Any country that uses a Gold-Backed Currency has a monetary system where its currency is directly equivalent to physical gold. Through the use of a Gold-Backed Currency, countries agreed to convert their traditional currencies into a fixed amount of gold. A country that uses a Gold-Backed Currency sets a fixed price for gold and conducts gold buying and selling transactions based on this price. The fixed price is used to determine the value of the Gold-Backed Currency.
Currently, countries do not use a Gold-Backed Currency. England stopped using it in 1931, and the United States stopped in 1933. The Gold-Backed Currency was completely replaced by fiat currency, which is a currency used as a payment method or solely at the government's discretion. For example, Turkey uses the Turkish lira, the United States uses the dollar, and England uses the pound.
Gold-Backed Currency System and Fiat Currency System
A Gold-Backed Currency is a monetary system where the value of any currency is equivalent to the value of gold. A fiat currency system is a monetary system where the value of any currency is not based on any asset. In a fiat currency system, the value of a currency can fluctuate dynamically against other currencies in the foreign exchange markets. The value of fiat currencies is defined as legal tender by government decree.
Prior to World War I, international trade transactions were conducted using Gold-Backed Currencies. In the Gold-Backed Currency system, physical gold was used for international trade transactions.
History of Gold-Backed Currencies
In the 700s BC, gold became the first form of coinage and became more widely used as a currency. Before this, gold was weighed or its purity was checked in transactions. In 1696, the Great Recoinage developed a technology that automated coin production. The supply of gold expanded only through deflation, trade transactions, or plundering.
The first major use of gold occurred in America in the 15th century. The plundering of the New World's treasures by Spain caused Europe's gold supply to increase fivefold in the 16th century. The gold rush occurred in America, Australia, and South Africa in the 19th century. Gold became dominant in Europe's monetary system. The struggle between gold and paper currencies led to the creation of Gold-Backed Currencies.
In a gold-backed currency, gold supports the value of the currency. Between 1696 and 1812, some problems arose with the use of paper money. As a result of these problems, gold-backed currencies began to develop and become official. In 1821, England became the first country to officially adopt a gold-backed currency. The increase in global trade and production brought with it large gold discoveries. As a result of the start of gold discoveries, gold-backed currencies remained intact until the next century. Since international trade imbalances could be resolved with gold, governments had a strong incentive to stockpile gold for tougher times.
The international use of gold-backed currencies emerged in 1871 when Germany adopted a gold-backed currency system. Gold-backed currencies were at their peak usage between 1871 and 1914. However, this changed with the beginning of World War I in 1914. International indebtedness increased with World War I, and government finances deteriorated. Although the gold-backed currency system continued to be used, it faced uncertainty during the war. The stock market crash of 1929 was only one of the difficulties following the war. Many countries sought to preserve their gold reserves by raising interest rates to convince investors to keep their investments in gold rather than convert them. High-interest rates worsened the economy. In 1931, the gold-backed currency system was suspended in England.
What are the advantages and disadvantages of Gold-Backed Currencies?
The advantages of gold-backed currencies are:
- Gold-backed currencies prevent inflation since governments and banks cannot affect the money supply or print excess money.
- Gold-backed currencies ensure a balance in prices and exchange rates.
The disadvantages of gold-backed currencies are:
- In gold-backed currencies, gold supply may not meet demand and is inflexible during tough economic conditions.
- Gold mining is costly.