As the 1800s turned into the 1900s, the global economy depended on the gold minted into currency in the United Kingdom. Britains gold sovereigns played a role similar today to the US dollar accepted by most nations in lieu of a local currency, with some nations choosing to utilize the UK currency instead of their own. The UK enjoyed its time in the sun as the banking and commerce capital of the world, up until World War Ones devastation of the European economy and the onset of the global depression in the 1930s. Though each nation pegged its currency to gold during the 1930s, many countries attempted to devalue their own currency in order to provide a better attraction for exporting goods. This disastrous race to a lower currency resulted in the meetings that would set up the International Monetary Fund, an effort by leading world nations to stabilize currency and prevent future collapses. For the rest of the 20th century, the IMF and the Gold Standard would be closely linked.
The Value Of A Gold Standard
For much of human history, economies have depended on gold in one way or another. Even ancient civilizations like the Persians, Aztecs, and Chinese utilized gold as a means of barter if they did not mint coins out of gold metal and gold dust. Gold provides a solid backing for any currency due to the fact that it is rare, and thus constantly in demand, and that it can be purchased and sold anywhere in the world so that a currency based on gold will always avoid collapse. The gold standard that the IMF utilized between 1947 and 1971 provided monetary stability based on the agreement of each nation to abide by its principles. Any country that uses a gold standard will have to keep a large quantity of gold on hand in order to keep a reserve for their currency. America created Fort Knox in Kentucky in order to house their reserve of nearly one hundred and fifty million ounces of gold (today worth a quarter of a trillion dollars.
Risks Of Gold-Backed Currency
Though a large number of nations committed themselves to the IMF and the Gold Standard and enjoyed prosperity for two and a half decades, the system was not without its drawbacks. During the early 1970s, the United States had accumulated much more gold than other IMF member nations. With more gold, the US had less demand and thus its gold supply could be purchased privately for a lower value. As such, it was possible for foreign entities (nations or corporations) to purchase American gold, ship it across the ocean, and sell it for a much higher price in a country where supply was lower and demand higher. This led to the USA de-linking its currency from the gold standard, adopting a floating currency that today is the model of global economics.
Liquidity And Markets
In order to grow an economy, it is necessary to have an expansion of capital. A gold standard economy necessarily limits the expansion of capital to the amount of gold on hand. Since the quantity of gold is inherently limited to what mines can pull out of the ground, an economy linked to precious metals can only expand when a new vein of gold is discovered. Yet the rapid expansion of economies in the 1950s and the 1960s during the post-war boom meant that growth depended on using notes as reserve, rather than gold. During the 1960s, as much as one third of the reserve economy depended on notes (like the dollar, pound, deutschemark, and franc) in addition to gold. The IMF took note of this trend in the 1960s, announcing that a limited amount of liquidity would mean that the global market would stagnate and trade would drop.
Transitions From The Gold Standard
When Richard Nixon signed the bill into law that would take the United States off of the gold standard, it created shock waves that resonated through the global economy. Many European nations followed suit by dropping the IMFs requirement for a gold standard, though they remained members of the IMF itself. Floating currencies led to far greater fluctuation of value, even though attempts were put in place to stabilize floating currencies. For example, the western European nations agreed to stabilize their currencies collectively in an agreement known as the European Snake. Under this accord, no nation could raise or lower the value of their currency by more than 1.125 percent. This did not affect their performance compared to the dollar, however, meaning that the comparative performance of the dollar to European currency had no restrictions when rising or falling.
The Future Of The Gold Standard
Without nations to utilize the precious metal as a backing for their currency, it could be expected that the demand for gold would fall. Instead, however, just the opposite happened. Since 1971, the value of gold per ounce has risen tenfold for several reasons. First, very little new gold has entered into the economy, so that supply remains relatively low while demand enjoys a consistent growth. Developing economies, most notably China and India, created new generations of middle- and upper-class consumers that desired gold for luxury goods and investment purposes. Finally, nations no longer needed a large quantity of gold in reserve, so they began to sell bullion and mint coins, precipitating a greater global exchange of gold. Today, every nation on Earth utilizes a floating currency system, and it remains extremely unlikely that any nation will return to the gold standard barring complete economic collapse.
The Role Of The IMF Today
No longer able to set limits on currency rates, the IMF today provides massive loans to member nations in order to allow the growth of markets and the creation of new infrastructure. With liquidity approaching a trillion dollars, the IMF has a greater value than all but the top fifteen economies of the world. Critics have charged that it should be done away with to allow for countries to directly promote trade with one another, yet support amongst member states remains high.
Charting Gold Prices
Check out the current spot price of gold here.