More History of Money

From: Soft Currency Economics, by Warren Mosler

The Gold System as the Basis for Bank Reserves

The gold standard was established in the U. S. in 1834. Under a gold standard the price of gold is set in terms of the dollar. The dollar was defined as 23.22 fine grains of gold. With 480 grains to the fine troy ounce, this was equivalent to $20.67 per ounce. The monetary authority was then committed to keep the mint price of gold fixed by being willing to buy or sell the gold in unlimited amounts.

The gold standard was suspended from 1861 to 1879 due to the Civil War. The variant which prevailed in the U. S. from 1880 to 1914 was a fractional reserve gold coin standard. Under that standard both government issued notes and notes issued by commercial banks (also deposits) circulated alongside gold coins. These forms of currency were each convertible on demand into gold. Gold reserves were held by the issuers to maintain convertibility.

In 1934 the Gold Reserve Act devalued the dollar by increasing the monetary price of gold from $20.67 to $35.00 an ounce. The Act put the U. S. on a limited gold bullion standard under which redemption in gold was restricted to dollars held by foreign central banks and licensed private users.

As a domestic monetary standard, gold reserves regulated the domestic money supply. In a fractional reserve gold standard the money supply was determined by the monetary gold stock and the ratio of the monetary gold stock to the total money supply which consisted of gold coins, fiduciary notes and bank deposits. Money creation was determined by the amount of gold reserves. Bank deposits depended on 1) the level of gold reserves held by commercial banks and the central bank, 2) the preferences of the public for gold coins relative to other forms of money, and 3) legal gold reserve ratios.

Reprinted from Soft Currency Economics