If you’ve ever heard the term gold standard, you might understand its current meaning but wonder exactly where it comes from and what it originally meant. In this article, we explore the precious metal’s previous role in monetary systems, what’s happening now and how that might change in the future.
We’ll explore the gold standard, the current relationship between it and economies, and the patterns that could point towards a revaluation of the precious metal. Keep reading to find out what all of that means to investors and potential buyers.
The Gold Standard
We now use the term gold standard to mean an excellent example of something or the pinnacle of a profession, practice, or product. However, the phrase actually comes from a more literal use. In the past, many countries across the world used the gold standard in their financial system. The value of a country’s currency was directly linked to gold.
The Rise
Countries with precious metals used the assets for trade. However, in the 18th century, paper money began to dominate day-to-day transactions. To set and establish the value of paper money, it had to have an equivalent value in gold or silver. By 1821, that arrangement became official, and the gold standard was adopted in England. It later spread to Germany and the US.
The Fall
However, World War I brought about changes to political alliances, and the gold standard didn’t work the way it once did. A stock market crash followed. England suspended the gold standard, and the US and France were the last to hold large reserves. A revaluation of gold by the US in 1934 devalued the dollar.
Following World War II, the Bretton Woods Agreement was drawn up, linking all national currencies to the US dollar, which still used the gold standard. By 1968, the market was determining the price, and only central banks could trade with the US for gold. By 1971, this system was no longer working, as countries simultaneously wants to cash in their dollars for gold, and the system ended.
Fiat Currencies and Gold
Today, the term fiat currency is used to describe our currencies, and often to differentiate it from crypto. Fiat is actually the system that came in after the gold standard, where the monetary system isn’t backed by a physical commodity, but by the government that issues it.
The value of fiat currency comes from supply and demand. Without the backing of a physical asset, this system is more at risk of losing value. Inflation and hyperinflation, due to printing too much money or other events, are what can cause a currency to become worthless.
The Move Away from Gold
Fiat currency was chosen because it gives governments and central banks more control over its supply, and, as a result, their economies. Gold, on the other hand, is a fixed resource that is scarce. Using a precious metal relied on mining to keep pace with demand. It lacked the flexibility that wasn’t required during difficult economic times, as seen during World War I.
Moving Back Towards Gold
Now, precious metal is still a major financial asset used by countries and central banks. Although there isn’t a gold standard, there’s potential for the precious metal to find a new role in our monetary systems. It’s used to hedge against loans and is used to indicate economic health.
Returning to the gold standard is unlikely, as that system was flawed. However, the use of the precious metal for trade or as a currency is something that could be considered. Recent events haven’t taken us quite that far, but they have amounted to a shift, if not a revaluation, of gold’s role in our monetary systems.
Basel III
Basel III regulations came into effect in 2023. They were set by the Basel Committee on Banking Supervision and were established in response to the 2007-2009 financial crisis. The latest change has reclassified physical gold from being a risky tier-three asset to a tier-one asset, which is zero-risk.
This move puts it in the same class as currencies and cash. It’s likely that the new risk-free status could encourage banks to buy more gold, and it looks like central banks are already increasing purchases.
Allocated and Unallocated
Paper gold, often referred to as unallocated, might have more than one owner. The bank keeps it and several people invest, with the bank ‘owing’ them the gold.
Allocated gold is the physical asset, where specific coins are bars are assigned to one owner. The recent move has made a clear differentiation between paper (unallocated) and physical (allocated), with the former being riskier.
Gold-Buying Trends and What It Means
Sometimes it’s necessary to look back to get a clearer understanding of our current situation. It can also help us make educated guesses about the future. In the past, the gold standard only lasted for around 50 years, which has many questioning whether it’s a workable system. If the precious is used as a commodity tied to currencies to prevent inflation, reforms will undoubtedly be required.
On the other hand, we might see unofficial moves towards revaluing gold. Central banks and other parties are showing more interest in buying up gold. It’s not certain whether prices will become more volatile, but it seems likely that the physical asset will once again be more appealing than paper or unallocated gold.
The Bottom Line
While some view recent changes as a step closer to something similar to the gold standard, others think that it won’t have an effect. It remains to be seen how gold could be revalued, but those who think that prices are likely to rise are making their investments sooner rather than later.
