The United States worked directly with a gold standard for its currency until 1933. As President Roosevelt worked to strengthen a beaten-down U.S. economy after the 1929 market crash, he made sure that the government would no longer have a run on the gold it kept. This direction was enforced by stopping civilians from changing their currency back to gold. This move forced civilians to have to use paper money as currency and reserves whether they liked it or not. The next step was to stop other governments from drawing away U.S. gold as well. That approach did not happen until the 1970s when President Nixon halted foreign governments from being able to convert U.S. dollars to gold. In doing so, foreign countries were then forced to recognize and value the U.S. dollar as a paper asset only rather than one that could be changed to gold. Both of these moves boosted the amount of U.S. currency supply, but they also devalued the U.S. dollar over time. A car that cost maybe $1,000 in the 1960s now today costs $25,000.
The gold standard represented for a long time the strength of and limitation on how much currency a government could print. Since governments could only print money based on the amount of gold physically held, some countries did very well while others were dependent on trade to bring economic strength. Even the United States until the 20th century used gold as the basis of its currency. In fact, in the 1960s, the U.S. Administration only allowed U.S. currency to reach quadruple paper value versus what was held in gold. Any further, and the United States would have risked an inflation scenario, causing its currency to not be trusted and become worthless.
A paper/growth currency foundation is also referred to as a fiat economy. In short, paper currency used by a country under such a system is not based on gold but instead on an inherent valuation of the country’s economy. The U.S. dollar, for example, is based in value on the U.S. economy, specifically the U.S. gross domestic product measurement (GDP). When the GDP does well, the dollar value goes up; when the U.S. economy drops, the U.S. dollar weakens. This linkage is based on the people’s trust that the economy sets the dollar value. However, there is no unit-to-unit relationship as there would be with a gold standard.
A fiat system also allows for the generation of new dollars via finance. In doing so, credit is created which isn’t based on anything except an obligation that someone has to pay a certain amount of money back to a lender. Too much credit creates a temporary buying power that may seem like it is boosting an economy, but, in reality, if the credit is not able to be paid back, an economy can sink rapidly. Since the dollar is hinged on economic growth, economic contraction reduces the paper dollar value without much warning.
A number of critics warn that, due to an over-extended national debt, the U.S. dollar will collapse in value from hyper-inflation. This will force the United States to then turn back to a gold standard. The expected related panic may cause investors to drive up the price of gold as an inflation hedge. However, no government that has changed to a paper fiat economy has gone back to gold yet.