Technology, Money & Questions

Gold had always held its superior place through out the history of civilizations mostly because of its rarity blended with its purely superior properties. It is hard, yet malleable enough to hammer it into a really thin leaf. Ancient Egyptians were very good at hammering gold into really thin leaves, it took 3,67,000 leaves to make a one inch pile. Even in the very early civilizations, people had made jewelry and other ornaments. From the Mesopotamian civilization to this 21st century, people around the world are still mesmerized and go behind gold. Very convenient, not sure whether we've got anymore place left to dig for gold.

Gold also served two other important purposes:
1) Gold as the currency of a nation - gold coins
2) Representative currency of a nation - currency backed by gold

Those countries who started using gold as a currency had hit the wall in no time because of the limited availability of gold. Most of the countries also used silver as a medium of currency. Nevertheless, all of them realized the fact that all these limited natural resources cannot be used for something very fluctuating in demand like currency. So, the majority of the world countries started to adopt the Gold Standard.

Enough with the introduction. Now, What actually was the GOLD STANDARD?

An economy which backed its paper currency with gold was said to follow the gold standard. In such an economy, at any given time, people can redeem their paper currency for gold.

To be more precise, the paper currency derived its value from the gold reserve. A country under the gold standard would set the price for gold, for example Rs.1000 for 1 ounce of gold. This effectively sets the value of the currency; as per this example, 1 rupee would be worth 1/1000th of an ounce of gold.

Advantages:

1) Since the actual currency is backed by equivalent gold, the government cannot go on a printing spree or rather the cash flow in the economy is controlled by the availability of the gold reserve. This normalized the inflation in the economy over a long run.

2) Introduced the first use of formalized exchange rate in history. The exchange rate under the gold standard monetory system is determined by the economic difference for an ounce of gold between the two currencies.

Disadvantages:

There were actually more disadvantages than the notable advantages brought by the gold standard.

1) Because of the limited availability of gold, a country on gold standard cannot take control on the fluctuation of demand for currency internally.

2) A gold standard severely limits the stabilization policies the Federal Reserve can use. For example, most economic recessions can be mitigated by increasing the money supply into the economy. When the currency is backed by gold, a limited natural resource, no stabilization activities could be done.

3) Inflation or deflation in the economy solely depends on the production rate of gold in a particular country.

Luckily, soon after the revival of the Great Depression the world countries realized the flaw in the system and moved out of the gold standard. Now, none of the major countries follow gold standard. Still, gold is one of the main commodity every country keeps in reserve and humans are still fascinated by this precious metal.

P.S.
I could not even imagine how USA would have handled the recent economic recession if it still followed the gold standard. How many tons of gold they should have had in reserve in order to print 1.7 trillion dollars? Can you imagine?