Fiat money and Gold Standard

Fiat money is money that is intrinsically useless; is used only as a medium of exchange.

Gold standard: a commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold. National money and other forms of money (bank deposits and notes) were freely converted into gold at the fixed price. A combination of the gold and silver standard is known as bimetallism.

The Bretton Woods System, enacted in 1946 created a system of fixed exchange rates that allowed governments to sell their gold to the United States treasury at the price of $35/ounce.

The benefits and costs of Gold Standard:

The main benefit of a gold standard is that it insures a relatively low level of inflation.So long as the supply of gold does not change too quickly, then the supply of money will stay relatively stable. The gold standard prevents a country from printing too much money.The government can only print as much money as its country has in gold.


The gold standard also changes the face of the foreign exchange market.The extensive use of gold standards implies a system of fixed exchange rates. If all countries are on a gold standard, there is then only one real currency, gold, from which all others derive their value. The stability the gold standard cause in the foreign exchange market is often cited as one of the benefits of the system.

The disadvantages of gold standard:

One disadvantage of a gold standard that the size and health of a country's economy is dependent upon its supply of gold, not the resourcefulness of its people and businesses.The gold standard causes countries to become obsessed with keeping their gold, rather than improving the business climate.

The stability caused by the gold standard is also the biggest drawback in having one. Exchange rates are not allowed to respond to changing circumstances in countries. A gold standard severely limits the stabilization policies the Federal Reserve can use. Because of these factors, countries with gold standards tend to have severe economic shocks. Moreover, because the gold standard gives government very little discretion to use monetary policy, economies on the gold standard are less able to avoid or offset either monetary or real shocks.