The Federal Reserve and Gold: A Brief History

"Marriner S. Eccles Federal Reserve Board Building" by AgnosticPreachersKid - Own work. Licensed under CC BY-SA 3.0 via Wikimedia Commons

To understand why gold and silver investing have taken their place as a store of value today, it’s worth taking a brief look at how monetary standards have taken shape over the past hundred years in America (and elsewhere as well). We can divide this into three main periods.

Gold as Money

Before the creation of the gold standard and other metallic standards, precious metals (almost invariably gold and silver) were used as money throughout the civilized world for thousands of years. Many words for “money” are in fact derivatives of either “gold” or “silver”. So ultimately, if you had precious metals, you had money. If you didn’t, you didn’t. Simple enough.

The Gold Standard

As time went on, governments and banking systems realized that they could make a pretty good living from fractional reserve banking. Since those who deposited their money with a bank or trusted a government with it didn’t automatically demand possession of the metal, people could be given notes of exchange to “represent” precious metals, which didn’t always correspond to the amount of actual metal in possession (this is in fact a form of debasement, but it was considered a great advance in banking).

Meanwhile, the use of multiple metals led to the creation of a gold “standard.” Gold would be used as a base metal against which to rate other metals. This led to a drop in parity between gold and other metals.

The combination of these two factors came to a head at the beginning of the 20th century, as the use of metals as a base for defining wealth severely curtailed how much the government could produce. During times of crisis, the use of precious metal bullion could also lead to bank runs – if the bank didn’t have enough metal in reserve to return to depositors, customers could lose trust, leading to widespread bank closures.

The Creation of the Fed

Because of this “instability” in the U.S. and other economies (in fact, the instability was in the fractional reserve system and affected bankers and people who made a living speculating on the system) the Federal Reserve Act was passed in 1913 while a substantial portion of the U.S. Congress had gone on holiday break. This allowed the federal government to determine the value of wealth independently. While it still had not reversed the exchange of gold for the dollar, it created the system which would make it possible.

Government’s Decoupling of the Dollar

With the central bank now in charge, gold was seen as a limiting factor in the production of money. At the end of the Second World War, President Franklin Roosevelt ordered a surrender of the public’s gold to the government, with no guarantee of return. Since the people believed in the bimetallic American ideal (American coinage was still in silver) most peacefully went along with it.

Three decades later, President Lyndon Johnson would take silver away by simply producing coinage in base metals. Finally, in an ironic twist, President Nixon stopped paying foreign debts in gold, revealing that the government had been paying foreign creditors in specie and its own citizens with paper!

With Nixon’s move, metals were officially no longer a peg for the dollar, while inflation eroded the dollar’s value.

You can continue learning about the history of the U.S. Federal Reserve here.

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