The gold standard was a system under which nearly all countries fixed the value of their currencies in terms of a specified amount of gold, or linked their currency to that of a country which did so. Domestic currencies were freely convertible into gold at the fixed price and there was no restriction on the import or export of gold. Gold coins circulated as domestic currency alongside coins of other metals and notes, with the composition varying by country. As each currency was fixed in terms of gold, exchange rates between participating currencies were also fixed.

Central banks had two overriding monetary policy functions under the classical gold standard:

1. Maintaining convertibility of fiat currency into gold at the fixed price and to defend the exchange rate.
2. Speeding up the adjustment process to a balance of payments imbalance, although this was often violated.

The classical gold standard existed from the 1870s to the outbreak of World War I in 1914. In the first part of the 19th century, once the turbulence caused by the Napoleonic wars had subsided, money consisted of either specie (gold, silver or copper coins) or of specie-backed bank issue notes. However, originally only the UK and some of its colonies were on a gold standard, joined by Portugal in 1854. Other countries were usually on a silver or, in some cases, a bimetallic standard.

In 1871, the newly unified Germany, benefiting from reparations paid by France following the Franco-Prussian war of 1870, took steps which essentially put it on a gold standard. The impact of Germany’s decision, coupled with the then economic and political dominance of the UK and the attraction of accessing London’s financial markets, was sufficient to encourage other countries to turn to gold. However, this transition to a pure gold standard, in some opinions, was more based on changes in the relative supply of silver and gold. Regardless, by 1900 all countries apart from China, and some Central American countries, were on a gold standard and this lasted until the disruption of World War 1. Periodic attempts to return to a pure classical gold standard were made during the inter war period, but none survived past the 1930’s Great Depression.