Croesus, King of Lydians (Asia Minor), has been the symbol of wealth and power since ancient times. 650 BC he implemented his idea of making money from gold by having coins minted which then became official currency.
A new "era" had begun. The new small and handy exchange objects soon spread throughout the cultural area of the then Greek world and the adjoining regions.
Money represents the joint measure of all economic transactions. On the one hand, it is the (interim) means of exchange, which simplifies the exchange of goods (trade) amongst one another and, on the other hand, it embodies the function of the maintaining of value as well as a calculation unit.
Then, as today, money is a generally accepted means of payment prescribed by the state. The Latin word for money is "pecunia" and was derived from "pecus" = cattle.
When browsing through the history books of mankind, different objects (such as incense, wheat, metals, salt, stones, furs, shells, cigarettes, alcohol, paper money, etc.) were used as money medium, depending on the era.
Gold and silver were particularly significant here. This was and is not coincidence, because they are an ideal exchange and value maintenance medium due to their properties.
Wheat is only a luxury item in the event of a famine, but may rot and is thus not durable.
A diamond is durable and beautiful to look at, but arbitrarily divisible and similar.
Gold can be divided and melted arbitrarily and is in limited supply and has been known for centuries.
The history of money can be broken down into several steps, which may be by topic very different, but cannot be held apart in terms of time. In general, we distinguish the following steps: Natural exchange (goods for goods), natural money (a good, e.g. wheat or shells, was defined as money), metal money(full-value coins made from precious metals, expert term face-value coins, inferior to uncovered coins, expert term secondary coins),
cash (covered paper money and coins), as well as bank money is also called bank money (out money today, which is based on the creation of credit).
2. A glance into the past
In old Mesopotamia (3000 to 2000 BC) there was a money system that could be called the predecessor of the gold standard.
To be precise, the name "wheat standard" would be more befitting, because the underlying was not gold but wheat. It was defined that 1 shekel = approx. 170 grains. The word "she" roughly means wheat and "kel" was a measure similar to a bushel.
(The word "shekel" still exists in Hebrew as the name for the Israeli currency.)
Already back then, the attempt was made to define the exchange good (= money) by specifying money to the weight of the underlying (wheat) per unit. However, this money system was unsuccessful because wheat is entirely unsuitable as the underlying for a money system. (rotting, difficult storage, differing harvests, etc.)
In ancient times pieces of metal were finally applied as sign or emblem. Initially, every lump of gold had different measurements and weights, meaning that the value determination of every individual piece had to be re-established when trading; this meant that finally the idea was born to standardise the dimensions and weight of the metal pieces - the coin was born.
The thus minted coins made of gold (and silver) represent a gold currency, because they embody the value of the money in the form of firmly defined gold or silver proportion.
The fact that countries with a gold currency existed longest in history is remarkable.
The Eastern Roman Empire existed after introducing the solidus by Constantine the Great in 324 for more than 12 centuries, the Republic of Venice for half a millennium after starting to mint the ducat in 1284.
When introducing a gold coin currency, Julius Caesar saved Rome from a demise which would have occurred 400 years earlier. Rome only collapsed when the successors to Caesar continuously reduced the gold content of the coins.
Gold or silver coins of that time did not only have many benefits, but also drawbacks. Some drawbacks were the weight, storage and transport - in particular of large amounts over long distances.
Also the many centuries of attempts to dilute and minimise the precious metal content of the coins, had an adverse effect on money stability.
After several attempts, the gold deposit standard was implemented in Europe in the 17th century. It could be regarded as the predecessor of the gold standard, although it involved silver and not gold.
The historic gold standard, which is generally referred to in the publications and vernacular, started its global triumphal procession from England in the 19th century.
Here, an exchange rate set by the state was agreed. The value printed on the paper money was deposited in gold. The paper money was re-convertible at any time back into gold, while the exchange rate was the same.
A gold standard, i.e. a partial cover of the state money by gold, no longer exists globally. Some countries do have gold reserves (e.g.: USA 8,146 tonnes, Germany 2,960 tones, Switzerland 2,590 tonnes decreasing, France 2,546 tonnes, etc.), but they are in no way related or proportional to the relevant national currency.
If must, however, be noted that countries such as Mexico or Russia announced in 2001 to issue official currency money with silver or gold coins. On the internet numerous private providers, such as eGold or eDinar, offer a gold-covered currency on the basis of a clearing account.
2.1. The two forms of the gold standard
In the late Middle Ages, gold coins were the currency with the highest nominal value. Goldsmiths were regarded as particularly suitable to check whether the coins were pure and genuine. In addition, they had stable cassettes, in which they could protect the gold securely from thieves; this meant that private gold was deposited for safety reasons. Goldsmiths issued a receipt for the coins and charged a small safekeeping fee. If the owner wanted his gold back, he redeemed the receipt.
Over time, it was regarded as safer and, in particular, far more convenient to pay open invoices simply with such receipts. This means that the receipts of the goldsmiths became pledges to pay for the promise. And as soon as someone accepted the receipt as payment, he implicitly concluded a purchase agreement with the goldsmith, who thus fulfilled the function of a bank.
Summary: This type of gold standard is the gold deposit standard, where gold or silver was saved in a central clearing office (collection office), which corresponded to a gold coverage of 100%. In turn, the businessmen were issued with a voucher (=money substitutes) in paper form. With this credit, further transactions could be made in terms of accounting or exchanged for other goods and services.
The gold deposit standard, although based on silver, was used by private clearing banks, which played a major role in Venice, Genoa, Nuremberg, Amsterdam and Hamburg from the 17th century. In the 19th century there were more than 30 private so-called "note banks", which all issued vouchers. The Hamburg-based clearing bank (Hamburger Banco) had its own currency for more than 300 years, the so-called "Mark Banco", which was always linked to the specific silver price and thus fully stable.
However, Hamburger Banco nearly collapsed in 1857 when the businessmen had to withdraw silver and the bank was devoided of its precious metal. The crisis was avoided through major silver supplies from Austria-Hungary. A couple of years later, the private bank was closed by the state.
(It must be noted that this currency was simply a calculation currency which was never minted.
Mark was an old German weight measure, approx. half a pound).
A slightly different variant was the Banque Royale in France, founded in 1716 by John Law, which went down in history as the first state central bank. Law promised to cover bank notes with gold. The gold owners (mainly noble men) gave their gold to the bank and received shares in Banque Royale in return. Compared to interest-free gold, the shares promised a dividend. The gold served as the basis of trust for the issue of bank notes (livres). The notes were issued as credit to the state.
A couple of years later, John Law founded the Mississippi Compagnie, whose shares were sold for livres. Their business purposes was to promote the extraction of gold in Louisiana, which was a French colony at the time. In reality, the continuously increasing equity capital was diverted to the state treasury for consumption purposes. The more notes John Law's central bank brought into circulation through state loans, the higher the share price of John Law's Compagnie rose. As all bank notes were used for state consumption, they did not have any real value, except for the original gold amount.
In 1720 the first run on Banque Royale occurred. John Law was forced to undertake exchange control. He banned the private ownership of gold and jewellery in order to increase the gold stock of the bank. But the bank nevertheless went under.
The first central bank with strict rules for the gold cover of the bank notes in circulation was the Bank of England. Established already in 1694, it was forced to compete with private issue bank for the issuing of loans to the British state in the first 150 years of its existence.
Its main competitor was the South Sea Company, which in 1720 redirected the capital flowing out of the Mississippi Compagnie into its own shares. The money was partly invested into some opaque projects and partly in state consumption. The South Sea Company turned out to be as equally dubious as the company on the Mississippi, and its share prices and the trust in pound notes ended in a South Sea bubble.
The Bank of England survived the competition. The issuing of notes was subjected to a strict limit in 1844 as a result of the negative experiences, meaning that notes for a maximum of 14 million pounds were allowed to be uncovered. (Peel's Bank Act). This trust contingent was covered by state securities, but did not have gold as the underlying. Every additional pound could only be issued if purchasing gold.
This resulted in the classic gold standard as the first internationally valid currency system with paper money on a gold basis, with which issuing banks were allowed to issue more vouchers (money) than they held in stock in the form of gold (=partial gold cover).
A 100% cover with gold, as with the gold deposit standard, no longer existed, but a minimum cover was introduced. Gold hence only played the role of a regulative, because it was not possible to lend more than permitted by the cover threshold ("golden break"). We will come back to this later.
When fixing the parity, Sir Isaac Newton made a mistake in 1707 (the gold-silver exchange rate was wrongly calculated), with the result that gold and not silver became the standard.
At the start of 1800, Britain was regarded as the world's leading trade nation and thus the classic gold standard became the global system in the following years, after a short interruption.
Due to the war between Britain and France, which erupted in 1802, the Bank von England had to suspend the gold redemption of its bank notes. The gold prices subsequently rose strongly. (On the real reasons of this process, the banker David Ricardo informed the public in 1810/11 in his famous thesis On the High Price of Bullion.) After the end of the war in 1815, Britain reverted to the gold standard.
Other countries (France, Belgium, Italy and Switzerland) founded on 23.12.1865 in Paris a common coin association, which went down in history as the Latin Monetary Union. 3 years later (in 1868), Greece joined the association. Other countries, such as Austria, Finland, several small European states, some states in Central and South America, the colonies of contracting states, the German Empire (officially in 1873) and other states assumed the rules and regulations of the Latin Monetary Union.
The objective of the monetary union was to create a common money exchange as well as eliminate exchange rate fluctuations in order to establish in the long term a global currency covered with precious metal on the basis of the franc.
An outstanding figure in the 1870s was Britain's Prime Minister Disraeli (in office: 1868 and 1874-1880). It is more or less thanks to him and his connections to the Rothschild family that the international gold standard was established and London became the centre of the international currency system.
It must also be mentioned that the Rothschilds were the world's leading gold dealers.
Another important factor for the success of the gold standard were Britain's domestic policies. The link of monetary and employment policies was little known, the influence of trade unions and socialist parties insignificant. National bankers were able to implement their monetary policy in a strong currency and low inflation without any consideration.
The strict policy of a stable currency gave national banks a lot of trustworthiness. Therefore, they had the opportunity to influence the behaviour of the investors - which was particularly beneficial in times of crisis.
Every currency was - in line with the British model - simply a national name for a certain amount of gold, while the gold price (per troy ounce) was specified by the intervention policy of the Bank of England at its London gold market. It remained (unchanged) for nearly a century at 3 pounds 17 shillings and 9 pence.
(parity rate: 1 kg of gold = £ 136.57 = M 2,790 or £1 = M 20.43).
This resulted in fixed, unchangeable exchange rates of the currencies amongst one another.
This means that there was a global currency, gold, which was circulated as different paper money throughout the world, but interlinked through fixed exchange rates.
With a gold content of the pound of 9 grams of gold and of the thaler of 3 grams of gold, everybody knew that 3 thalers = 1 pound and 1 thaler = 1/3 pound remained such, because the monetary laws could be changed by parliaments but not by markets.
It must again be pointed out here that not money but gold is the measure.
Money is measured by gold and not the other way round. (Money was always devalued compared to gold, an increasing amount of money units had to be handed over per gram of gold.)
The gold standard was until 1914 a guarantor for international stability, stable prices and full employment for nearly a century.
The gold standard's stability was based on the strict compliance with national laws and cover provisions and the trust of the world of finance in the reliability of the system.
This is all the more remarkable as there were no international regulatory and monitoring authorities (IMF, World Bank, etc.).
(A couple of interesting calculation examples regarding gold then and today can be provided by Dr Timmermann.)
In addition, it should be mentioned here that employment rose and unemployment decreased during the era of the gold standard. Unfortunately, as the images prove, this fact is often presented differently.