From the dawn of time, gold has been a universal currency. Gold coins were first minted in Lydia (a city-state in Turkey) around 610 BCE. Since then, the value of a country's currency has typically been defined in terms of a fixed weight in gold, and paper currency was convertible into gold at that price. The “classic gold standard period,” when most countries were on a gold standard, was 1870–1914. Under a gold bullion standard (the United States was on a bullion standard from the early 1930s until 1971), countries hold reserves of gold bars, which can be exchanged to settle international transactions. The United States went off any form of gold standard in 1971. All currencies freely float against one another.
From the beginning of the United States as an independent country, banks usually exchanged paper currency for specie, usually in the form of gold or silver coins, except in times of war. In the 1780s, the United States declared a silver standard based on the Spanish milled dollar. The First Bank of the United States (1791–1801) served as a de facto central bank and exchanged paper currency for specie, essentially a bi-metallic standard.
Until 1861 paper currency was supplied by state banks, and the federal government minted coins. The National Banking Acts and Legal Tender Act established national banks with the authority to issue paper currency backed by government bonds. Simultaneously, the Treasury issued nonredeemable notes called “greenbacks,” some $400 million by the end of the Civil War. After the war, the Treasury began to withdraw greenbacks from the market, reducing the value of gold from $300 in greenbacks to about $130. This set up the unsuccessful attempt by Jay Gould and James Fisk to corner gold in 1869.
The Bank of England pegged the value of gold at £6 for one troy ounce of gold. The Bank of England maintained that exchange rate, and other countries pegged their currencies relative to Britain. The United States set the dollar exchange rate at $30 for one troy ounce; therefore $5 equaled £1. The Bank of England effectively established the equivalent to a world currency. The insistence on maintaining this rate would cripple the British economy in the 1920s.
The Coinage Act of 1873 put the United States on the gold standard, limiting coinage to gold. This put an immediate damper on silver prices and western silver mining, but the major negative impact fell on the money supply and resulting deflation, with a dramatic effect on debtors, including railroads and farmers. Government policy flip-flopped from gold to a bi-metallic standard.
When the United States returned to the gold standard in the late nineteenth century, the Treasury Department typically maintained $100 million in gold. The economy generated trade surpluses and the government operated with budget surpluses, keeping gold coming to the United States and into the Treasury coffers. Speculation and business overcapacity resulted in the Panic of 1893. The Panic resulted in business failures, including many railroads and banks. Foreign sales of U.S. securities dropped the supply of American gold, with Treasury's gold hoard falling below $100 million. When the Treasury's gold hit only $9 million and the only alternative was to go off the gold standard, President Grover Cleveland and the Treasury Department turned to J. P. Morgan. Morgan and other banks raised $100 million in gold reserves from Europe. Federal gold bonds were issued on Wall Street and London, backed by these reserves, and sold quickly at a premium. Morgan's syndicate acquired the bonds at $104 and offered them to investors at $112. Pierpont used all his global banking experience to fill the Treasury's gold coffers, and by the middle of 1895 Treasury reserves rose to $107.5 million. A depression was on, but financial catastrophe was avoided. Typical for Morgan, his actions bailed out a fragile economy, but proved profitable for Morgan.
A major problem in the United States was the inability of government to manage the economy. The creation of money was left up to banks, and under a gold standard this limited the growth of money based on the supply of gold. No central bank existed to regulate money and credit. The federal government was only a small economic player (the major expenditure was military and the primary revenue source tariffs) and did not take on the responsibility to influence economic activity.
Another panic hit in 1907 for similar reasons of speculation and overleverage. Again Morgan came to the rescue. This time Congress held hearings about the problems with the financial system and the “Money Trust” centered on Morgan and Wall Street. One result was the creation of the Federal Reserve System as the United States’ central bank. Initially, the Fed was nominally headed by a Federal Reserve Board of seven members located in Washington, DC. The Board would achieve real power under New Deal legislation. The Federal Reserve Bank of New York (one of the 12 regional branches) became the most powerful, since it was located in the nation's money capital, New York City, and dealt directly with Wall Street as well as European central banks and global markets. The New York Fed would basically determine monetary policy and the role of gold until the Great Depression.
The Federal Reserve pushed interest rates lower in support of Britain returning to the gold standard in 1925. The British return to the gold standard proved to be an idiotic move, helping keep the British economy relatively depressed. The value of the English pound was just too high to sustain and reduced English exports while making imports cheaper. In the United States, cheap money just encouraged the boom and allowed greater speculation using borrowed money. This policy can be considered a major contributing factor in the speculation of the 1920s and stock price bubble.
After the market crash of 1929, Treasury Secretary Mellon wanted higher interest rates to stop the flow of gold to Europe and stabilize the value of the dollar; the United States would maintain the gold standard. To raise rates, the Fed cut money supply beginning in 1930. According to Nobel Prize–winning economist Milton Friedman, this action caused the recession of 1929 to turn into the Great Depression of the 1930s. Money supply dropped about a third. And while short-term interest rates fell as the economy worsened (plus deflation meant that loans would be paid back in “more expensive” dollars), Treasury bond yields actually increased from 3.3 percent to 3.7 percent from 1930 to 1932. Mellon got what he wanted; the world got a depression.
Within a month of his inauguration in 1933, Franklin D. Roosevelt and Congress quickly suspended the gold standard to stop the massive exodus of gold from New York, devaluing the dollar to 59¢; the Fed had no reason to prop up the dollar by keeping bond interest rates high. Gold would no longer be a major factor in economic policy.
As World War II was ending, a new international order was created by the Bretton Woods Agreement. The system put the U.S. dollar as the dominant (reserve) currency and the United States as the only nation with a currency convertible into gold (fixed at $35 to the ounce)—only central banks and national treasuries could use the conversion privilege. All remaining currencies defined their currencies relative to the dollar (legal par values), a gold-exchange standard. As U.S. balance of payments deficits increased beginning in the 1960s, many foreign countries demanded gold for accumulated dollars as inflation devalued the dollar relative to gold. In 1971, President Nixon announced that dollars were no longer convertible, thus ending the agreement. Foreign currencies now float freely against the dollar (and all other currencies). The gold standard was over.
See also Bretton Woods Agreement; Federal Reserve System; Fisk, James (“Jubilee Jim”); Gold—the Corner of 1869; Gould, Jason (“Jay”); Great Depression; Morgan, John Pierpont; Panic of 1893; Panic of 1907; Roosevelt, Franklin Delano
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