Did The Gold Standard Cause The Great Depression?

Last Updated on July 3, 2025

One frequent criticism of the gold standard is that it caused the Great Depression. And that the recovery only happened because the tie to gold was severed by FDR in 1933.

The argument says that gold was a handbrake on money creation and that stimulus was necessary to avoid a deflationary spiral.

This has become a pervasive myth that people just accept even if they don’t understand it and is one of the first retorts you will hear if you are an advocate for gold.

But this is not the case.

The simple reason is that what existed at the time of the Great Depression was not the gold standard.

It was something known as the gold exchange standard and it was implemented in a politically incompetent way.

That one word – “exchange” – may not seem like much, but it makes all the difference. Technically it’s a type of gold standard but it is essentially a sham.

Yes, there was a role for gold in the money system of the late 1920s, but it was faulty and mismanaged.

To understand this we first need to go back to the classical gold standard that was in place before World War One. We need to look at why that was abandoned, the monetary impacts of the war and then why and how Britain returned to gold in 1925.

Then we can look at why that didn’t work and what actually caused the Great Depression.

The Classical Gold Standard

The classical gold standard emerged in the 1870s when the United States and Germany joined Britain in abandoning bimetallism and having gold as a monometallic monetary standard. The world’s major powers soon followed.

National currencies were defined as fixed weights of gold and those paper currencies were freely convertible into gold.

The ability to redeem paper currency freely is a critical component of the classical gold standard. Gold is the real money and the paper is merely a receipt that acts as a substitute for the real thing. The ability for the substitute to be converted into the real money ensured that there was honesty and integrity in the system and excess money was not created.

Gold was the common money of the world and the economic boom that happened between the end of the US Civil War and the start of World War One was unprecedented.

The gold standard was a handbrake on inflationary money printing by governments. For governments to acquire revenue they had to tax their citizens or borrow money. They could not create new monetary units in order to finance deficit spending.

The Abandonment of the Classical Gold Standard

When World War One broke out everybody thought it was going to be over by Christmas. Unwilling to raise taxes, governments decided to abandon the gold standard and fund the conflict through currency creation.

Only the United States Dollar remained pegged to gold at $20.67 an ounce (the US did not enter hostilities until 3 years later).

The destructiveness of World War One was only made possible by the abandonment of the gold standard. If governments had been forced to pay for the war through taxation, the citizens would have felt the burden much more immediately and would have been much more likely to resist.

The result was four years of human and economic slaughter and the cost would have to be paid.

All the European currencies had been massively devalued by the wartime money printing.

The French franc had lost 64%, the Italian lira 71% and the German mark 96% compared to their value in 1914. Britain had fared the best with only a 35% reduction in value for the pound sterling.

After licking her wounds and surveying the situation, Britain decided to return to the gold standard.

The only problem was that it was not the same gold standard that she would return to.

The Gold Exchange Standard

When Britain decided to tie the pound sterling to gold in 1925, the big question was at what price?

A lot of money had been printed in the 11 years since the war broke out, which suggested that the price should be adjusted accordingly to account for the inflation of the money supply.

However, nostalgia mixed with a bit of hubris meant that they went back to gold at the pre-war price. That could have worked, but only if the money supply contracted and prices were allowed to deflate.

But the government planned to continue an inflationary policy.

Murray Rothbard describes the folly:

“Great Britain, in the post-World War I world, committed itself to a monetary policy based on three rigidly firm but mutually self-contradictory axioms: (1) a return to gold; (2) returning at a sharply overvalued pound of $4.86; and (3) continuing a policy of inflation and cheap money. Given a program based on such grave inner self-contradiction, the British maneuvered on the world monetary scene with brilliant tactical shrewdness; but it was a policy that was doomed to end in disaster…the British would insist on having their cake and eating it too: on enjoying the benefits of gold at a highly overvalued pound while still continuing to inflate and luxuriate in cheap money.”

In addition to going back to gold at the wrong price, the 1925 gold standard was not a true gold standard at all.

Either the classical gold standard or the 100% gold standard require free convertibility of paper money into gold. That is because gold is the real money and the paper is a mere substitute.

But under this new gold standard there was no free convertibility. Pound sterling could only be converted into bullion of 400oz or more and only to non-British residents.

Essentially this meant that convertibility was accessible only to wealthy international traders and not to every single Briton as it needed to be if it were to work.

Rothbard explains the rationale:

“The purpose of redemption in gold bullion, and only to foreigners, was to take control of the money supply away from the public and to place it in the hands of the government and central bankers, permitting them to pyramid monetary expansion upon the gold centralized in their hands.”

Britain then influenced the rest of the major European powers to follow her lead and also implement the gold exchange standard. The USA stood alone as the only power remaining on the pre-war classical gold standard which had full convertibility.

What Caused the Great Depression?

So we have seen now that there was no true gold standard in the post-war world. Although gold did play some role in the monetary system it provided no check on monetary expansion and in fact encouraged it.

Rothbard again:

“The gold-exchange standard, then, cunningly broke the classical gold standard’s stringent limits on monetary and credit expansion, not only for the other European countries, but also for the base or key currency country, Great Britain itself. Under the genuine gold standard, inflating the number of pounds in circulation would cause pounds to flow into the hands of other countries, which would demand gold in redemption. Thereby gold would move out of British bank and currency reserves, and pressure would be put on Britain to end its inflation and to contract credit. But, under the gold-exchange standard, the process was very different. If Britain inflated the number of pounds in circulation, the result, again, was a deficit in the balance of trade and sterling balances piling up in the accounts of other nations. But now that these nations have been induced to use pounds as their reserves rather than gold, these nations, instead of redeeming the pounds in gold, would inflate, and pyramid a multiple of their currency on top of their increased stock of pounds. Thus, instead of checking inflation, a gold-exchange standard encourages all countries to inflate on top of their increased supply of pounds.”

The USA maintained the classical gold standard while Europe embraced what Rothbard calls the “sham” gold standard.

The problem for Britain was that in this circumstance gold would naturally flow out of England and into the USA in accordance with Gresham’s law. Britain pleaded for the USA to maintain an inflationary easy money policy to prevent this from happening. The USA obliged. Somewhat constrained by their tie to gold, they did what was in their power to assist Britain through their monetary policy.

This easy money policy from the US pumped the stock market up to dizzying heights and in October 1929 Black Tuesday occurred and the stock market began to plummet.

The government and the Fed had options. Rothbard identifies what would have been the best course of action:

“In short: they could have recognized the folly of the preceding inflationary boom and accepted the recession mechanism needed to return to an efficient free-market economy. In other words, they could have accepted the liquidation of unsound investments and the liquidation of egregiously unsound banks, and have accepted the contractionary deflation of money, credit, and prices. If they had done so, they would, as in the previous cases, have encountered a recession-adjustment period that would have been sharp, severe, but mercifully short. Recessions unhampered by government almost invariably work themselves into recovery within a year or 18 months.”

But they didn’t.

Instead, they tried to inflate their way out of the situation. Rather than recognise that inflation was the problem that had caused this mess, policymakers decided that more of the same was necessary to get them out.

Instead of a short recession they produced stagflation and a long drawn out recovery.

Jim Rickards sums it up nicely in The New Case for Gold:

“Gold did not cause the Great Depression; a politically calculated gold price, and incompetent discretionary monetary policy, did. For a functional gold standard, gold cannot be undervalued (the United Kingdom in 1925, and the world today). When gold is undervalued, central bank money is overvalued, and the result is deflation. A gold standard can work fine, so long as governments set gold’s price on an analytic rather than political basis…The Great Depression was then prolonged by experimental policy interventions [that gave rise to] “regime uncertainty,” which meant that large corporations and wealthy individuals refused to commit capital because they were uncertain about regulatory, tax, and labor policy costs. Capital went to the sidelines and growth languished.”

He also argues that the US had ample room to expand their money supply during the Great Depression, while they were still on the gold standard. The law allowed money expansion up to 250% of the gold supply. Yet they never got near those levels.

Why not?

Because growth in the money supply was constrained by the fact that nobody wanted to borrow and banks did not want to lend. Nobody had any confidence.

That cannot be blamed on gold.

Conclusion

The argument that gold caused the Great Depression because it prevented the necessary stimulus being provided is a myth.

The Great Depression occurred because of monetary stimulus which created malinvestment, wild speculation in stocks and ultimately a crash. Instead of allowing a deflationary correction, government policy prolonged the crisis.

Britain’s return to gold at the pre-war rate was a large contributing factor. But it wasn’t gold that was the problem, it was the tie to gold at a mismanaged rate coupled with the continuation of easy money policies.

As Jim Rickards says, “Gold did not cause the Great Depression; a politically calculated gold price, and incompetent discretionary monetary policy, did.”

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