The Legacy of King Croesus

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The idea that a currency cannot be trusted unless it is backed by gold seems as durable as the metal itself. In the early 19th century, British Economist David Ricardo declared that without the gold standard the then mighty pound sterling would be at the whim of "all the fluctuations to which the ignorance or the interests of the issuers might subject it."

Though pure gold coins were first minted by King Croesus of Lydia (modern day western Turkey) in the 6th century B.C., a gold-backed currency is usually traced back to 1717, when Sir Isaac Newton, then Master of the Mint, fixed the value of the pound sterling at about .24 oz. of gold. For the next 200 years, except when it was briefly suspended during the Napoleonic wars, the gold standard made the pound the world's most trusted currency and helped Britain dominate world finance and trade.

During World War I, however, Britain went off the gold standard in order to make it easier to finance its military effort. In 1925 Winston Churchill, then Chancellor of the Exchequer, returned the country to the gold standard, believing that such a step would help restore the British Empire to its former preeminence. But he made the mistake of setting the value of the pound at its prewar gold price, which did not take account of high wartime inflation. This was a major cause of the nationwide general strike that virtually immobilized the economy in 1926. Indeed some historians believe that Churchill's decision to return to the gold standard helped trigger the worldwide Great Depression. In 1931 Britain again abandoned the gold standard.

As the heir to Britain's role in world finance following World War I, the U.S. clung to the gold standard. Franklin D. Roosevelt partly revoked it in 1933, when he attempted to help banks by forbidding Americans to hold gold. During the international chaos surrounding the Depression and the beginning of World War II, gold flooded into the U.S. The American gold supply jumped from $4 billion at the beginning of 1934 to $17.6 billion by the end of 1939. The U.S. suddenly held 60% of all the gold reserves in the world, and Washington officials worried about the problem of having too much gold.

The Bretton Woods Conference of 1944, which established the postwar international monetary structure, set up the gold-exchange system. The price of gold was fixed by the U.S. Treasury at $35 per oz., and Washington agreed that foreign governments could always exchange their dollars for gold. This system worked well for about two decades, but by the mid-1960s governments fearful of the future convertibility of the American currency started turning in more and more dollars for gold. At the same time, French President Charles de Gaulle began a campaign to restore the full gold standard, proclaiming its merits as a form of payment that is "eternally and universally accepted." On Aug. 15, 1971, President Richard Nixon finally ended the gold-exchange system, when he announced that the U.S. would no longer redeem foreign-held dollars for American gold.