard, encouraged countries to hold foreign currencies such as sterling or dollars as reserves instead of gold. Britain returned in 1925 at the pre-war parity despite reduced competitiveness, while France and Belgium chose devalued parities. [2] [3]

The interwar system broke down in stages. Britain left in 1931 after massive gold and capital outflows, because its gold holdings were low relative to its short-term obligations. The US held the dollar's gold price until 1933, and the last adherents, France, the Netherlands and Switzerland, left in 1936. Chatham House argues that the system required price deflation for growth, which meant more unemployment and falling living standards that were politically unacceptable, so countries abandoned it one by one. Other accounts describe the gold standard as a transmission belt that tied countries together so that a contraction in one spread to others. [2] [4]

Historians debate how much blame the system deserves. The Chatham House paper says it is a matter of some debate whether the gold standard prolonged the Great Depression or merely contributed to it, but that it clearly prevented the 1931 banking crisis from being contained, since it limited central banks' ability to expand the money supply and lower interest rates. It notes that the US recovery began only after the US left gold. [2]

In 1933 Roosevelt nationalized privately held gold. From 1946 to 1971 the Bretton Woods system had most countries settle balances in dollars, which the US promised to redeem for gold at $35 per ounce. Persistent US balance-of-payments deficits drained US gold reserves and reduced confidence in that promise. On August 15, 1971, Nixon announced the US would no longer redeem currency for gold. A last attempt to keep pegged rates, the Smithsonian Agreement of December 1971, failed to hold, and most major currencies were floating by March 1973. [3] [2]