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What Constitutes a Gold Standard

Tags Gold Standard

01/05/2011Edwin Walter Kemmerer

[Excerpted from Gold and the Gold Standard (1944).]

Definition and Explanation

The generic gold standard may be briefly defined as a monetary system where the unit of value — in terms of which prices, wages, and debts are customarily expressed and paid — consists of the value of a fixed quantity of gold in a large international market that is substantially free.[1]

This definition calls for some explanation. It contains no mention of gold coin or of free coinage of gold. Both of these may be of great convenience and may facilitate the efficient operation of a gold standard, but neither is necessary to the existence of a gold standard. The gold-bullion standard, and the gold-exchange standard, does not ordinarily make any provision for the minting and circulation of gold coins, but both of these standards are clearly forms of the gold standard.

The definition makes no mention of legal tender, a useful quality for standard money to possess but not a necessary one. Legal tender is a purely legal concept of late historical development, usually relating only to debt-paying rights, and a gold standard can exist and perform all of its necessary functions without any legal-tender laws whatsoever. On the other hand, full legal-tender money has at times been driven out of circulation through the force of Gresham's law[2] or of custom by non-legal-tender money.

There is no mention in the definition of redeemability in gold (or its equivalent) of paper money and of fiduciary coins, which is a privilege in most successful gold-standard systems. This privilege is highly desirable, but it is not necessary, provided that sufficient other effective means are used for maintaining the parity of the different kinds of money with the gold unit, such as limiting their supply and receiving them without limit in payment of taxes and other public dues.

All the above-mentioned qualities are useful devices for maintaining the gold standard, but not one of them is absolutely necessary. Furthermore, a currency system might conceivably have any or even all of them and still not be a true gold standard.

A good illustration of the principle here discussed is found in the experience of the Union of South Africa in 1919 and 1920.[3] At that time gold sovereigns, which were unlimited legal tender in the Union, and which enjoyed the free-coinage privilege in England — there was no mint in the Union of South Africa — circulated freely in the Union, and the bank notes there were redeemable at their respective banks of issue in gold sovereigns on demand at parity. However, the exportation of gold bullion from the Union was rigidly controlled by the government. South African gold coins could not be legally exported to what would otherwise have been their best market, but were extensively smuggled out of the country and sold for more than the foreign-currency equivalent of a South African pound.

A sovereign in South Africa, and likewise the gold-bullion content of a sovereign, were worth there less than in the outside free-gold markets of the world. In order to get the sovereigns with which to redeem their notes on demand, as required by law, the South African banks of issue were compelled to buy raw gold in London at a premium, to get it coined in London in the usual way at the British mint, and then to bring it to South Africa. At times they had to pay as much as 26 or 28 shillings of South African bank notes to obtain a sovereign in England. The sovereign was then paid out in South Africa by the bank of issue in redemption at par of a 10-shilling bank note.

Monetary history offers many instances of gold coins dammed up in a country and circulating there at a discount from their bullion value in outside free markets.[4]

On the other hand, a governmental prohibition on the importation of gold in a supposedly gold-standard country, by restricting the supply within the country, might force up the value of gold bullion and gold coin within the country above their values in the free international markets and thereby give them an artificial scarcity or monopoly value.

Whenever the gold value of the monetary unit of a country is divorced from the market value of gold in the free markets of the world, the country cannot be said to be on a true gold standard.

Regardless, therefore, of which of the many common means may be adopted by a nation to maintain the value of its money — such as convertibility, legal tender, and free coinage — the supreme test of the existence of the gold standard is the answer to the question whether or not the money of the country is actually kept at a parity with the value of the gold monetary unit comprising it, in the outside free international gold market, assuming, of course, that such a market of reasonable size actually exists. It is not a question of the means adopted to obtain a particular result, but rather, one of the results itself. The gold standard exists then in any country whenever the value of a fixed quantity of gold in a large and substantially free international market is actually maintained as the standard unit of value.

The Monetary Unit — a Fixed Weight, Not a Fixed Value

Under a gold standard (as well as under any other metallic-money standard), it is the weight of the metallic content of the monetary unit that is fixed and not the value, which is an expression of purchasing power. In this respect the unit of value differs from all other units of measurement. For example, the pound as a unit of weight is a fixed weight, the yard as a unit of length is a fixed length, and the gallon as a unit of volume is a fixed volume.[5]

The gold dollar, however, which is our American unit of value, is whatever value is attached at a particular moment to a fixed weight of pure gold, now, one thirty-fifth of an ounce Troy. This value, like the value of anything else, is a continually changing thing — a fact that gives rise to our most difficult monetary problems.

Gold as a Money Metal

From the monetary standpoint, gold possesses certain well-known physical qualities, which have never been better described than by W. Stanley Jevons in his classic little book, Money and the Mechanism of Exchange, from which much of the material in this section is taken. Largely by reason of its beauty and its scarcity, gold has been a commodity of universal demand for countless generations, being prized highly by the most primitive peoples as well as by the most advanced.

Possessing a large value in a small bulk, it is easily transported. Pure gold is homogeneous, i.e., uniform throughout the mass, so that equal weights will always have exactly the same value. Like other metals, but unlike skins, precious stones, and most other commodities, gold has the quality of divisibility without loss. A nugget of gold can be cut into pieces without loss and the pieces in turn may be readily restored to the original form, likewise without loss. Gold is very durable, being

remarkable for its freedom from corrosion or solution [and] being quite unaffected and untarnished after· exposure of any length of time to dry, or moist, or impure air, and being also insoluble in all the simple acids. … In almost all respects gold is perfectly suited for coining. When quite pure, indeed, it is almost as soft as tin, but when alloyed with one tenth or one twelfth part of copper, becomes sufficiently hard to resist wear and tear, and to give a good metallic ring; yet it remains perfectly malleable and takes a fine impression.[6]

Because of its high value it is carefully guarded by its owners. This fact and the great durability of gold largely explain its high degree of stability in value. There is gold in the world today that men extracted from nature thousands of years before Christ. Our present supply is the "accumulation of the ages," and most of it can readily be made marketable, since it is largely in relatively unspecialized forms, such as coins and bars. The world's annual production of gold, which, for a number of years prior to the Second World War, was approximately equivalent to only about 4 percent of the world's known stock of monetary gold, acts very slowly in affecting the value of such a large marketable supply.

The Demand for Gold, Highly Elastic

Gold is a commodity of highly elastic demand; in fact, it probably has the most elastic demand of all commodities on the market in a gold-standard country. All three of the principal kinds of demand for gold are highly elastic; they are (1) the monetary demand; (2) the demand for the purpose of ornamentation, including jewelry and utensils; and (3) the hoarding demand.

The Monetary Demand

The demand for gold for monetary uses is obviously highly elastic when the principal countries of the world are on a gold standard and when these countries are offering to buy at fixed prices in unlimited amounts all the gold offered to them for monetary purposes.

The Demand for Ornamentation

The demand for gold to use in ornamentation is likewise highly elastic. Primitive man's first form of clothing was probably some form of paint or mud on his skin — in other words, ornament. Clothing for protection came later. The desire for ornamentation from that day to this has been universal and practically unlimited. Gold is the most widely treasured material for articles of beauty. Most people in the world would like to have more gold ornaments than they do possess and would buy more if such articles were to become cheaper. Reductions in the value of gold ornaments and utensils as compared with other goods, therefore, stimulate an increased demand, and this demand acts as a buffer to gold depreciation.

The Hoarding Demand

The demand for gold for the purpose of hoarding is, again, highly elastic. The practice of hoarding gold, common to all countries of the world, is resorted to increasingly in times of unsettlement and fear. It is especially prevalent in India and China. Gold, to the Oriental peoples who hoard it, is a symbol of wealth in general. A given quantity of gold jewelry is not only a commodity that gives direct enjoyment to the Hindu farmer, but it is also a blank check, which he can fill out at any time with the name of any commodity he may want at its market price, a check that can be cashed on demand. His gold trinkets and jewelry serve as his savings-bank deposit and his insurance policy against famine and other misfortune.

The capacity of India and China to absorb gold and silver in hoards is well known. For many generations India was known as the "sink" of the precious metals. From 1931, however, when India went off the gold standard and the price of gold in terms of Indian rupees, instead of continuing stable, advanced greatly through 1940, India's hoarded gold was poured onto the world's markets at rates even greater than those at which it was previously accumulated.[7]

This high degree of elasticity of demand is an important factor in maintaining the high stability of value that gold possesses.

Characteristics of Gold in Its Relation to the Gold Standard

Gold in its relation to the gold standard has three important characteristics.[8] Although they are not entirely distinct, they are best considered separately. These characteristics are (1) a fixed price, (2) an unlimited market, and (3) the fact that normally the production of gold from year to year is controlled chiefly by changing costs in its production and not by changing prices of the product itself.

A Fixed Price

When a government adopts a gold standard, it fixes the gold content of the monetary unit. Prior to 1933, for example, the unit of value in the United States was defined as the dollar consisting of 25.8 grains of gold 0.900 fine,[9] which means 90 percent was pure gold and 10 percent was copper alloy, making the fine-gold content of the dollar 23.22 grains. Since there are 480 grains in a troy ounce, an ounce of gold was equivalent to as many dollars as 480/23.22 or $20.67, and could always be coined into that amount of gold coin. To say that the dollar was 23.22 grains of pure gold and to say that the mint price of gold was $20.67 were identical propositions. It was like saying that a foot is 12 inches and that an inch is one-twelfth of a foot.[10] Gold coin, on the other hand, at any time could be melted down and reconverted into gold bars. Except for a brief period at the time of the First World War, there were from 1879 to 1933 no restrictions or tariff charges on the importation and exportation of gold.

An Unlimited Market

Not only was the price of gold always the same at the mint and assay offices, but these concerns were under obligation to buy all gold presented to them in proper form, no matter whether it was produced within the United States or abroad or whether it was new gold or gold obtained from the melting down of foreign coins or from jewelry, ornaments, or other sources.[11]

The Production of Gold, Correlated Inversely with the Prices of Other Commodities

The third characteristic of gold in its relation to the gold standard is the peculiar relationship of its market price to the volume of its current production.

In the case of other commodities, production normally increases as their market prices advance and production decreases as their market prices fall. This, however, is not true for gold in a gold-standard country. Here, as has been previously pointed out, the price of gold does not change.

For example, between 1879 and 1916, inclusive, in the United States, no matter how much gold was being produced in the world's markets or how little, the price of pure gold at the mint was always $20.67 an ounce; and, although during these 38 years the world's annual production of gold increased fourfold and the value or purchasing power of an ounce of gold varied continually and at some times substantially, the price of gold never changed. The reason was that our gold-standard system itself fixed the price of gold, while it did not and could not fix the value of gold.

Although gold producers always received the same price for their gold at the mint and assay offices, the costs of producing this gold were continually changing, as the value of the purchasing power of the gold changed. An increase in the production of gold relative to the demand tends to increase the supply of monetary gold and of the other money and deposit-currency circulation that is based upon it, and thereby, through increasing commodity prices, tends to make gold less valuable.

The commodities whose prices are thus increased include, among others, all those that are elements in the cost of mining gold itself, such as explosives and other chemicals, mining machinery, and labor; also, taxes. It is these rising costs pressing against a fixed gold price that tend to reduce gold production by cutting into the mine owners' profits when the value of gold is declining.

On the other hand, when the value of gold is increasing, i.e., when commodity prices are falling, the prices of the things that comprise mining costs tend to fall with the prices of other commodities. This reduces the cost of mining and, since the mine owner continues to sell all of his gold at the same mint price as before, his profits are increased and gold production is stimulated. Therefore, the production of gold tends to increase when the value of gold rises and to decrease when that value falls.

It should be noted, parenthetically, that gold is produced under widely varying conditions in different parts of the world, that considerable gold is produced as a byproduct of other metals, and that much is still obtained in backward places by primitive methods of panning; while large amounts of labor are continually being spent in more or less futile efforts to find pay dirt. All this means that at any one time it is difficult to ascertain just what is the cost of producing gold. The significant cost, the economist would say, is the marginal cost in the gold mines of substantial gold-producing areas like those of the Transvaal and Russia. This marginal cost, however, is not easily located.

Monetary Gold versus Gold in the Arts

When the value of gold falls and the commodity price level rises, the price of the gold used in manufacturing jewelry, utensils, etc., does not rise, although the costs of other materials and of labor involved in their manufacture and marketing will advance. This means that the prices of articles made largely of gold do not advance in times of rising price levels as much as do wages and the prices of most other commodities.

Gold jewelry and other gold articles, therefore, at such times appear cheap as compared with most other goods, and this situation stimulates demand for them, thereby increasing the flow of newly mined gold into the arts and diverting old gold into the arts from monetary uses.

The hoarding of gold, ornaments, trinkets, and bullion is also stimulated, particularly in countries like India and China, where there is usually an enormous demand for such commodities. All this tends to hold back the upward movement of general prices and the reduction in gold-mining profits that results from them.

When, on the other hand, commodity prices are falling and the value of gold is rising, we have the opposite situation. Then the prices of jewelry, ornaments, and other gold manufactures do not fall as much as the prices of most other things and as wages, because the price of gold itself does not fall. This makes gold products appear dear to the consumer and, therefore, lessens the demand for them.

It drives into the money uses gold that would otherwise have gone into the arts, and causes the melting down of gold jewelry and ornaments in India and China, and the flow of the gold bullion obtained therefrom into the money uses. Gold in the money uses is thereby made more plentiful, and this fact tends to check the declining commodity prices and the rising gold-mining profits.


[1] Obviously, for the gold standard to function, the international market must be more than a very narrow one, and obviously, also, it is unrealistic to expect a market that is 100-percent free.

[2] The monetary principle known as Gresham's law, although Sir Thomas Gresham had little to do with its discovery, is merely an application to money of the economic law of demand and supply. This is the law that says an economic good tends to go to the best market. The law superficially appears to operate somewhat differently for money than for other economic goods, because money is unique in the fact that one of its principal functions is that of passing from hand to hand as a commonly accepted medium of exchange. A precise formulation of Gresham's law within a few words is impossible. With minor qualifications, however, the law may be briefly stated as follows: when two or more kinds of money are in circulation in the same market, all enjoying essentially the same privileges under the law, custom, and public opinion, the poorest money will drive the better money or moneys out of circulation; provided that the total supply of all kinds of money in circulation is sufficiently large to make money so cheap that the better money is worth more outside of active circulation for hoards, merchandise, or export than in such circulation; and provided further, that a dual or other multiple currency system does not develop, under which there are different commodity prices for payments made in the different currencies.

[3] C.S. Richards, Currency in South Africa before Union, reprinted in E.W. Kemmerer and G. Vissering, Report on the Resumption of Gold Payments by the Union of South Africa (1925), p. 537.

[4] See Edwin Walter Kemmerer, "Mexico's Monetary Experience in 1917," American Economic Review (March 1918), pp. 261–62; also, the experiences of the Scandinavian countries and of Spain, 1916–1919, in the Federal Reserve Bulletin (1919), pp. 1039–42 and (1920), pp. 35–46.

[5] These units of measurement in advanced countries are determined meticulously by law. For example, the British Imperial standard yard is defined by law as the distance at 62°F. between two fine lines engraved on gold studs, sunk in a bronze bar, which is in the possession of the government.

[6] W. Stanley Jevons, Money and the Mechanism of Exchange, pp. 46–47.

[7] See Federal Reserve Bulletin (1935), p. 822 and (1943), p. 1201.

[8] These three characteristics would apply also to silver, under a silver standard and to both gold and silver under a system of successful bimetallism.

[9] Act of March 14, 1900, section 1.

[10] Our mint and assay offices (after January 14, 1873) made no charges to anyone for the process of coining gold brought to them, but did charge depositors of gold bullion small fees to cover such costs as those for melting, refining, and alloy.

[11] A like free-coinage privilege would apply to silver in a silver-standard country and to both gold and silver in a. bimetallic country.


Edwin Walter Kemmerer

Edwin Walter Kemmerer (1875–1945) was a professor of economics at Princeton University. He became famous as a "money doctor" or economic adviser to foreign governments all around the world, promoting plans based on strong currencies and balanced budgets.