What Was the Gold Exchange Standard?


Active Member
We all know that wars cost a lot of money, but what we all don't know is how that money is created and what that money creation does to banking and the fiscal policy of a given country. I'm continuing on with reading Michael Maloney's Guide to Investing in Gold & Silver and have made it to the chapter called Greed, War, & the Dollar's Demise. Before I go any further with this post though, I want you keep something in mind as you read what I have to say below. I'd like you to remember that while someone usually loses in the world of high finance, someone else usually wins. It's what we like to call a zero sum game. Your loss is my gain. The two balance each other out. So while you read that there was rampant money creation at some point in history and that money creation partially severed the link between the dollar and gold, ask yourself who the winners and losers of that were. Ask yourself who the winners and losers are in all things related to banking and politics and you'll come to learn a great deal about this world. Remember, most large scale events don't just "happen." They're usually orchestrated. Pay close attention to what occurs after those events have come to close. It's striking what you can uncover.

Let's get into World War One. In general, the nations that were battling one another spent like it was going out of style. They stopped allowing the redemption of their currencies for gold, printed money like crazy, charged their citizens and importers much more in taxes, and borrowed money from anyone and everyone who would lend it to them, including the citizens of those nations involved, foreign governments, and international and national banks. It was a very messy scene and much of Europe was in financial disarray when all was said and done.

While the United States wasn't directly involved with the war effort for its first few years, it did play a huge role in the manufacture and shipment of supplies to those who needed them. The U.S. charged those nations for those supplies and because of that, its coffers were rather full of gold. So while there was a huge export of gold throughout Europe, there was a huge import of gold in the United States. What did those nations do when they ran out of gold, you ask? Well, the U.S. loaned them money to pay for more supplies. So right here, we already have one beneficiary to one small part of the war.

When the U.S. finally did join the war effort, it too spent mightily. The U.S. national debt exploded 25 times its original amount from one billion dollars to 25 billion dollars. Who loaned the nation the money? I can't be sure because Michael Maloney failed to mention that, but since the Federal Reserve had already been formed and since it loaned dollars to the U.S. government, I'd say it was them. And as we're already aware, the Federal Reserve is a private bank that loans the United States money at interest, I'd say we've just uncovered another beneficiary.

Let's be clear - the Fed was loaning money to the United States to fight the war, but the United States was still loaning money to its allies. So to say that the rising national debt of the U.S. was a bad thing would be somewhat disingenuous. It's not like the U.S. spent all the money it borrowed. I guess you can consider it somewhat of a pass through entity in regards to borrowing and lending. Also, I wonder what the terms of joining the war were. Nations don't just go in for nothing. Did the United States charge its European allies for its effort and for all the costs it incurred? I think that's something we mere mortals will never know.

After the war was over, most countries agreed that being on the gold standard was better than having total fiat currency. Economies and currencies were more stable when they were backed by something of real value and those who traded internationally appreciated having trust in the various currencies in which they traded. Because of this, there was an effort to return to something that seemed like the gold standard. You need to remember, because so much money was printed all around the world during the war, if a return to the traditional gold standard - the one the world used before the war - was implemented, a massive devaluation would have occurred. Governments and banks don't like to lose money, so they figured out a better solution. Or, something that seemed better, anyway.

Because the post war global reserve currencies were the U.S. dollar, the British Pound, and gold, that's what central banks around the world held in their accounts as reserves. But since a unit of the dollar was in no way redeemable for a unit of gold any longer (the way it used to be), the idea of fractional reserve banking was born. It was actually born before this time, but was put into action on a large scale at this point. Simply put, the idea of fractional reserve banking means that by holding only a fraction of what was once redeemable for a dollar in gold, the bank can print or lend out multiples of dollars based on the amount of gold it held. So before the war, if a bank held one ounce of gold and was allowed to lend out one dollar (I'm making these numbers up), after the war, if they held one ounce of gold, they were allowed to lend out ten dollars. This was a great way to maintain the appearance of having a currency that was still backed by gold. It was also a great way to keep all of that currency floating around in the global economy. To learn more, check out the post on fractional reserve banking.

While this new "gold standard" doesn't seem terrible on its face, it didn't stop there. The problem was, the Fed abided by this standard, but so did commercial banks. Actually, commercial and foreign banks abided by a system that was similar, but not the same. They abided by a fractional reserve system, but not one that was based on gold. They based their fractional reserve system on U.S. dollars, which were backed partially by gold. So if the Fed was allowed to loan dollars based on a fraction of the gold that was held in the U.S. treasury, all of these other banks were allowed to loan money that was based on a fraction of U.S. dollars. You can imagine how many dollars and other currencies around the world came into existence by basing their loans on fractions. The entire operation morphed into a giant cycle of money creation. Ultimately, one $20 gold coin turned into $1,250. Talk about inflating the currency supply! And that, my friends, is what the gold exchange standard was all about. People certainly love money, don't they.