Throughout history, gold has always played an important role in the international monetary system. The earliest known use of gold was in 645 B.C. in Lydia (present-day Turkey). At that time, gold was part of a naturally occurring compound known as electrum, which the Lydians used to make coins. By 560 B.C., they figured out how to separate the gold from the silver, thus creating the first truly gold coin.
There was a time when paper money was backed by gold in the United States, a time known as the gold standard. The gold standard was essentially a promise that if you had a dollar, you could take it to the government at any time and trade it in for a fixed amount of gold. In the early part of the 20th century, all of the world's key economies were on the gold standard.
What is the gold standard?
The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold. By the mid-1800s, most countries wanted to standardize transactions because the world trade market was booming. In turn, they adopted the gold standard, which guaranteed that paper money could be redeemed by the government for its value in gold.
There is no government in the world today that still uses the gold standard. The gold standard was completely replaced by fiat money, which is currency that a government declares to be legal tender but is not backed by a physical commodity.
Why the United States abandoned the gold standard
During the Great depression, the U.S. government found that there was little they could do to stimulate the economy. When the stock market crashed in 1929, investors began trading in currencies and commodities. As the price of gold began to rise, people started trading in their dollars for gold. The situation got worse when the banks started to fail and people started hoarding gold because they no longer trusted financial institutions.
The Federal Reserve continued to raise interest rates in an attempt to make the dollar more valuable and to discourage people from further depleting the U.S. gold reserves. The higher interest rates were worsened by the Great depression, making the cost of doing business more expensive.
On March 3, 1933, President Roosevelt closed the banks, and by the time the banks re-opened 10 days later, they had turned in all of their gold to the Federal Reserve. At that point, people were no longer able to redeem their dollars for gold. On April 5, 1933, President Roosevelt ordered all Americans to turn in their gold coins and certificates in exchange for paper currency. Americans were required to deliver all gold coins, bullion, and certificates to the Federal Reserve by May 1st for a set price of $20.67 per ounce. By May 10, the government had taken over $300 million in gold coins and $470 million in gold certificates. This created the gold reserves at Fort Knox.
End of the gold standard
In 1934, the government price of gold was increased to $35 per ounce. It stayed at that price until August 15, 1971 when President Nixon announced that the United States would no longer convert dollars to gold at a fix price. This is when the United States completed abandoned the gold standard. In 1974, President Ford signed legislation that allowed Americans to own gold bullion again.
Although the United States no longer operates using the gold standard, gold never lost its appeal as an asset of value. Whenever a recession or inflation looms, investors still turn to gold to help them protect their assets.
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