The history of gold as money spans thousands of years and has played a pivotal role in the economic and cultural development of numerous civilizations. Throughout history, gold has been valued not just for its beauty and rarity but also for its durability and divisibility. Its role as money has evolved over time, but its significance in the global economy remains undiminished. Here’s a historical overview:
Ancient Civilizations (circa 600 BC):
- The first recorded use of gold as money was in ancient Lydia (modern-day Turkey) around 600 BC. The Lydians used electrum, a naturally occurring alloy of gold and silver, to mint coins.
- Ancient Egypt also valued gold highly, not just as a form of wealth but also for its spiritual significance. They buried their pharaohs with gold artifacts, believing it would help them in the afterlife.
- The Roman Empire adopted gold as a primary form of currency. The aureus, a gold coin, was introduced in the 1st century BC and was widely used throughout the empire.
- The Greeks also used gold coins, with the most famous being the drachma.
- With the fall of the Roman Empire, the use of gold coins declined in Europe, but it continued in the Islamic world. The Byzantine Empire also continued to use gold coins like the solidus.
- In the late Middle Ages, European countries like Italy and the Netherlands reintroduced gold coins.
Renaissance to 19th Century:
- The discovery of the Americas, especially the gold from the New World, led to an influx of gold in Europe, causing inflation but also facilitating trade and the rise of new economies.
- The 19th century saw the adoption of the Gold Standard by many countries. This meant that the value of a country’s currency was directly linked to a specific amount of gold.
- The Gold Standard was abandoned during the World Wars due to economic pressures. Countries needed more flexibility in their monetary policies, which the Gold Standard didn’t allow.
- In 1944, the Bretton Woods Agreement established the US dollar as the world’s primary reserve currency, linked to gold. However, this system ended in 1971 when President Richard Nixon announced the suspension of the US dollar’s convertibility into gold, leading to the era of fiat money.
- Today, gold is no longer used as a primary form of currency in daily transactions. However, it remains a crucial reserve asset for central banks and is considered a safe-haven asset, especially during economic downturns.
- Gold is also used as a hedge against inflation and currency fluctuations.
Competing Economic Theories
Keynesian and Austrian schools of thought represent two distinct approaches to economic theory and policy, especially when it comes to the role of gold and broader economic principles. Keynesian theory is what the majority of today’s economies are centered around. Right or wrong, facts. Here’s a comparison of their views:
Role of Gold:
- Keynesians: View the gold standard as a “barbarous relic” that restricts the ability of governments and central banks to manage economic downturns. They believe in the flexibility of fiat money systems.
- Austrians: Generally advocate for a return to a gold standard or a commodity-based monetary system. They argue that gold provides a stable and reliable form of money that prevents inflation and economic distortions.
- Keynesians: Believe in active monetary policy to stabilize economies. They argue that central banks should adjust interest rates and the money supply to manage demand, employment, and inflation.
- Austrians: Are skeptical of central bank interventions. They believe that artificial manipulation of interest rates can lead to malinvestments and economic booms and busts.
- Keynesians: Advocate for active fiscal policy, especially during economic downturns. They believe in government spending to stimulate demand and address unemployment, even if it means running deficits.
- Austrians: Emphasize limited government intervention in the economy. They are generally critical of deficit spending and believe that the market should correct itself without government interference.
Business Cycle Theory:
- Keynesians: Believe that business cycles can be managed through government and central bank interventions. They see recessions as failures of aggregate demand that can be addressed through policy.
- Austrians: Attribute business cycles to central bank interventions, especially artificially low interest rates. They believe recessions are necessary corrections to prior malinvestments.
Role of Government:
- Keynesians: See a significant role for government in managing and stabilizing the economy. They believe in regulations, interventions, and social safety nets.
- Austrians: Advocate for minimal government intervention in the economy. They emphasize individual freedom, property rights, and the importance of sound money.
Views on Inflation:
- Keynesians: Tend to be more tolerant of moderate inflation, especially if it’s seen as a trade-off for higher employment. They believe that deflation can be harmful and should be avoided.
- Austrians: Are highly critical of inflation, viewing it as a hidden tax and a distortion of economic signals. They believe that sound money (like gold) is essential to prevent inflation.
More on Keynesian Economic Theory
Keynesian economics, named after the British economist John Maynard Keynes, emerged in the 1930s as a response to the Great Depression. Keynesian economists are generally critical of a strict gold standard, believing it limits the tools available to address economic downturns and can lead to deflationary pressures. They advocate for a more flexible monetary system that allows governments and central banks to actively manage economies to achieve full employment and stable prices. Here’s how Keynesian economists generally view gold:
Gold as a “Barbarous Relic”:
Perhaps the most famous quote from Keynes regarding gold is that the gold standard is a “barbarous relic.” By this, he meant that the gold standard was an outdated system that unnecessarily constrained modern economies. Keynes believed that tying a nation’s currency to gold limited the ability of governments and central banks to use monetary and fiscal policies to address economic downturns.
Flexibility in Monetary Policy:
Keynesians argue that a gold standard restricts the flexibility of central banks in setting interest rates and conducting open market operations. This flexibility is seen as essential for stabilizing economies and addressing unemployment. They believe that in times of economic downturn, it’s crucial for central banks to lower interest rates and for governments to engage in deficit spending to stimulate demand. A gold standard could hinder these actions.
Under a gold standard, if a country faced a trade deficit, it might have to use its gold reserves to settle imbalances. This could lead to a reduction in the money supply, causing deflation (a general decrease in prices). Deflation can increase the real burden of debt and discourage consumption and investment. Keynesians argue that deflation can be as harmful, if not more so, than inflation, and that a gold standard can exacerbate deflationary pressures.
Gold as an Investment:
While Keynesians might not advocate for a return to the gold standard, they don’t necessarily dismiss gold as an investment. Like other assets, gold can serve as a hedge against inflation, geopolitical risks, and currency devaluation.
Global Economic Stability:
Keynes was instrumental in the design of the Bretton Woods system after World War II, which pegged various currencies to the US dollar, and the US dollar was pegged to gold. However, this system was not a pure gold standard. It was designed to provide global economic stability while still allowing for some flexibility in national monetary policies. The Bretton Woods system eventually collapsed in the 1970s, leading to the modern system of floating exchange rates.
More on Austrian Economic Theory
Austrian economics, a school of economic thought founded in the late 19th century by Austrian scholars like Carl Menger, Ludwig von Mises, and Friedrich Hayek, has a distinct perspective on money, banking, and especially gold. Austrian economists generally view gold favorably as a form of money due to its intrinsic value, stability, and the limitations it places on monetary manipulation. They see a gold standard as a way to prevent inflation, economic distortions, and the boom-bust cycles they associate with central bank interventions. Here’s how Austrian economists generally think about gold:
Gold as Money:
Austrian economists often advocate for a return to a gold standard or a commodity-based monetary system. They argue that gold has historically served as a reliable and stable medium of exchange, store of value, and unit of account. They believe that money should have intrinsic value, and gold, being a tangible asset with limited supply, meets this criterion.
Critique of Fiat Money:
Austrian economists are critical of fiat money (money not backed by a physical commodity). They argue that fiat money, which can be printed without limits, leads to inflation and economic distortions. They believe that central banks, by manipulating the money supply and interest rates, can cause economic booms and busts. A gold standard, in their view, would limit the ability of central banks to engage in such manipulations.
Business Cycle Theory:
Ludwig von Mises and Friedrich Hayek developed the Austrian Business Cycle Theory, which posits that artificially low interest rates set by central banks lead to malinvestment and eventually economic downturns. A gold standard, they argue, would prevent such artificial manipulation of interest rates.
Gold as a Hedge:
Austrian economists view gold as a hedge against inflation and economic instability. Since gold has intrinsic value and cannot be printed at will, it retains its purchasing power over time, unlike fiat currencies which can be devalued.
Freedom and Decentralization:
Austrian economists value individual freedom and decentralization. They see a gold standard as a way to decentralize monetary power, taking it away from central banks and governments and putting it back into the hands of individuals.
Critics within the School:
While many Austrian economists advocate for a gold standard, not all do. Some believe that any commodity (or basket of commodities) could serve as money, as long as it’s chosen by the market and not imposed by the government.