In the foreign exchange market, under the gold standard, exchange rates could, in principle, fluctuate only within very narrow limits determined by the costs of shipping and insuring gold. Thus, if U.S. residents accumulated pounds sterling as a result of exporting more goods and services to Britain than they imported and being paid in pounds for the excess, the U.S. holders of sterling had the option of converting pounds into gold at par value at the Bank of England and shipping the gold back to New York. During the 1880-1914 period, the "mint parity" between the U.S. dollar and sterling was approximately $4.87, based on a U.S. official gold price of $20.67 per ounce and a U.K. official gold price of £ 4.24 per ounce. The sterling/dollar exchange rate would not fluctuate beyond the "gold points"—about three cents above and below the mint parity—which represented the cost of shipping and insuring gold, since at any exchange rate outside the gold points it would be possible to gain an arbitrage profit by converting currency into gold and shipping the gold to the other centre. While some gold transfers actually took place under this system, such shipments frequently were avoided by monetary policy moves. In the example above, the U.K. might raise interest rates to attract capital inflows—i.e., increase the demand for sterling—and counterbalance the financial impact of the import excess. Higher interest rates also would have a deflationary effect in the deficit country.

This automatic operation of the balance of payments adjustment process under the gold standard required, in theory, that in their financial policies, participating countries give an absolute priority to external adjustment over domestic objectives. This meant that in any periods of conflict between domestic and external objectives, policy tools might not be available to be used for domestic problems of recession, unemployment, or inflation. But the philosophy widely held in those pre-Keynesian times was that economies would tend naturally toward reasonably high levels of employment and reasonable price stability without such government policy actions.

For a forty-year period there were no changes in the exchange rates of the United States, UK, Germany, and France (though the same did not hold for a number of other countries). There were few barriers to gold shipments and few capital controls in the major countries. Capital flows generally seem to have played a stabilising, rather than destabilising, role. After the outbreak of the First World War, one combatant country after another suspended gold convertibility, and floating exchange rates prevailed. The United States, which entered the war late, maintained gold convertibility, but the dollar effectively floated against the other currencies, which were no longer convertible into dollars. After the war, and in the early and mid-twenties, many exchange rates fluctuated sharply. Most currencies experienced substantial devaluations against the dollar; the U.S. currency had greatly improved its competitive strength over European currencies during the war, in line with the strengthening of the relative position of the U.S. economy.

In Europe, especially in the UK, there was a widespread desire to return to the stability of the gold standard, and a worry about the growing attractiveness of the dollar—which was convertible into gold—and of dollar-denominated assets. Following a disastrous five years back on the gold standard, the UK abandoned it in 1931, and others followed over the next few years. In 1933, US President Franklin Roosevelt imposed a ban on U.S. citizens’ buying, selling, or owning gold. While the U.S. Government continued to sell gold to foreign central banks and government institutions, the ban prevented hoarders from profiting after Congress devalued the dollar (in terms of gold) in January 1934. This action raised the official price of gold by more than 65 percent (from $20.67 to $35 per troy ounce). Gold coins and certificates considered collectors’ items were exempt from the prohibition, and artistic and industrial users of gold were permitted to deal in the metal under a special Treasury license. Gold at $35 set off a mining boom. US output rose from 2.6 m.oz in 1933 to 4.4 m.oz in 1936, and peaked at 6.0 m.oz in 1940 (not equalled until 1988). Canada hit 5.5 m.oz in 1941 (best until 1991). World output up from 20 m.oz to 38.6 m.oz by 1940.

In 1971 President Richard Nixon ended US dollar convertibility to gold and the central role of gold in world currency systems ended. The dollar and gold floated and in January 1980 the gold price hit a record of $850 per ounce against a background of an international crisis arising from the Soviet invasion of Afghanistan and the Islamic Revolution in Iran. In 2006 dollars, the all-time record price would be $2,100.