People often throw out the phrase “gold standard” into conversation, but it’s worth keeping in mind that there have been several iterations of the gold standard over the course of history. This article describes each type of gold standard using historical examples for clarity.
1. The Gold Coin Standard, or Specie Standard
-Bimetallic Coin Systems-
Medieval coinage systems were typically bimetallic, relying on both gold and silver. To ensure the realm was well-supplied with coins, the monarch maintained a network of mints. Mints in the medieval times operated very differently than they do now. According to the principles of free coinage, access to these mints was available to anyone. By bringing their stash of raw precious metals to the mint, members of the public could ask the mint master to turn it into a specified number of coins, albeit for a fee.
English gold noble, half noble, quarter noble, silver groat, and silver penny (source)
To ensure that a variety of large and small transactions could be made by the public, the mint typically produced a range of small and large coin denominations. In England’s case, by the 1500s it was issuing pennies, farthings (1/4 pennies), groats (4 pennies), testoons (12 pennies), half crowns (30 pennies), gold nobles (100 pennies), and more.
Minting low denomination coins like farthings and pennies out of gold was generally not a feasible option because the resulting coin would be tiny and easily lost. Twinning gold with a large amount of base metals like copper might have resulted in a larger and more manageable low-denomination gold coin, but then it would be susceptible to counterfeiting. As for high denomination silver coins, they would be large and bulky. Thus bimetallism amounted to a sensible sharing of the monetary load by both gold and silver coins.
-Accidental Monometallic Gold Coin Systems-
Bimetallic standards sometimes careened off course and became what are known as monometallic standards, with either gold or silver dominating. Thus emerged the first true gold standards, albeit entirely by accident. The mechanism underlying this muddling into monometallism was rooted in the fixed price between the two metals as enforced by the monarchs’ mints.
To illustrate how this fixed price worked, consider that in August 1464 anyone could bring raw silver to the London Mint and have it minted into English pennies that contained 0.72 grams of silver. The mint would also turn raw gold into English nobles which contained 6.69 grams of gold. Since law stipulated that a noble was worth 100 pennies, that meant that the mint effectively valued a fixed amount of gold at 11 times the same amount of silver. (I get this data from John Munro [pdf]).
Gold guinea, 1664, which replaced the British unite coin
When the mint’s chosen gold-to-silver ratio diverged too far from the global market ratio of gold-to-silver, then one of the two metals would begin to be ejected from the domestic monetary system. The reason for this is that a divergence effectively meant that the monarch was undervaluing one metal and overvaluing the other, and since no one who owned gold (or silver) coins wanted their property to be less than its true worth, the undervalued metal would be taken off the market.
For instance, if the mint was undervaluing silver, then anyone who purchased £1000 worth of raw silver and brought it to the mint for conversion into coins would get less purchasing power than if they had bought £1000 worth of gold and bought it to the mint. So the flow of silver to the mints would grind to a halt. Furthermore, any high quality silver coin already in circulation would be sent overseas in order to take advantage of the true gold-to-silver ratio. At this point a gold standard had emerged.
England stumbled onto a monometallic gold standard in the 18th century after having operated on a bimetallic basis for centuries. The gold-to-silver ratio used by the mint in the later 1600s and early 1700s undervalued silver and overvalued gold, so England’s silver coins were steadily being shipped to the continent, causing silver coin shortages. Isaac Newton, the famous physicist who was appointed Master of the Mint in 1699, counseled the government to bring the ratio in line with the market. But when he finally moved to fix the problem in 1717, he undershot the amount of adjustment necessary, so that silver remained undervalued and the export of silver coins continued. Thus England was pushed onto a gold standard.
-The Hybrid Circulation of Coins and Paper Money-
By the 17th century, banknotes had joined coins in circulation. Paper money was originally convertible into a fixed amount of coins, issuers holding enough reserves in their vaults to ensure that ready convertibility was possible. A banknote is far easier to carry and handle than a coin, and since the public generally trusted the issuers of these notes, gold coins were pushed out of circulation and into bank vaults or non-monetary uses like jewellery. By the 1800s, it was rare to see a gold coin circulating in England.
Even as banknotes came to dominate, the British standard effectively remained a gold coin standard. Since a banknote was convertible into a fixed amount of coin, the note’s purchasing power was regulated by the value of the coin itself. If there was any divergence between the two, say notes became more valuable than underlying coins, than arbitrageurs would push them back into line by buying coins for 99c and converting them into $1, earning 1 cent in risk-free profits.