The causes of the Great Depression were numerous, and after the stock market crash of 1929, a number of complex factors helped to create the conditions necessary for the longest and deepest economic downturn in modern history.President Franklin D. Roosevelt’s decision to take the United States off the gold standard may have helped to ease the worst effects of theDepression.
What is the gold standard?
Sacks of gold, exchanged by the American people against currency, being stocked in the vaults of a New Jersey bank, 1933.
The gold standard is a monetary system in which a nation’s currency is pegged to the value of gold. In a gold standard system, a given amount of paper money can be converted into a fixed amount of gold. Countries on the gold standard can’t increase the amount of paper money in circulation without also increasing their reserves of gold.
From the late 1800s until the 1930s, most countries in the world—including the United States—adhered to an international gold standard. (Many European countries temporarily abandoned the gold standard during World War I so they could print more money to finance war efforts.)
Bank failures led ordinary citizens to hoard gold.
The U.S. economy boomed during the first part of the 1920s—the Roaring Twenties—with industries such as construction and automobiles driving the post-war recovery. In an effort to combat inflation, the Federal Reserve raised interest rates in 1928.
But European countries that had borrowed money from the United States during World War I had trouble paying off their debts. As a result, demand for U.S. exports slowed.
A slowing economy combined with the stock market crash of 1929 and a subsequent wave of bank failures in 1930 and 1931 led to crippling levels of deflation. Soon, the frightened public began hoarding gold.
European countries began to abandon the gold standard
The United States and other countries on the gold standard couldn’t increase their money supplies to stimulate the economy. Great Britain became the first to drop off the gold standard in 1931. Other countries soon followed.
But the United States didn’t abandon gold for another two years, deepening the pain of the Great Depression.
President Franklin D. Roosevelt as he signs the Gold Bill on his 52nd birthday, surrounded by members of the Treasury Department and the Federal Reserve Board.
FDR bans Americans from owning monetary gold
In 1933, President Roosevelt took the U.S. off the gold standard when he signed an executive order making it illegal for individuals and firms to possess most forms of monetary gold.
People were required to exchange their gold coins, gold bullion and gold certificates for paper money at a set price of $20.67 per ounce.
Abandoning the gold standard helped the economy grow
This exchange of gold for paper money allowed the United States to increase the number of gold reserves at the United States Bullion Depository at Fort Knox. After signing the 1934 Gold Reserve Act, Roosevelt raised the price of gold to $35 per ounce, allowing the Federal Reserve to increase the money supply. The Gold Reserve Act restored parts of the gold standard, allowing the dollar price to remain fixed until Richard Nixon fully abandoned it in 1971.
The economy slowly began to grow again, but it would take the United States most of the 1930s to fully recover from the depths of the Great Depression.
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Because the international gold standard linked interest rates and monetary policies among participating nations, the Fed's actions triggered recessions in nations around the globe. The Fed repeated this mistake when responding to the international financial crisis in the fall of 1931.
In addition, the gold standard, by forcing countries to deflate along with the United States, reduced the value of banks' collateral and made them more vulnerable to runs.
How did staying on the gold standard make the Great Depression worse? The government could not increase the money in the economy because we could not increase our gold supply. Why were Americans so willing to invest in the stock market? Prices were generally going up (Bull Market) throughout the 1920s.
Gold equities acted as a proxy for bullion during this time and saw huge buy volumes during the Great Depression. From 1929 until January 1933, the shares of Homestake Mining, which was the largest gold producer in the United States, shot up an impressive 474%.
The Gold Standard was a system under which nearly all countries fixed the value of their currencies in terms of a specified amount of gold, or linked their currency to that of a country which did so.
The gold standard limited the power of the government banks, and it created certainty in international trade by providing a fixed pattern of exchange rates.
Among the suggested causes of the Great Depression are: the stock market crash of 1929; the collapse of world trade due to the Smoot-Hawley Tariff; government policies; bank failures and panics; and the collapse of the money supply.
This higher price for gold increased the conversion of gold into U.S. dollars, effectively allowing the U.S. to corner the gold market. Gold production soared so that by 1939 there was enough in the world to replace all global currency in circulation.
The Great Depression was triggered by the stock market crash of 1929, but many other causes contributed to what became the worst economic crisis in U.S. history. The stock market crash cost investors millions of dollars and contributed to bank failures and industry bankruptcies.
Gold, along with silver, functioned as the international store of monetary value until the beginning of World War I. At that time, the gold standard was abandoned, primarily because nations needed deficit financing for the war, which increased the amount of paper money in circulation beyond nations' gold reserves.
When central banks purchase gold, it affects the supply and demand of the domestic currency and may result in inflation. This is largely due to the fact that banks rely on printing more money to buy gold, thereby creating an excess supply of fiat currency.
Empires across North Africa, the Middle East, and Europe minted gold into coins and used it to make and to embellish luxury objects. West African gold provided rulers and merchants in Saharan centers with the means to acquire goods from afar.
One notable period in history when owning gold was illegal was in the United States between 1933 and 1974. On April 5, 1933, President Franklin D. Roosevelt signed an executive order that essentially criminalized the possession of gold.
The gold standard limits the power of governments to inflate prices through excessive issuance of paper currency. 3. The gold standard makes chronic deficit spending by governments more difficult, as it prevents governments from inflating away the real value of their debts.
Returning to a gold standard could harm national security by restricting the country's ability to finance national defense. A gold standard would prevent the sometimes necessary quick expansion of currency to finance war buildup.
When and Why Did Nixon End the Gold Standard? President Richard Nixon closed the gold window in 1971 in order to address the country's inflation problem and to discourage foreign governments from redeeming more and more dollars for gold.
The precious metal was effectively converted from a currency to a commodity with the passage of the Act. The intended effect of the law was to increase the money supply and stem deflation by devaluing the dollar, including in foreign exchange markets.
The Gilded Age ended with the financial panic of 1893. A conflict over the value of the nation's currency led lenders to call in their loans. A weakening American currency frightened foreign investors, helping to start a four-year depression. One way to limit the supply of money is to tie the dollar to gold.
This article appeared in the Summer 2021 issue of The Independent Review. The cause of the Great Depression was the post-World War I decision to resume the gold standard on prewar terms, after immense inflation during the war.
In conclusion, the gold standard has its advantages and disadvantages. While it provides stability, transparency, and discipline, it also limits the money supply, flexibility of monetary policy, and requires sufficient gold reserves. Whether it is still a viable economic system in the modern world is up for debate.
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