Why the Dollar Replaced Gold as the Global
Standard
Economics Semester Project Report
By
Muhammad Kazim - 289592
Eilad Tariq - 321661
Muhammad Basit Raza – 294216
Asad Raza – 301592
Talha Naeem - 242062
Instructor: Ma’am Zainab Zeeshan
November 19th, 2022
School of Electrical Engineering and Computer Science
National University of Sciences and Technology
Islamabad, Pakistan
(2022)
1
Contents
1.
Introduction ........................................................................................................................ 3
2.
Historical Perspective ........................................................................................................ 3
3.
Causes ................................................................................................................................ 3
4.
Consequences ..................................................................................................................... 4
5.
Data and Analysis .............................................................................................................. 5
6.
Conclusion ......................................................................................................................... 7
7.
Recommendations .............................................................................................................. 7
8.
References .......................................................................................................................... 8
2
1. Introduction
The gold standard has long been seen as a stable and reliable way to value currencies. However,
in the 20th century, the dollar emerged as the dominant global currency, replacing gold as the
standard by which other currencies were measured. This shift was due to a variety of economic
and political factors, and it had significant consequences for the global economy. In this report,
we will explore the reasons why the dollar replaced gold as the new standard, and examine the
impacts of this change on the global economy.
2. Historical Perspective
The use of gold as a standard for currencies dates back to ancient civilizations, where gold was
used as a medium of exchange and store of value. The gold standard as we know it today,
however, originated in the late 19th century, when many countries began to tie the value of
their currencies to a specific amount of gold (Amadeo, 2022). Under the gold standard, a
country's central bank would hold a certain amount of gold in reserve, and the value of its
currency would be based on the amount of gold it held. This meant that the value of a currency
was directly tied to the amount of gold that a country had in its reserves, and people could
exchange their currency for gold at a fixed rate.
The gold standard remained in place for much of the 20th century, but it began to face
increasing challenges in the 1930s, due to the economic instability and deflation caused by the
Great Depression (Pells, 2022). In an effort to stimulate economic activity and combat
deflation, many countries began to abandon the gold standard and adopt fiat currencies, in
which the value of a currency is not tied to a specific commodity like gold, but rather is
determined by the issuing government.
During this time, the United States emerged as the dominant economic power, and the dollar
became the de facto global reserve currency. This meant that other countries began to rely on
the dollar as a stable and reliable currency, and the gold standard was eventually abandoned in
favor of a fiat currency system. Today, the dollar remains the dominant global currency, and
gold is no longer used as a standard for valuing currencies.
3. Causes
There were several causes that led to the shift away from the gold standard and the emergence
of the dollar as the dominant global currency. Some of the main causes include:
1. Economic instability and deflation during the Great Depression: The economic
instability and deflation that occurred during the Great Depression of the 1930s played
a major role in the shift away from the gold standard (Pells, 2022). Under the gold
standard, the value of a currency was tied to the amount of gold that a country held in
its reserves. This meant that if a country's economy was experiencing deflation, its
currency would also lose value, as people would be less likely to hold onto the currency
in the hopes of exchanging it for gold at a later date. This led to a downward spiral of
economic activity, as people were less likely to spend money, leading to further
deflation and currency devaluation.
3
2. Increasing global demand for American goods during World War II: The United States
emerged from World War II as the dominant economic power, and as a result, other
countries began to rely on the dollar as a more stable and reliable currency. This led to
the dollar becoming the de facto global reserve currency, and the gold standard was
eventually abandoned in favor of a fiat currency system.
3. The Bretton Woods Agreement: The Bretton Woods Agreement, which was signed in
1944, played a significant role in the shift away from the gold standard. Under this
agreement, the value of the dollar was pegged to the price of gold, and other currencies
were pegged to the dollar. This effectively made the dollar the global reserve currency,
and it helped to establish the dollar as the dominant global currency (Chen, 2022).
4. Economic policies and decisions by the US government: The economic policies and
decisions of the US government also played a role in the emergence of the dollar as the
dominant global currency. For example, the US government's decision to maintain a
strong economy and a stable monetary policy helped to establish the dollar as a reliable
and stable currency (Lioudis, 2022).
In summary, the shift away from the gold standard and the emergence of the dollar as the
dominant global currency were caused by a combination of economic and political factors,
including economic instability and deflation during the Great Depression, increasing global
demand for American goods during World War II, the Bretton Woods Agreement, and
economic policies and decisions by the US government.
4. Consequences
The shift away from the gold standard and the emergence of the dollar as the dominant global
currency had a number of consequences, both positive and negative. Some of the main
consequences include:
1. Increased global trade: The adoption of the dollar as the dominant global currency
facilitated increased global trade, as it made it easier for countries to conduct
transactions with one another. This helped to stimulate economic activity and boost
global economic growth.
2. Greater economic stability: The dollar, as the dominant global currency, provided
greater economic stability, as it was seen as a stable and reliable currency. This helped
to reduce currency exchange rate fluctuations and made it easier for countries to
conduct business with one another (Lioudis, 2022).
3. Increased US economic power: The adoption of the dollar as the dominant global
currency also increased the economic power of the United States, as it allowed the
country to exert greater influence on the global economy.
4. Dependence on the US economy: One potential negative consequence of the dollar's
dominant position is that other countries may become overly dependent on the US
economy. This can lead to increased vulnerability to economic downturns in the US,
which can have negative impacts on the economies of other countries (Amadeo, 2022).
In summary, the shift away from the gold standard and the emergence of the dollar as the
dominant global currency had a number of consequences, including increased global trade,
greater economic stability, increased US economic power, and potential dependence on the US
economy.
4
5. Data and Analysis
Federal Reserve mismanagement caused the U.S. economy to turn from the “roaring Twenties”
to a sharp recession in 1929-1930.
The Federal Reserve was
responsible for providing a
stable money supply, but as
Fig. 2 shows, they failed at that
task. The classical gold
standard had led Americans to
expect 1-4% money supply
growth per year. After World
War 1 and the establishment of
the Federal Reserve, however,
the central bank had massive
gold reserves and discretion
over the money supply. Money supply growth was rapid in 1923, 1924, and 1925. It returned
to relatively normal levels in 1926, 1927, and 1928, and then the Federal Reserve
dramatically tightened the money supply in 1929 and 1930 out of fear that stock prices were
“too high.”
The most interesting story for the Great Depression seems to be sticky wages. Monetary
contraction reduced price levels (deflation), which caused real wages to rise, making workers
unaffordable. So employers laid off workers, creating persistent unemployment. Fig. 3 shows
what happened to prices in some major economies as the global recession deepened.
Wages adjusted for deflation rose in all these economies in the first two years of the
recession, which is the least desirable thing to happen to wages in a recession. Ideally, wages
need to fall in a recession so that employers will start wanting to hire again. The U.S. saw
real wages rise 20% from 1929 to 1937, which is why the U.S. had the worst depression of all
the major economies: workers couldn’t get jobs at these elevated wages. Because fewer
people were working, industrial production fell (Fig. 5). The U.S. had the sharpest decline of
these five economies and the second-slowest recovery (after France). Japan left the gold
standard early and immediately depreciated its currency. Britain and Germany went off the
5
gold standard in 1931, depreciated their currencies, and immediately started to recover. The
U.S. didn’t go off the gold standard until 1933, and that greatly delayed its recovery.
Countries that got off the gold standard earlier recovered more quickly (Tab. 2). Countries
that allowed their currencies to float freely in international markets, where their exchange
rates were set by supply and demand, did better than exchange-control countries that tightly
regulated people’s ability to convert their money.
Getting off the gold standard allowed central banks to increase the money supply, causing
inflation, reducing real wages, and encouraging hiring (Fig. 8). U.S. money supply collapsed
between 1929 and early 1933, then started rising again after President Roosevelt took the
U.S. off the gold standard. By 1937, the U.S. had had the most rapid increase in the money
supply of the following four economies.
6
6. Conclusion
In conclusion, the shift away from the gold standard and the emergence of the dollar as the
dominant global currency was a significant event in the history of the global economy. This
shift was caused by a combination of economic and political factors, including economic
instability and deflation during the Great Depression, increasing global demand for American
goods during World War II, the Bretton Woods Agreement, and economic policies and
decisions by the US government. The adoption of the dollar as the dominant global currency
had a number of consequences, including increased global trade, greater economic stability,
increased US economic power, and potential dependence on the US economy. Today, the dollar
remains the dominant global currency, and it continues to play a central role in the global
economy.
7. Recommendations
Based on the analysis provided in this report, it is recommended that countries carefully
consider the consequences of adopting a particular currency as their standard. While the shift
away from the gold standard and the adoption of the dollar as the dominant global currency
had a number of positive consequences, it also had the potential to create economic
vulnerabilities for other countries that became overly dependent on the US economy. It is
important for countries to carefully weigh the benefits and risks of adopting a particular
currency as their standard, and to consider the potential impacts on their own economies. In
addition, it is important for countries to maintain strong and stable economies and monetary
policies in order to promote the stability and reliability of their currencies.
7
8. References
(n.d.). From https://www.britannica.com/event/Great-Depression
Amadeo, K. (2022, March 17).
Chen, J. (2022, March 21). From
https://www.investopedia.com/terms/b/brettonwoodsagreement.asp
Lioudis, N. (2022, March 04). From https://www.investopedia.com/ask/answers/09/goldstandard.asp
Pells, R. H. (2022, December 5). From https://www.britannica.com/event/Great-Depression
Nathan K. Lewis, Gold: The Final Standard (2017, May 30)
8