A gold standard is simply when a currency’s value is linked to gold. For example, the U.S. government can decide that 20 dollars are equal to an ounce of gold, thus creating a fixed value of the dollar relative to gold. In this scenario, one dollar would be equal to 1/20 of an ounce of gold. Similarly, exchange rates between currencies become fixed when they are all linked to gold, so that if an ounce of gold is worth 100 Mexican pesos, one dollar would then be worth five pesos.
By contrast, a fiat currency, which is the type of currency in the U.S. and the rest of the world nowadays, is not fixed to gold or any other commodity. The value of a fiat currency is based on faith or confidence derived from a government decree that it is to be used as a means of exchange. Today, the values of currencies float freely against one another based on economic news.
Some economists believe that the gold standard is more effective than a fiat currency at stemming inflation, which is a central part of their argument for a return to a gold standard. They argue that unlike a fiat currency, which can be printed in unlimited amounts, the amount of currency backed by gold that can be printed would be constrained by the amount of physical gold possessed by the country. Therefore, they argue, without the possibility of massive amounts of money printing, the likelihood of high inflation would be very small or nonexistent. Historically, inflation has been much more subdued under a gold standard than under fiat currencies. This is due to the fact that the amount of gold in the world is relatively stable because of its rarity, increasing by one to two percent annually from mining.
While a currency could in theory be backed by other commodities, or even a basket of commodities, it is gold’s unique qualities, such as its rarity, malleability, durability and divisibility that entice economists to argue for a return to a gold standard. Gold is the only commodity universally recognized as a form of money that can be converted to cash quite easily. Silver has similar properties, and, though it too has been used as a form of money in many countries historically, it has tended to be significantly less valuable than gold due to its greater abundance on earth. However, it is possible for both gold and silver to be used to back a currency, which would be a bimetallic standard.