Friday, October 26, 2012

The Gold Standard did not Prevent Price Inflation

It was once claimed by Murray Rothbard that deflation was the natural state of the economy: or, that is to say, what Rothbard imagined as the “natural state” in his anarcho-capitalist fantasy world.

Needless to say, anarcho-capitalism has never existed in the real world, so we really have no empirical evidence to support such an idea. If we turn to the real world, the most laissez faire economy ever seen in the US (relatively speaking) was certain periods during the gold standard era. Austrians are fixated on the 1873–1896 period because of the near continuous price deflation in that time, but the truth is that it was an historical aberration.

A look at the data on price inflation in the US shows that inflation regularly occurred in the late 18th and 19th centuries:
Year | Inflation Rate
1775 | -5.24%
1776 | 14.17%
1777 | 21.87%
1778 | 29.78%

1779 | -11.51%
1780 | 12.25%
1781 | -19.34%
1782 | 9.70%
1783 | -12.33%
1784 | -3.88%
1785 | -4.84%
1786 | -2.55%
1787 | -1.85%
1788 | -4.43%
1789 | -0.93%
1790 | 3.75%
1791 | 2.71%
1792 | 1.87%
1793 | 3.45%
1794 | 10.95%
1795 | 14.38%
1796 | 5.26%

1797 | -3.75%
1798 | -3.33%
1799 | 0.00%
1800 | 2.10%
1801 | 1.31%

1802 | -15.73%
1803 | 5.49%
1804 | 4.38%

1805 | -0.70%
1806 | 4.23%
1807 | -5.41%
1808 | 8.66%
1809 | -2.05%
1810 | 0.00%
1811 | 6.80%
1812 | 1.26%
1813 | 20.02%
1814 | 9.89%

1815 | -12.29%
1816 | -8.65%
1817 | -5.36%
1818 | -4.34%
1819 | 0.00%
1820 | -7.87%
1821 | -3.52%
1822 | 3.65%
1823 | -10.65%
1824 | -7.88%
1825 | 2.57%
1826 | 0.00%
1827 | 0.83%

1828 | -4.96%
1829 | -1.85%
1830 | -0.89%
1831 | -6.26%
1832 | -0.95%
1833 | -1.93%
1834 | 1.97%
1835 | 2.89%
1836 | 5.62%
1837 | 2.77%

1838 | -2.70%
1839 | 0.00%
1840 | -7.10%
1841 | 0.95%
1842 | -6.62%
1843 | -9.24%
1844 | 1.12%
1845 | 1.10%
1846 | 1.09%
1847 | 7.69%

1848 | -4.14%
1849 | -3.14%
1850 | 2.16%
1851 | -2.11%
1852 | 1.08%
1853 | 0.00%
1854 | 8.68%
1855 | 2.95%

1856 | -1.91%
1857 | 2.92%
1858 | -5.67%
1859 | 1.00%
1860 | 0.00%
1861 | 5.96%
1862 | 14.17%
1863 | 24.82%
1864 | 25.14%
1865 | 3.68%

1866 | -2.53%
1867 | -6.82%
1868 | -3.91%
1869 | -4.14%
1870 | -4.24%
1871 | -6.40%
1872 | 0.00%
1873 | -2.03%
1874 | -4.83%
1875 | -3.62%
1876 | -2.35%
1877 | -2.31%
1878 | -4.73%
1879 | 0.00%
1880 | 2.48%
1881 | 0.00%
1882 | 0.00%
1883 | -2.02%
1884 | -2.06%
1885 | -2.00%
1886 | -2.15%
1887 | 1.10%
1888 | 0.00%
1889 | -3.25%
1890 | -1.12%
1891 | 0.00%
1892 | 0.00%
1893 | -1.13%
1894 | -4.36%
1895 | -2.40%
1896 | 0.00%
1897 | -1.23%
1898 | 0.00%
1899 | 0.00%
1900 | 1.24%
1901 | 1.23%
1902 | 1.21%
1903 | 2.28%
1904 | 1.17%

1905 | -1.16%
1906 | 2.23%
1907 | 4.47%

1908 | -2.09%
1909 | -1.12%
1910 | 4.42%
1911 | 0.00%
1912 | 2.06%
1913 | 2.13%
1914 | 0.94%


http://www.measuringworth.com/calculators/inflation/result.php
If we ignore those periods of war such as the American War of Independence (1775–1783), the War of 1812 (or Anglo-American War from 1812–1815), and the Civil War (1861–1865), we still find many periods of price inflation, usually when booms were occurring (that is, expansions in the business cycle).

Even in the 19th-century, gold-standard era, booms were basically inflationary (outside of the historically aberrant 1873–1896 period). For example, the US had price inflation under the gold standard in the following booms: 1825, 1834–1837, 1844–1847, 1841, 1852–1855, 1857, 1859, 1880, and 1896–1914. In particular, there was a period of protracted price inflation in most Western nations from 1896–1914. And note that the United States had no central bank for most of this period.

It is interesting to compare the periods of deflation above with those periods when the US suffered recessions in the 19th century, on the basis of Davis’s list from real manufacturing output data:
US Recessions in the 19th Century
Years (Peak–Trough) | Recession Length (years)

1796–1798 | less than 1
1802–1803 | less than 1
1807–1808 | less than 2
1811–1812 |
1815–1816 |
1822–1823 |
1828–1829 |
1833–1834 |
1836–1837 | less than 1
1839–1840 | less than 3
1856–1858 |
1860–1861 |
1864–1865 | less than 2
1873–1875 | less than 3
1883–1885 | 1
1892–1894 |
1895–1896 |
1903–1904 |
1907–1908
(Davis 2006: 106).
Although there is not a perfect match, it nevertheless seems to me that many of these recessions were deflationary periods as well: this tends to confirm that, before the unusual period of deflation from 1873 to 1896, people tended to think of strong booms as inflationary and recessions as deflationary.

Thus when Irving Fisher wrote this in 1933, he had could have cited some considerable evidence in US history to support it:
“I had since 1909 been stressing the fact that deflation tended toward depression and inflation toward a boom.” (Fisher 1933: 350, n.).
And that is how many economists have come to see the nature of deflation too.

BIBLIOGRAPHY

Davis, J. H. 2006. “An Improved Annual Chronology of U.S. Business Cycles since the 1790s,” Journal of Economic History 66.1: 103–121.

Fisher, Irving. 1933. “The Debt-Deflation Theory of Great Depressions”, Econometrica 1.4: 337–357.

7 comments:

  1. Fancy charts aside, pegging a currency to gold (which, incidentally, is still required by the US Constitution) keeps its price as stable as gold. Pegging a currency to paper puts it at the mercy of the state (or whoever runs the printing presses) - which inevitably devalues the currency for its selfish ends. Furthermore, competing currencies (which were also assumed would continue by the founders) prevent monopolization (as in any product or service) along with all of its symptoms. Nothing could be more foolish than to subject banking and currency to politics. Leave it to the discipline of the natural laws of the market. Politics contaminates everything it touches.

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  2. "Pegging a currency to paper puts it at the mercy of the state (or whoever runs the printing presses)"

    And a gold standard puts it at the mercy of arbitrary gold discoveries and private sector money creation (read: potentially millions of private printing presses in banks, private bills of exchange, promissory notes, etc.)??

    E.g., the US currency was "debased" from 1898-1913 by price inflation (without even any central bank existing), but by private sector activity. Why wasn't this a horrible evil?

    Anyway, complaints about "devaluing the currency" are mostly grossly misleading, because even under mild to moderate price inflation real wages rise and real living standards rise too.

    The vast majority of people do not in fact become poorer just because price inflation occurs.

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    Replies
    1. I've never come across an Austrian explanation of the Price Revolution, a period of specie-based inflation in early modern Europe when gold lost about 85 percent of its purchasing power:

      http://en.wikipedia.org/wiki/Price_revolution

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    2. You have to wonder what Austrians would say if a technological breakthrough turned gold into a cheap throwaway commodity like aluminum, which in the past 150 years or so went from a scarce metal more valuable per ounce than gold to something we use for disposable food and beverage containers.

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  3. "The vast majority of people do not in fact become poorer just because price inflation occurs."

    Up to surprisingly high levels of price inflation - double figures at least.

    Even less so if they have salary linked pensions and decent union representation.

    Neither do productive businesses which just mark up whatever input costs they have. In fact inflation tends to cover off mistakes.

    So equity investors in productive businesses are covered - with their dividend and value growing with the inflation.

    So that, I think, just leaves money lenders at a fixed rate...

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  4. "pegging a currency to gold (which, incidentally, is still required by the US Constitution"

    No it isn't.

    "keeps its price as stable as gold"

    Price volatility was higher during the gold standard period.

    "competing currencies (which were also assumed would continue by the founders"

    No they weren't.

    You clearly don't have a clue what you're talking about.

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  5. This period of deflation also coincided with the industrial revolution in the US.

    For Austrians, this is the golden age so to speak. Huge boom in productivity and efficiency AND falling consumer prices.

    To the point about inflation during booms and deflation during busts while on the gold standard. Austrians are fine with this. The key is deflation during the busts. The FED and fiat system we have now almost assures price INFLATION during recessions. This is exactly what current Fed policy is aiming at! Even with high unemployment. A double whammy on consumers. Ouch....

    ReplyDelete