Is Money Backed By Gold?
Is Money Backed By Gold?
A comprehensive exploration of modern fiat currency, gold standard history, and what backs our money today
The Short Answer:
Money is not backed by gold, nor by any other commodity. It hasn't been since 1971.
I've spent my career studying and researching monetary history. My expertise focuses on gold's role in this regard—but it's fascinating how many different materials have been used as money throughout human history.
Complete Analysis
Historical Forms of Money
At various times, even up through the 18th century, people around the world used many forms of commodity money. This isn't an exhaustive list, but it should give you an idea of how money is simply a representation of value.
Commodity Money Throughout History
- Salt
- Tobacco
- Wheat
- Cowry shells
- Beads
- Small tools
- Feathers
- Animal pelts
Money facilitates trade and is more efficient than simple barter. Theoretically, anything could be used to fill this role. Yet you will find that some materials functioned better as money than others did. Gold proved to be the best among them, for reasons we will discuss below.
Why Gold Excelled as Money
Gold's properties made it superior to other commodity money: durability, divisibility, portability, recognizability, and scarcity. These characteristics explain why gold became the preferred monetary standard and why many investors today still choose gold as a store of value in their portfolios.
Understanding Fiat Money
The most recent polling from 2019 suggests that as high as 30% of the American population mistakenly believes that the U.S. dollar is backed by gold. An additional 4% of people believe it is backed by oil.
What is Fiat Money?
Fiat money simply describes a currency that derives its value from government decree. In other words, fiat money has value merely because the government says so.
While fiat currency has no intrinsic value, that doesn't mean it's inherently worthless.
Sources of Fiat Value
- Government acceptance for tax payments
- "Full faith and credit" of issuing government
- Legal tender status
- Network effects and widespread acceptance
What Backs the U.S. Dollar Today
Fiat currencies can be backed by intangible things. In the case of the U.S. dollar, its value partly derives from macroeconomic factors:
Economic Factors
- Large size of U.S. economy relative to other countries
- Foreign central banks holding dollars as reserve asset
- Strong network of trade alliances
- Strength of American military
Systemic Advantages
- World's primary reserve currency
- International oil trading denomination
- Deep, liquid financial markets
- Political and economic stability
How the Gold Standard Worked
At various times throughout history, world trade operated on a de facto gold standard. Gold was used as money throughout the world. This arrangement arose organically as early as the 7th century BCE.
Origins of Gold as Money
The use of gold as a monetary standard began organically in ancient civilizations, establishing a precedent that would last for millennia.
Classical Gold Standard Period
The height of the "classical" period of the gold standard. Under this system, a government could only issue money if there were enough gold reserves to back its value.
How It Functioned
The banknotes and copper coins that circulated around the economy were supposed to be redeemable for gold specie (gold coins). This was in addition to actual gold coins struck by government mints up until 1933. But for the most part gold only migrated between large commercial banks—functioning more like bank reserves.
Benefits of the Gold Standard
Domestic Benefits
- Fiscal discipline on government spending
- Limited monetary expansion
- Price stability over long periods
- Prevented currency debasement
International Benefits
- Universal measuring stick for value
- Fixed exchange rate stability
- Facilitated international trade
- Consistent global standard
Roosevelt's Gold Price Adjustment
To combat the Great Depression, the Roosevelt administration adjusted the gold price from roughly $21 per troy ounce in 1932 to $35/oz by 1934. In essence that meant the purchasing power of the dollar declined by two-thirds, losing 67% of its value versus gold.
End of Gold Convertibility
President Nixon "closed the gold window"—thereby ending the U.S. dollar's direct convertibility to gold. This marked the definitive end of the gold standard era.
Gold Standard Limitations
Despite its benefits, the gold standard was hardly perfect. It was periodically suspended, at times it was abused by government officials, and it wasn't uniformly adopted by every country on the planet. Nonetheless, adhering to a gold standard created a consistent standard for the value of money all around the world.
Modern Monetary Implications
In a word, no—our money is not worthless. It does mean that our money is subject to the effects of inflation and won't hold its value over time. Our current regime of fiat money is not designed to reward saving money. That's one of the main reasons why people make investments.
Money as a Tool
It's best to think of money as a tool. It serves as:
- Medium of exchange
- Unit of account
- But NOT a reliable store of value
Money is useful (and worth something) by virtue of what it can buy.
Currency Strength Trade-offs
With floating exchange rates, there's a trade-off:
- Weaker currency: Makes exports more attractive
- Stronger currency: Increases purchasing power for imports
Economic policy often balances these competing interests.
Investment Considerations
Gold is no longer used as money, but simply saving money is not an investment in the future. Understanding monetary history helps explain why precious metals remain relevant in modern portfolios.
Why Gold Remains Relevant
- Hedge against currency debasement
- Portfolio diversification benefits
- Store of value during crises
- No counterparty risk
- 5,000+ year track record
Consider adding gold to your portfolio as insurance against monetary instability.
Precious Metals Strategy
- Understand your investment timeline
- Consider dollar-cost averaging
- Diversify across metals types
- Monitor market conditions
- Balance with other asset classes
Track both gold and silver prices for optimal timing.
Historical Perspective
While we no longer have a gold standard, gold continues to serve important monetary functions. Central banks still hold substantial gold reserves, and during periods of monetary uncertainty, both institutions and individuals often turn to precious metals as a store of value. This explains the continued interest in silver and gold investments despite their removal from the official monetary system.
The Bottom Line
Money today is not backed by gold, but this doesn't make fiat currency worthless. It does mean that money's purchasing power erodes over time through inflation. Understanding this dynamic helps explain why many investors include precious metals in their portfolios—not as a return to the gold standard, but as a hedge against the inherent instability of fiat monetary systems.
Disclaimer: This article is for educational purposes only and should not be considered financial advice. Precious metal investments involve risk, including potential loss of principal. Past performance does not guarantee future results. Always consult with qualified financial advisors before making investment decisions.