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A country's monetary system[?] is said to be on the gold standard when paper currency is backed by gold. This means that money represents gold: coins are made of the corresponding amount of gold, and/or coins and notes represent an amount of gold held in a vault somewhere.

If all circulating money can be represented by the appropriate amount of gold, then this is known as a 100% reserve gold standard, or a full gold standard. In truth there is no other form of gold standard, since on any "partial" gold standard the value of circulating representative paper in a free economy will always reflect the faith that the market has in that note being redeemable for gold.

The commitment to maintain gold convertibility tightly restrains credit creation, because doing so would be to commit fraud. Credit creation by banking entities under a gold standard threatens the convertibility of the notes they have issued, and consequently leads to undesirable gold outflows from that bank. This is caused when people realise that the bank notes are, in a sense "oversold", and go to redeem their notes for their printed face value in gold - if they are quick enough.

Hence, notes circulating in any "partial" gold standard will either be redeemed for their face value of gold (which would be higher than it's actual value) - this constitutes a bank "run"; or the market value of such notes will be viewed as less than a gold coin representing the same amount.

Traditionally, the gold standard was not limited to one or two countries; it was an international system. With gold as money, international trade was conducted much more smoothly than it is now. With a gold standard, or indeed, with any money based on specie, traders and travellers need not constantly be concerned with losses they may suffer from exchange rate fluctuations. This also means that in a worldwide gold or specie standard, poor countries are not at the whim of international currency speculation. Those living in poor countries can instead depend, from year to year, on the value of their exports, the cost of their imports, and interest on their debts. With a specie or gold standard, poor countries are not at the whim of the currency manipulation of governments of more wealthy nations.

It is common to speak of the "collapse" of the gold standard, with the implication that the gold standard did not work. In fact, governments abandoned the gold standard because it worked precisely as it was supposed to: it prevented governments and their central banks from surreptitiously diverting wealth from its rightful owners to themselves.

The primary effect of a gold standard is to limit inflation and deflation, since it prevents unlimited government deficit spending[?]. The gold standard, as with any specie money, is a currency mechanism in which the amount of circulating currency is not based on government whim, but on the production of intrinsic value in the economy.

The constitution of the United States, a document written in 1787 designed to protect the people from the tyrrany of government, contained in Article One, Section 10, Clause 1 introduced by Roger Sherman at Constitutional Convention, the words as follows:

“No State shall ... coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; ....”

The United States dollar started on a bimetallic standard which was effectively a silver standard[?] and switched to a gold standard in 1901 (see Gold Standard Act). Starting in 1933, U.S. currency was no longer directly convertible by individuals to gold and the possession of gold by individuals for investment purposes was made illegal. Transfers of gold were still used to settle liabilities between central banks.

Starting in the 1950s, the United States began running persistent trade imbalances which created liabilities in the United States to other central banks, and beginning in the early 1960s, the United States no longer had sufficient gold to cover liabilities to other nations. To help alleviate this problem, the United States Congress on March 18, 1968 repealed the requirement for a gold reserve to back US currency. But US dollars could still be converted to gold. This became a serious problem in the early 1970s when a lack of confidence in the U.S. dollar led to mass conversions to gold. As a result, the United States went off the gold standard on August 15, 1971 when Nixon announced that the United States would no longer convert dollars to gold at a fixed value.

Nixon's move to cease allowing foreign Governments to redeem dollars for precious metal was the final act in a 150-year-long 'transfer' of the citizen's gold and silver to the Federal Government's vault. This allowed the U.S. Government to have much more freedom in determining the rate of printing and volume in circulation of its fiat currency.

The gold standard is supported by advocates of Austrian Economics[?], Monitarism[?], Objectivism, and even the anarchic proponents of Libertarianism.

Opponents of the gold standard argue that an expanding economy with a supply of gold that inceases more slowly than the economy expands would cause a tiny, but steady, deflation. Gradual deflation by itself is not a bad thing, but it is imagined by gold standard opponents that this gradual deflation would throw the economy into recession. However, this has already occurred for about a century, and the gradual deflation did not cause a recession.

Due to the gold standard in Britain throughout the 19th century there was a steady small deflation, which is a gradual increase in the buying power of gold. During the 19th century the rate of growth of the British economy was around 7% p.a., but the gold supply only expanded by around 5-6% p.a. during that time. This meant that as time went on the same weight of gold had more purchasing power. As a result of this effect, by the end of the 19th century the gold price of goods in Britain was around half what they cost at the beginning of the century. Britain, far from suffering a continuous recession, was unarguably the worlds strongest economy during the 19th century while on the gold standard.

See also: bimetallic flow[?]

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