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Dobra: The rise and fall of the gold standard
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Dobra: The rise and fall of the gold standard

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I recently had the honor of addressing the Hayek Group, named for Nobel Prize winning economist Friedrich von Hayek whose most famous book The Road to Serfdom published in 1944 is considered a classic. The topic of my presentation at the historic Piper’s Opera House in Virginia City, Nevada, was the “Lure of Gold,” a commentary and explanation of the role Virginia City played in shaping the world’s monetary system.

In keeping with the governor’s COVID-19 orders, the presentation was given to a maximum crowd of 50 people. Below is a summary of my presentation.

The lure of gold is one of the world’s oldest obsessions, captivating everyone from ancient civilizations to untold royalties and it continues as strong as ever today. The precious commodity has been actively “mined” for more than 7,000 years, and people have been “goldsmithing” for at least four millennia, making jewelry and objects of fine art.

Gold becomes the standard

The first monetary use of gold dates back to the Lydians who lived in western Anatolia (modern western Turkey) around 400 B.C. Philip II of Macedon, who ruled Macedon between 359 B.C. and 336 B.C. was an early ruler to stamp his image into gold coins, a practice still used by monarchs and heads of state throughout the world today. Gold mining is still going strong in today’s modern-day Macedonia.

The coinage of gold, silver and other metals would only grow over the next two millennia, primarily because of the intrinsic value and scarcity of the metals. Coins could be divided into several pieces, which is where the expressions “pieces of eight” and “two-bits” originates. The coins would be split or shaved and sold by weight.

As the years went by, and economies grew during the 17th and 18th centuries, a constant complaint was the shortage of money that abounded. With a fixed quantity of gold and silver available to mint into coins, rising output caused constant deflation. This often led to liquidity crises or financial panics. The relative scarcity of gold compared to silver led most countries throughout the world to establish a silver standard, such as Pound Sterling used in the United Kingdom.

It was not until famed scientist Sir Isaac Newton was appointed Master of the British Royal Mint in 1696 that the roots of the gold standard were planted. It was largely an honorary job because he had invented calculus and his laws of physics, but he apparently took the job seriously. Based on what he thought was the crustal abundance of the metals, he set the value of gold at 16 times an ounce of silver. This turned out to overvalue gold relative to silver and gold flowed in to England and silver flowed out. England was soon on a de facto gold standard in spite of the fact that the Pound Sterling was its official currency.

Because of Newton’s calculation error and Britain’s economic and military dominance for the next two centuries, its capital city of London evolved into the largest gold market in the world, a title it still enjoys. Today, virtually all gold trades around the world, whether they are in Dubai, Hong Kong or New York, are cleared or settled in London or, as they say, “in loco London.”

Gold and the U.S. government

A little more than a century after Newton walked the streets of London, the First National Bank of the U.S. was established by Secretary of the Treasury Alexander Hamilton and the U.S. Congress. A monetary system for the young nation was established with a gold standard and set the value of a U.S. dollar at about $20 per ounce of gold and $1.25 per ounce of silver – a 16 to 1 ratio following Newton.

For the next three decades the U.S. operated under a gold standard, but the scarcity of gold in the growing economy became a persistent problem because of commodity price deflation, falling farm commodity prices, farm mortgage foreclosures, and reoccurring financial panics.

In 1832 Congress reauthorized the Bank of the United States which had regulated banks and the monetary system, but President Andrew Jackson, a westerner representing farmers, vetoed it. This ushered in the era of “free banking” where banks, without regulation, could issue their own paper currency, supposedly backed by specie, but it frequently wasn’t or, at least, not backed adequately. Runs on banks and bank failures were commonplace and farmers, who were mostly Democrats, suspicions of banks and bankers was intensified. In essence, the American monetary system was in shambles.

The discovery of gold in California in 1848 temporarily alleviated the financial crisis in the U.S., due to the increased gold supply, and the gold of the American West helped facilitate the financing of the Civil War. The California gold rush also spurred rapid economic growth after the war’s 1865 conclusion.

Virginia City’s Big Bonanza

Known as the largest silver discovery in the United States, the Comstock Lode produced more than 900 million ounces of silver and 8 million ounces of gold between 1870 and 1900. Such a massive increase in the world’s supply of silver led to the price of silver to drop from $1.25 to $0.25 per ounce. This had a significant impact on countries on a silver standard, and devalued their currencies by 80 percent, setting off massive commodity price inflation. Newton’s 16-to-1 ratio soon shifted to 80-to-1, and by 1880, most countries in Europe were forced off the silver standard and onto a gold standard.

The era of the classic gold standard which was instigated by Nevada’s Big Bonanza lasted until it was suspended during World War I.

Following WWI, the debate over the gold standard and monetary policy continued on both sides of the Atlantic. A prominent voice in the debate was provided by John Maynard Keynes, a British mathematician and economist who advocated elimination of the gold standard altogether. Keynes argued that the problem with the gold standard had remained the same for centuries: limited supply led to continuing bouts of deflation, financial panics and instability.

During the inter-war period, most countries adopted the use of convertible notes, such as the “silver certificates” by the U.S. Federal Reserve. While the gold standard was still in use at this time, it was largely symbolic.

After WWII, the gold exchange standard was instituted by the Bretton Woods agreement, providing for gold to be exchanged between the central banks of signatory countries. In 1971, President Richard Nixon suspended gold payments by the Federal Reserve to stop gold from leaving the country. The gold standard had effectively been eliminated. Nixon told other countries that if they wanted to redeem their US dollars, they could bring them here and spend them.

Gold may no longer be “money” in the sense of a common medium of exchange, but it is still a store of wealth – which is another important function of money. In the last year gold and many gold stocks have shown a much better rate of return than the stock market. But that is a temporary situation and somewhat illusionary. Even at over $2,000 per ounce, the real, inflation adjusted price is still below its price in 1980.

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