Essay: The Pros & Cons of the U. S. Gold Standard: Reduced Inflation & Bank Runs?



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Tyler Patton

History/Literature

Mr. Meents

12/3/18

The Rise and Fall of the Gold Standard in the U.S.

The use of the gold standard had a major impact on the U.S. economy and its effects can still be seen today. The true gold standard lasted in the U.S. from 1879 to 1933. It was most effective at keeping inflation rates low in the long run, but it was unable to protect against sudden surges of gold that would have massive effect on prices. There were pros and cons to keeping an economy based on the gold standard. The cons, however, outweigh the pros.

The monetary system currently established in the U.S. uses money that is not backed by anything but faith in the federal government to give it value, but t first this was not the case. When the U.S. first instituted a currency, it was backed by gold and silver. This was a bimetallic standard, meaning the dollar was backed by two metals, gold and silver. In a dollar the ratio of gold to silver was fifteen to one. This ratio lasted from 1792 to 1834. In 1834 the ratio changed to 16:1, lowering the worth of silver in the United States. Business men and banks saw this as an opportunity to send the silver abroad to foreign countries that have higher values for it and use the gold in the U.S. where it is more expensive. This led to a major decrease in silver coins over the following years, and gold coins became the main currency in day to day transactions in the U.S.

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The entrance of paper money allowed for easy exchange and was a step toward a true gold standard. During the years leading up to the civil war (1861-1865), paper bank notes became a common means of exchange, almost as much as coins. Bank notes were issued by banks and could be redeemed for a specified amount of gold or silver. The bank would take the gold and silver that was deposited and use it on interest earning investments. These notes were not seen as legal tender by the U.S. government and were only backed by the banks that gave them out. This was an unofficial monetary system that closely resembles a modern gold standard.

The monetary system we use today is fiat paper money and it first had its start in 1862. During this period of the bloody civil war, the U.S. government found it difficult to convert treasury notes into gold and silver. This caused them to turn away from the gold standard for a short period and to try there hand at fiat money. This money was backed by nothing but the credit and faith in the U.S. government. It was not able to be converted to any amount of gold and silver by the government. You could, however, go into a marketplace and use it to buy gold or silver at a higher price that is set by the seller. During the war the fiat paper money, commonly called greenbacks, were mass produced to keep up with the war expenses causing massive amounts of inflation. Once the war was over, the government started to go back to money backed by gold and silver. This was done by slowly taking the greenbacks out of circulation. The made the value of greenbacks rise till they could be converted to gold. Once this was done the greenback were backed by gold and were no longer fiat money. The fiat paper money was out of circulation for now.

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The first true gold standard finally began in 1879 when U.S. money could only be exchanged for gold. The change to a true gold standard started with the new mint for a silver dollar in 1873. This led to silver becoming its own coin and not and not sharing value with gold.  Also greenbacks became the only thing you could change greenbacks for. Many producers of silver soon saw there industries failing in the U.S. and fought against this change. In 1878 the government agreed to have the treasury purchase a certain amount silver coins each year. The treasury paid for these coins with silver certificates that could be exchanged for silver or gold. With the value of silver plummeting in the United States, banks and businessmen sent all their silver abroad for investing. The dual role of gold and silver had finally passed.

The true gold standard in the U.S. made its mark started in 1879 and lasted till 1933. Gold was now the only substance that paper money could be turned into. There were four main types of paper money that could be converted to gold, the greenback, treasury note, bank note, and gold certificate. To firmly establish its commitment to the gold standard, the government put in action the Gold Standard Act in 1900. This act stated that all U.S. currency could be converted to gold and treasury notes were to be taken out of circulation. It stated that the government would issue its own paper money that could be converted to gold, the first dollar bill. The gold standard was in full use.

There were pros and cons to this period in American history. The greatest appeal to having a gold standard was that it had a very low rate of inflation. If large deposits of gold are found, however, than this would lead to dramatic inflation that would cause all prices to rise since everything’s price is based on the worth of gold. Another pro of having a gold standard is

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the certainty in having something physical back up the worth of the dollar. This gives the people a sense of security that their money will retain its value. Possibly the biggest con of all is that the gold standard makes banks venerable to bank runs. A bank run is when a large sum of gold is needed from an account. Most of the money that is deposited into the bank is invested for profit elsewhere, so the bank sometimes will not have enough cash on hand to pay. When someone sees another have trouble getting his money from the bank, he gets worried. This causes him to also withdraw his money fearing that the bank had lost it or was not handling it right, and when he too cannot get all the money he wants someone else may see this and fear the same. This chain reaction can be crippling to banks. To combat this problem the U.S. government created the Federal Reserve System which would allow the banks to loan money from the government to deal with these quick notice withdraws, yet it could only handle a certain amount. Sadly, the cons of the gold standard outweigh the pros.

Due to the banks failure to cash all the checks during bank runs and the Federal Reserves System’s failure to remedy this problem the U.S. was forced to abandon the gold standard in 1933. During the great depression there were massive bank runs that were shutting down banks nationwide. Everyone was in fear of losing their money. The Federal Reserve System just had no way of supplying enough money to the banks. One study says

“For the Fed to generate enough cash to meet the public’s changed demand for it, it would have had to create much more money and to lower interest rates. Lower interest rates, however, would have sped up the export of gold from the country as investors looked abroad for higher returns. Creating more paper money, moreover, would have created doubts about the ability of the United States to remain on gold. The greater these doubts, the greater the incentive to export gold, reducing gold reserves, and making it harder to maintain the dollar at its legal gold value.”(gold-standard.procon.org)

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The U.S. government realized they would need to quickly change there monetary policy if they were to keep the economy going, so they abandoned a true gold standard.

The years that followed the end of the gold standard still held onto some remnants of the gold standard as the government transferred to an economy fully based on fiat money. Cash was no longer able to be converted to gold but the dollar was still measured in gold. The only payments that were in gold were international. The fiat money took full control when in 1976 President Nixon took away all links of the dollar to the price of gold.

With the gold standard gone, some still call for its return. The rate of inflation increased with the full transfer to fiat money. With the gold standard the inflation rate usually stayed below 3%. With fiat money, however, the inflation rate would sometimes go higher than 5% and rarely went below 3%. Many struggled with the high inflation rates during the first two decades, but during the late 90’s the inflation rate began to settle at a comfortable level.

During the upbringing of the United State’s growing economy the gold standard marks an important part in its history. Gold was part of the U.S. currency long before there was a gold standard and it still had an effect once there was no gold standard. The rise and fall of the gold standard it an important lesson on the history of the United states economy.