The monetary system in the United States has undergone many changes throughout history, but many people are confused about what gives the dollar its value. So, is the US dollar backed by gold?
We’ve got the answer!
The United States dollar was once backed by gold, but the gold standard was abolished in 1976, and the dollar became fiat money, which is not linked to any external resources and relies solely on the government’s monetary policy. Monetary policy is set by an independent body – the Federal Reserve.
Many people still think that the US dollar is still backed by gold, but the value of the currency is determined by trust in the stability of the currency, making its value somewhat arbitrary.
But you need to understand why. It’s can also aid your understanding of why fiat currency systems like Bitcoin can fix some notable flaws.
History of The Gold Standard & The US Dollar
For more than 100 years, the United States Dollar was linked to gold reserves, with each dollar representing a physical asset (i.e., gold., But since the 1920s, the dollar was progressively decoupled from it from the 1920s until the government officially abandoned the gold standard in 1976.
People have used gold (as well as silver and other precious metals) as a unit of currency for millennia, and we can find the first instances of using gold for trade in Lydia (in present-day Turkey) as far back as the year 600BCE.
Britain was the first nation-state to adopt the gold as early as 1717 under the Master of the Royal Mint, Sir Isaac Newton. Before this, people merely exchanged coins to pay for things, and the coins themselves carried value.
However, carrying large amounts of gold around is not practical.
Rather, paper money would represent a quantity of gold of a specified value determined by the Royal Mint. In other words, the paper bill represented an asset – gold, even if people didn’t physically exchange the gold.
As Britain became a global superpower of the 19th Century, countries worldwide would adopt their monetary system. However, the gold standard began to present problems due to its susceptibility to volatile market forces.
When the global economy went through a meltdown during the Great Depression, governments began to realize that the gold standard made it difficult to carry out the expansionary monetary policies (adding more money to the system) that were needed to pull the US out of economic devastation and reduce unemployment.
Consequently, the gold standard was abandoned until a global financial framework known as the Bretton Woods system became the norm. Bretton Woods dedicated those countries worldwide would fix their exchange rates to the US Dollar rather than gold.
Central or reserve banks such as the Federal Reserve would be able to exchange their gold reserves at a rate of $35 per ounce and would “peg” their currencies to the Dollar and would therefore have a fixed value representing gold in Dollars.
However, flaws in the Bretton Woods system were exposed when France reduced its gold reserves in the 60s, and the market destabilized, undermining US influence on the global economy.
And, consequently, President Richard Nixon brought an end to the convertibility of gold to US Dollars.
Following a series of small changes to the system that Nixon set up, which was supposed to be temporary, the US officially abandoned the Gold Standard in 1976.
But what is the fiat currency that we use today backed by?
Fiat Money & Floating Exchange Rates
After the United States abandoned the Gold Standard, a new system to determine exchange rates between currencies around the world had to be pegged to something.
When a government sets a specific fixed exchange rate for its currency with a foreign currency or several currencies, this is known as a currency floating exchange rate.
Alternatively, some countries opt for a fixed currency, where its value is pegged to another currency.
This is done to ensure that the value of the country’s currency remains relatively stable, and its competitiveness is safeguarded by the exporting of goods and services, meaning the more a country trades their goods, the more valuable their currency will be, due to an increase in demand.
To buy goods from country X, you need to buy them in that country’s currency and to do so, you need to exchange them at a rate set to a US dollar value.
The US and other major currencies do not use a fixed, pegged currency, like smaller economies whose currencies are less reliable, but rather uses a floating currency.
This means that its value changes according to its performance in foreign exchange markets.
However, this also means that the US Dollar, and every country around the world whose currency is not backed by a stable asset such as gold, derives its value from something more arbitrary – the belief that the currency has value.
It requires confidence in the independent party that issues the currency – The Fed. But what happens when the people using the currency lose faith in the policymakers?
The 2008 Financial Crisis and Satoshi’s Answer
In 2008, the United States’ economy went into free fall after the housing bubble popped. The government’s failure to regulate risky speculation and profit-chasing stock brokers and financiers led to the biggest economic downturn since the Great Depression, which set the foundations for abandoning the gold standard.
These failures in policy to prevent irresponsible market speculation created the Financial Crisis and, in the wake of it, the failure to punish the party’s responsible, along with Quantitative Easing, made many Americans lose faith in the Federal Reserve’s ability to enact sound monetary policy.
What happened next is that an anonymous individual or group of individuals writing under the pseudonym, Satoshi Nakamoto, penned a white paper that could completely overhaul this system with a single point of failure.
Nakamoto’s white paper, Bitcoin: A Peer-to-Peer Electronic Cash System,introduced us to the concept of cryptocurrencies that are built on a framework known as blockchain technology.
Blockchain effectively does the Fed’s job, while putting the power in the hands of the people who use it.
In other words, it is a decentralized currency that can upend the role of central banks who haven’t found a way to stabilize economies, maintain employment or keep the financial system operating during times of crisis.
Bitcoin has the potential to uproot the entire system and put power over it into the hands of the people and not a single authority.
Final Thoughts
Now that you understand what the gold standard is, why it was abandoned and how our currencies are attributed value today, you’re ready to explore the future of currencies – cryptocurrencies like Bitcoin – and the potential for true economic stability that it has.
The Gold Standard was phased out almost half a century ago and, having experienced several market crashes ever since, most notably the 2008 Financial Crisis, it is clear that its time to move on from the incredibly vulnerable free-floating fiat currency system that we use today.
