Today, the U.S. dollar is a fiat currency, but this hasn't always been the case.
Today’s topic is the gold standard.
In last week’s episode, I explained that the U.S. dollar, like most currencies throughout the world today, is a fiat currency, meaning that it’s backed by faith, rather than something physical of value.
But this hasn’t always been the case. There was a time when the U.S. dollar was backed by something more tangible than faith, and that something was gold.
After last week’s episode, a listener named Pam S. e-mailed me with this question: “Why isn’t the U.S. dollar still backed by gold and why did FDR recall all gold coins?”
A Brief History of the Gold Standard
To get to an answer to this question, let’s take a quick look at the history of the gold standard.
In 1900, the United States and most of Europe adopted a monetary system based on gold. The Gold Standard Act of 1900 made paper dollars convertible to 1.5 grams of gold. A troy ounce of gold (which is one-twelfth of a pound) was a little over $20. (1) In practice, most people used paper dollars because of their convenience, and didn’t often redeem them for gold.
If you take a close look at a U.S. dollar bill today, you’ll see the words “Federal Reserve Note” printed on it. You’ll also see the words “This note is legal tender for all debts public and private.”
When dollars were backed by gold, the words printed on bills were different. For example, in the case of a $50 bill they read, “This is to certify that there is on deposit in the Treasury of the United States of America $50 in gold coin payable to the bearer on demand.” These gold-backed bills were literally gold-backed: the backside of the bill was printed in yellow. For those of you who are curious to see what these gold-backed bills looked like, Here's a link to an image of one.
FDR Makes Owning Gold Illegal
Well, during the widespread bank failures of the Great Depression, many people and institutions both in the U.S. and around the world actually did redeem their dollars for gold, which drained the Federal Reserve’s gold supply. In response to this crisis, in 1933 President Franklin D. Roosevelt made private ownership of gold illegal and confiscated gold by executive order. U.S. citizens had to turn in their gold and gold-backed paper money to the central banking system and were paid a little over 20 paper dollars for each troy ounce of gold, which had been the official gold price since 1900.
After the gold confiscation, the U.S. government reset the price of gold to $35 per troy ounce, which, in one fell swoop, devalued the dollar by more than 40%.