Gold Standard and Fiat Currency: Which is Better?

goldfalling

There was a time, not too long ago, when most people who knew the difference between gold standard and fiat currency were either students of economics attending their history lectures or people so old they have actually experienced that history themselves, storing it in their living memory. However, every time there is a crisis or a major tectonic shift in financial markets, some analysts blow the dust off their history books and start talking about the fact that currency itself used to be worth something. In those days, gold standard was the norm.

History of Gold Standard

Gold standard
Gold standard

Until World War I, most countries enforced the gold standard; it meant currency units and gold could be freely exchanged at a fixed rate. While this provided increased economic security as well as fully formalized exchange rates for the first time in human history, there still had to be enough gold in a country’s vaults to cover every single banknote, coin or bill issued. The concept itself was formalized in XVII century, but it wasn’t until 1821 that a country had officially adopted it (it was Great Britain). When the Great War broke out, all major powers needed enormous sums of money to cover the expenses, so gold standard got suspended. After the war, instead of reintroducing it, most governments decided to switch to fiat currency instead. While the gold standard had its merits, its Achilles’ heel was exposed to the world: it was simply too rigid to withstand the pressure of modern markets. It featured a brief return in US monetary politics after World War II, but it was abandoned under Nixon’s administration.

Nowadays

Fiat currencies are the norm in modern economics. They have no value in any actual commodity, or outside the supply/demand ratio on the open market. Its value is based on faith – as long as people believe it is worth something, they will use it. When that is no longer the case, fiat currencies will not be worth the paper they are printed on, due to hyperinflation that will ensue. Compared to the gold standard, this system is somewhat more practical, but reliability is still a major issue. This is why many traders turn to commodities rather than hard currency when it comes to savings. However, it already managed to beat the official gold standard in terms of longevity, such as it is. While it makes countries less responsible in fiscal terms, fiat currency does give them more maneuvering space to tackle any economic issues than ever before.

Conclusion

The restrictive nature of gold standard proved to be its greatest foe. Even so, its safety and frugality it encouraged are being lamented by economists and historians alike. The return of gold standard, however unlikely, cannot be ruled out in advance. Despite its ubiquity, the fact that fiat currency has no intrinsic value is its greatest weakness and the likely cause of its downfall – should it ever occur. Only time will tell.