From Tulips to Bitcoins

The End of the Gold Standard

1973

Gold and silver have been recognized as legal currencies for centuries, but in the late 19th century silver gradually loses this function. Gold keeps its currency status until the fall of the Bretton Woods system in 1973. The current levels of sovereign debt are causing many investors to reconsider an investment in precious metals.

“Gold and silver, like other commodities, have an intrinsic value, which is not arbitrary, but is dependent on their scarcity, the quantity of labour bestowed in procuring them, and the value of the capital employed in the mines which produce them.”

—David Ricardo

“You have to choose . . . between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the government. And, with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold.”

—George Bernard Shaw

“Only gold is money. Everything else is credit.”

In June 2011 the US Mint announced a 30 percent increase in silver coin sales compared to the previous month. With more than 3.6 million silver eagles sold, the US Mint reached its limit of production, so great was the interest of investors in silver coins. Similar figures were reported by the Royal Canadian Mint, the Australian Mint in Perth, and also by the Vienna-based Mint Austria, producer of the Vienna Philharmonic Coin. In March 2011 newspaper headlines proclaimed that the state of Utah was considering once again accepting gold and silver as legal currencies. Utah was not an isolated case in the United States; Colorado, Georgia, Carolina, Tennessee, Vermont, and Washington were also looking to return to the stable value of gold.

What seems curious at first glance made many investors thoughtful. After all, the use of a paper currency without a tie to precious metals like gold or silver is a relatively recent experiment. Only in the early 1970s, when President Nixon abolished gold convertibility in 1971, and with the collapse of the Bretton Woods system of fixed exchange rates and the convertibility of all currencies into gold in 1973, was the gold standard abolished and replaced by fiat money.

Fiat money is a currency without intrinsic value that has been established as money, often by government regulation. Thus, the fiat money experiment has been tested in international financial markets for less than 50 years.

The international monetary system—detached from gold and silver—has existed in this form for less than 50 years.

Gold or Silver?

In the historical context, the gold standard was just a short transitional period for global financial markets. For many centuries silver was the dominant currency. Most countries used a silver standard or a bimetallic standard. Similar to the gold standard, under a silver standard the total amount of money in circulation is hedged by silver, while a bimetallic standard additionally prescribes a fixed exchange ratio between silver and gold. For many years in the United States, that was 1:16. The gold-silver ratio indicates how many units of silver are needed to buy one unit of gold.

After both the silver and gold standards ended, the range of this ratio has fluctuated between 1:10 and 1:100. At the beginning of the 1980s, the ratio dropped below 1:20. In the early 1990s, it peaked at just under 1:100. In the years 2009 and 2010, the price of silver rose much more sharply than the price of gold. While 80 ounces of silver had to be paid for 1 troy ounce of gold by the end of 2008, it was just 40 ounces in mid-2011 and fell further to 1:50 by the beginning of 2019. Considering the natural resources and the amount of each metal mined annually, it would imply a long-term ratio of 1:10.

Figure 5. Gold-silver ratio, 1973–2013. Data: Bloomberg, 2019.

All central banks were obligated to other central banks to exchange currency for gold at a fixed rate of 35 USD per ounce. But since the 1960s, US gold reserves have been shrinking, due to increasing account deficits. Social welfare entitlements and the growing financial burden of the Vietnam War accelerated the US current account deficit, raised inflation, and lowered international confidence in the US dollar. For the first time in 1970, the US money supply exceeded the amount of gold reserves. A year later, in August, President Nixon stopped the conversion of US dollars to gold (an event known as “Nixon shock”), but it was not until 1973 that the Bretton Woods system was officially overruled and replaced by a system of floating exchange rates. After that, the gold standard faded into history.

Silver Gives Way to Gold

Silver gradually lost its official payment function in the late 19th century due to several factors. On the one hand, the United Kingdom, as a leading economic nation, was able to prevail with its gold standard against the French-dominated Latin coinage based on the silver standard. On the other hand, gold discoveries in California and Australia led to a tenfold increase in worldwide gold production and thus to lower gold prices. This made the gold standard more attractive. In 1871 Germany also switched to the gold standard. The transition from the silver or bimetallic standard to a pure gold standard led to an oversupply of silver and weighed on the price of silver for several decades.

However, attention again has been focused on the solvency of many countries, including the United States, Japan, and some European economies. Measures taken to combat the financial and economic crisis that started in spring 2007 with the US real estate crash caused the national debt and the money supply to explode.

Global debt accelerated to 320 trillion USD, whereas global GDP only rose to 80 trillion USD, and the dollar’s purchasing power declined by more than 90 percent since 1971. In addition to some European countries—Portugal, Ireland, Greece, and Spain (known as “PIGS countries”)—the United States was also temporarily threatened by a downgrade of its creditworthiness by international rating agencies. In the face of all this, it is not surprising that gold and silver bullion and coins, even if they are no longer legal tender, are popular with investors, and that bitcoins have emerged as an alternative currency. Gold-backed cryptocurrencies offer another alternative to fiat money. It seems like the gold standard is rising from its ashes through private initiatives instead of by government institutions.

Key Takeaways

•In 1933 President Franklin D. Roosevelt issued Executive Order 6102, which declared private possession of gold bars and coins illegal and punishable by up to 10 years in prison. All private gold holdings had to be turned over to the Federal Reserve in exchange for paper money at 20.67 USD per troy ounce. This prohibition against gold ownership wasn’t lifted until 1975 by President Gerald Ford.

•After World War II, the US dollar was declared the world reserve currency, pegged to gold at a fixed exchange ratio. All other currencies were then pegged to the US dollar (the “Gold Standard”).

•As US debt spiraled out of control, President Nixon ended the convertibility of US dollars into gold in 1971 (the “Nixon Shock”).

•With the end of the Bretton Woods system in 1973, one of the greatest economic experiments began: a system of free and floating exchange rates for currencies that are not backed by any collateral other than the faith in national governments.