For some investors, the gold standard is a hedge against inflation, but others think this model has passed its sell-by date.

The Gold Standard: Out of Date Economic System or Key to the Future?

The Gold Standard: A Key to the Future?

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For the first time in decades, inflation has spiked in developed markets - reaching double digits in many countries. Because of this, calls for a return to a gold standard are getting louder from advocates who say it could keep inflation in check and ensure monetary stability. 

In this article, we’ll look at what the gold standard is, its historical role in the global economy and the pros and cons of the system💸.

The gold standard is a monetary system that dominated the global economy for several decades, but was gradually abandoned during the 20th century.

, it’s a system of currency consisting either of gold coins or banknotes. These can be exchanged for physical gold, as is the case when a country’s central bank either decides, or is forced, to make this swap at a fixed exchange rate.

a currency’s value is directly linked to a specific amount of gold

. Each bank note or coin in circulation is valued in this way, and could theoretically be exchanged for gold at a central bank.

gold standard dollar vs gold coins

To understand why some people want the gold standard back, let’s look at the history of the system. It was first established in the 19th century, an era when precious metals - especially gold - were widely used as an exchange method.

Britain was the first official gold standard nation 🇬🇧. In 1844, the Bank of England adopted the standard, establishing parity between pound sterling and the defined quantity of gold. The currency could only be issued if the nominal value of banknotes was fully covered by gold or government bonds.

Britain’s currency had been volatile for a while, and with gold coins in circulation the standard offered a solution based on economic stability.

Other nations followed Britain’s lead. Between 1870 and 1914 - the onset of the First World War - the ‘Classic Gold Standard’ was internationally established. With leading economies such as the United States 🇺🇸, France 🇫🇷 and Germany 🇩🇪 on board, easier international trade facilitated sustainable growth worldwide.

The graph below shows U.S. GDP growth and inflation during and outside gold standards (Consensus Economics, EcoWin, ING). It demonstrates that during the gold standard periods, inflation was generally lower and more stable compared to the more volatile post-gold standard era.

The graph below shows U.S. GDP growth and inflation during and outside gold standards (Consensus Economics, EcoWin, ING).

After the First World War, the system was largely abandoned. This is because countries faced huge costs of arming themselves for the war, which led to the suspension of the gold standard to enable governments to print more money and fund their military efforts. Inflation soon rose around the world, effectively putting an end to the gold standard system.

When the war ended, countries such as Britain and France desired a return to the gold standard. However, with many nations’ finances in flux - later made worse by the Great Depression of the 1930s - agreement among all countries was impossible.

Things changed again after the Second World War. In 1944, the 

 was established to regulate international economic relations after the conflict. It pegged global currencies to the U.S. dollar, which in turn was convertible to gold at a fixed rate of $35 per ounce. It didn’t end the gold standard, but it did transform it - by creating a modified version of the system with the U.S. dollar acting as a global reserve currency. 

U.S. President Nixon finally brought an end to the gold standard in 1971, when he announced the suspension of dollar convertibility to gold.

gold bars on the world map

What are the benefits of the gold standard?

Why did the gold standard endure for decades, and what are its key benefits? Let’s take a closer look:

 - In the classic gold standard era, countries were able to contain inflation by tying their currency to a fixed gold value. Each coin and note had tangible value, which helped build trust in economic policy and boost global trade.

 - It led to fixed exchange rates and reduced the risk of currency fluctuation. This made international business transactions easier.

 - The gold standard limited the ability to issue currency without a gold counterpart. This helped stop hyperinflation, which can happen when banks print too much money to pump into the economy - often at the behest of governments.

What are the disadvantages of the gold standard?

a man balancing between a hand with a thumn pointing up and a hand with a thumb pointing down

Critics of the gold standard say the system is too rigid. However, they also argue it was never quite as stable as it seemed – but why?

Many experts argue that the gold standard looked good but wasn’t a viable long-term option for economies. The First World War led to the system’s suspension and is the best example of why the framework might buckle under pressure at a time when countries need more money in the short term than the gold standard system allows.

A currency that depends on the fixed value of deposited gold is too rigid - and doesn’t allow flexible responses to economic shocks such as high inflation or recessions.

pamp suisse gold bars on the blue background with a fluctuating line

Alternative economic systems are always a strong topic of debate among experts who believe there may be a better way for countries to shape their financial situation. This is particularly true among some US politicians who regularly point to the perceived success of the gold standard in the past.

They argue gold’s value as a tangible but limited asset could restore financial stability. Proponents also say this system could stop national economies from ‘overheating’ due to relaxed government policy around money supply.

But complexities in the global economy - not least adjustable exchange rates used by individual nations to remain competitive in global trade - mean the return of a common gold standard is unlikely. And that doesn’t even take into account the need for huge international cooperation - which seems unlikely in an era of conflict.

 major financial asset for countries and central banks

, and is used by banks as a way to hedge against loans made to their government. It’s also a helpful vehicle for investors to diversify their portfolios.

relying exclusively on stocks, bonds or real estate can leave your investments vulnerable to volatility

, while gold holds its value. Here are some of the key benefits of investing in gold:

🥇Gold tends to have an inverse relationship with the stock market - its price often rises during economic uncertainty or downturns

🥇Gold could help protect you the value of your investments from being eroded by inflation

🥇While the gold standard is now history, physical gold remains a good long-term savings solution to protect and accumulate your wealth over time.

The gold standard may be a thing of the past, but the debate around it is still going strong among economists. Whether it ever makes a comeback is anyone’s guess, but one thing's for sure—

 It remains a solid choice for investors today. 

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