History of Gold as Money

Gold was money in ancient Egyptian times. It has historically been money due to its “hardness”. Hardness does not mean physically hard, it means hard to produce. It is hard to mine gold from the ground. This means that the global supply of gold increases by less than 2% per annum.

Banknotes – receipts for gold

In the 16th century, banks started issuing banknotes as receipts for gold deposited at the bank. These receipts carried the words “I promise to pay the bearer on demand the sum of …”. Whoever presented the banknote (the bearer) to the bank could exchange it for the appropriate weight of gold.

Goods and services were purchased using banknotes. The gold held at the bank backed all the banknotes in circulation. The numerical value of the banknote represented the weight of gold. So the new bearer of the banknote could claim the gold.

Central banks & the gold standard

Governments granted monopolies on issuing a nation’s money to central banks (such as The Bank of England & The Federal Reserve) at the end of the 19th century and beginning of the 20th century. The nation’s central bank backed the money in circulation with the gold that it held. International trade boomed in the 19th century because this “gold standard” meant that the money of many nations was redeemable for gold.

Many countries came off the gold standard during the first world war. The war was paid for by printing money without increasing the amount of gold backing it.

The UK government tried to return to the gold standard after the war, but was eventually forced to abandon it in 1931. This was because a large amount of money was exchanged for gold. This happened because the total value of the all the money in circulation was more than the total value of all the gold held by the central bank after printing money to pay for the war. Hence people preferred to hold gold instead of pounds because the gold was more valuable than the corresponding money. This is a “run on the bank”. People exchanged their money for gold, as nobody wanted to be in the queue after the gold had run out.

In 1933 Roosevelt outlawed private ownership of gold, effectively ending the gold standard in the US. After the second world war, the US promised to exchange dollars for a fixed amount of gold. But the gold standard was eventually abandoned in 1971 in order to print money for the Vietnam War and avoid large amounts of dollars being exchanged for gold.

Money without gold = inflation

The dollar has not been backed by gold since 1971. The price of gold has risen from about $40 to $4,000 per troy ounce since then.

The word “inflation” means rising prices, but it used to mean an increase in the volume of money in circulation. An increase in the volume of money in circulation causes rising prices. Hence the meaning of the word “inflation” has changed from describing the cause to the effect. This change in meaning obfuscates the cause of rising prices, which is money printing.

“The value of a sound money (gold) is that it prevents planners from redistributing the wealth and savings of the productive classes to the political classes in order to finance expensive unproductive agendas – or from depleting the savings of fixed income earners, or the wages of the poor” Alan Greenspan, Federal Reserve Chairman: 1987 – 2006

Hence, an increase in the volume of money in circulation increases the gold price.