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The Gold Standard is Not Standard Anymore

The Gold Standard is the money system where all the payments are processed in standardized gold units or in banknotes (government notes from Central banks) that have physical gold as a reserve.

Currently, the total volume of the world economy surpasses the existing gold reserves significantly. But the problem is not only about that. Gold can be replaced with any other precious asset. However, the governments of the leading countries prefer to increase the gap between the liquid reserves and the total issued money supply.

The result of that is inflation and total destruction of savings of the common people.

You can find more details about the reasons of inflation and methods of fighting it in another article of Reserveum Group: “Why do cheeseburgers become even more and more expensive?” .

The authors of this article believe that inflation is not just an accidental phenomenon but a well-thought-out scenario that is made by the world’s financial and political elite.

The history of the gold standrard.

Officially, the system of tying down banknotes to gold traces back to the XIX century. The idea was that every banknote could be exchanged for a certain amount of gold at first notice, which was guaranteed by the state. This is why the government could not issue more banknotes than the gold reserve it possessed.

But this practice was present back in the Middle Ages Venice. In the XII century, wars and crusades required a lot of money from the authorities. The main source of money was taxation, but this resource was limited and it was not enough to supply the army. Then the government of Venice came up with a compulsory loan. They collected money from the people in return for the official loan certificates — obligations. On every obligation, they specified the amount of money in gold that the citizen gave and that s/he in fact lent to the government. Such an obligation guaranteed returning the whole amount in gold with 5% extra as a profit after the obligation period was over.

Thus, all the gold in the country, or at least most of it, for several years could be replaced with obligations that were used for buying and selling and were in fact a prototype of the banknotes with the gold standard.

The next step to the gold standard was made in 1694 in Great Britain when William III was about to start a war with France. To finance the campaign, the king addressed a group of merchants who offered him a deal: they lend the king 1,2 mln pounds in gold for the war, but in return, the king allows them to print banknotes. The total amount of banknotes was supposed to be equal to the king’s debt. Each of the banknotes was a loan certificate for a certain sum that allowed the owner to receive the corresponding amount of money with a guarantee from the king. The 100 pounds banknotes were allowed to be exchanged for 100 golden coins.

Thus, the merchants managed to distribute the king’s debt among the citizens of Great Britain as cheap loans in banknotes. This is how emerged the world’s first government bank — Bank of England, — and paper money — pounds with gold reserve.

Gradually, more and more countries were switching to the gold-reserve system given its obvious advantages. It solved the following problems of the precious metals system:

· complex and expensive transportation of precious metals;

· constant reduction of the money supply due to coin deterioration and loss;

· alloy counterfeiting.

Gold was an international currency for quite a long time, along with the British pound, until two world wars undermined the basics of the established practices. European countries, devastated by wars, ran out of their gold reserves, so at that time, 70% of the world’s gold ended up in the USA.

Which lead to the Bretton Woods system, a new system of international monetary relations accepted in 1944. The Bretton Woods agreement fixed the price for gold at 35 USD per troy ounce and established fixed exchange rates to USD for all counterpart countries. So now the US Dollar was tied down to gold, while the rest of the currencies were tied to USD. And though gold was still at the base of the system, now it only served as a backup for USD, this is why this system is also called the Gold Dollar Standard.

So after gold diversion from Europe to the USA during the world wars that were mainly supplied with the US industry, the major countries started depending on USD and partly lost their economical soveireignity.

The mechanism was working until the conference in Jamaica in 1976, when the gold standard was replaced with fluid currency rates based on USD.

This was not unexpected, as the global economy kept developing, it was becoming obvious that currencies could no longer be tied to gold. The demographic growth and the economic growth demanded growth of the money supply, since the more consumers are there in the country, the more goods are produced, and the more money is required to be used in all of the trading operations. But how to increase the money supply if the gold reserve is limited with the natural resources and the production?

According to the World Gold Council, every year gold production amounts to 3500 tons, also around 1000 tons of gold is produced by recycling. From all the produced gold, almost 3000 tons go to the jewellery industry, around 400–500 tons go to Central banks. This is around 30 billion USD per year for all the world’s countries.

The current money supply and gold market size.

Let’s compare the current amount of gold with the money supply.

According to Fed, in September 2021 it amounted to 20.98 trillion USD. So the total yearly gold supply produced in the whole world could only satisfy the supply of one country.

If we look into the gold supplies of all the countries, for the world’s leader, the USA, the gold supply is around 8000 tons, which is around 460 billion USD at the current rate. Thus, the money supply in the USA surpasses its gold supply by scores.

Gold always was and remains a limited natural resource. The world economy has long since outgrown its physical supply on Earth, both produced and still remaining in the ground.

Even if we forget all the other reasons why the gold standard is not working, such as gold market volatility and healthy inflation required for developing economies, the main reason why it is impossible to return to the gold standard is that gold is not a sustainable resource. It requires the rarest conditions in the world to form gold, the temperature and pressure that can only appear when giant stars burst and that only lasts for a few minutes. There are no such technical capacities on Earth that could replicate it, this is why gold will always be a rare and hard-in-production metal, which means it cannot work as money in modern civilization. At the same time, paper and virtual money can be produced in the required amount, which makes them more effective.

It is worth noting that even though it is impossible to create the gold supply, it doesn’t mean that it is not worth being created at all. Vice versa, the uncontrolled growth of money supply speeds up inflation and sparks regular economic crises.

The best option for reserve could be a structurally complex reserve that would include different assets that do not come down to one standardized form.

This is where the modern digital technologies can help us. For instance, the technology of tokenization. In other words, these are the technologies where the real asset is duplicated with a token that cannot be falsified, with its moving being obvious to all counterparts of the exchange. NFT and ERC-20 tokens of the Ethereum network can serve as an example of it.

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