Gold as a Monetary Metal
History of Gold
Throughout history, gold has played an important role in the international monetary system. The first gold coin was struck around 550 BC and has retained its value even after the introduction of paper money. During the mid-17th century, free exchange of paper money and gold led to the development of the Gold Standard.
The Classic Gold Standard system was used by nearly all countries wherein currencies were fixed to a specified amount of gold. Currencies and exchange rates were fixed in terms of gold and most countries had a minimum ratio of gold per currency note. By the turn of the 19th century, all countries except China and parts of Central America were on the gold standard. The Gold Standard ended in 1933 and evolved into an adjustable-peg exchange rate system under the Bretton Woods agreement-attributed as a time when inflation was very low and stable.
The Bretton Woods system, a quasi-gold standard, was adopted after the end of the Second World War. The system was developed at the Bretton Woods Conference in the US in 1944. Political and economic dominance of the US made it necessary for the US dollar to be at the center of the system. After the war ended, the need for stability with fixed exchange rates was seen essential for trade, but a more flexible system than the traditional Gold Standard was desired. The Gold Standard without domestic convertibility was implemented under the Bretton Woods agreement. The US dollar was used as a unit of account, and other countries' currencies were defined in terms of the US dollar. Countries kept gold reserves and could settle in gold, but most countries typically used the dollar to settle accounts and rarely converted into gold.
Although most countries defined their currencies in terms of the dollar, for many years, countries self-imposed exchange restrictions in order to maintain their exchange rates-efforts made to prevent depletion of their reserves. Until the 1950s, major trading countries dropped their exchange restrictions and were officially on an international gold standard. Soon after, there were issues with countries maintaining their currencies' value relative to the dollar-to-gold ratio. Mild inflation in the US developed as too many dollars were issued to keep the gold price at its official price point. Elsewhere in other countries, periodic currency crisis took place where there was poor discipline to maintain official gold convertibility rates. Internationally, the dollar became overvalued and worth more than it’s intended buying power.
The world economy grew rapidly during the era of the Bretton Woods system. Keynesian economic policies allowed governments to dampen economic fluctuations and recessions were generally minor. but strains on the economy started to show in the 1960s The International Monetary Fund was originally designed to help with the exchange process and to help keep initial exchange rates fixed but failed to do so with the invention of the Special Drawing Right" (SDR) as international reserves became inadequate. At this time, the US trade deficit drained US gold reserves and required agreement among surplus countries to raise their exchange rates against the dollar to provide equilibrium.
The London Gold Pool was formed in 1961 is eight nations pooled their gold reserves to keep the exchange rate of $35 (US) per ounce of gold and to prevent the price of gold from increasing. This strategy worked for some time, however in 1968 a two tier gold market was introduced with a freely floating private market and with transactions in the official fixed exchange rate. The two tier system was fragile, and as the US deficit intensified. banks became more reluctant to accept $5 dollars in settlement, As a response to this problem President Nixon closed the gold, window and announced that the US would end on-demand convertibility of dollars to gold for the central banks of other countries, Gold started to freely trickle on the world's markets and the Bretton Woods system collapsed.
The Gold Market Today
Generally, gold considered a safe asset that is ideal for legal currency. In times of economic uncertainty, gold has been a safe-haven. Central banks adjust their gold holdings in response to economic change and during extreme negative market shocks and in crisis periods, gold can act as stabilizing force to hedge against stock loss. Its physical properties make it an ideal currency-it is scarce, indestructible, divisible, homogenous, malleable and portable.
The use of gold as a currency has changed over the last 50 years. In recent times, it has been replaced by fiat money, or cash, which allows for payments between individuals. However, fiat money can be printed out of thin air and in historical financial disasters, hyperinflation has impoverished households with large holdings of central bank currency. Furthermore, most countries require third-party involvement to issue cash-as is the case for central banks and treasuries which hold a monopoly on currency.