The years between 1896 and World War I were the heyday of the gold standard. As data in Figure 19.2 indicates, prices rose at a moderate rate, about 2 percent per year. International exchange rates among the industrial countries were fixed because most were on the gold standard. Indeed, it could well be said that there was really only one international currency—gold; it simply had a different name in different country. Fixed exchange rates and mildly rising prices encouraged the free flow of goods and capital across international borders. London was the financial center of the world. Bonds sold there sent streams of capital into the less-developed parts of the world. No wonder many economists still look to this period as a model for the world’s monetary system. In The Economic Consequences of the Peace, John Maynard Keynes mourned the loss of the world economy (of which the gold standard was an important part) as it existed before World War I.
A cornerstone of the second industrial revolution, rose an astonishing 6.4 percent per year as the United States became the world’s leader. Of course, deflation did not affect everyone the same way. If a lender and a borrower entered into a contract without factoring in the deflation, the lender would receive an unanticipated profit at the expense of the borrower. And while the period as a whole was one of rapid economic growth, there were shorter periods of hard times, especially in the mid-1870s and early 1890s. Still, a look back at this period helps put the simple equation of deflation and economic stagnation into richer perspective.
NEW VIEW 19.1
DEFLATION
Source: Prices and real GDP per capita: Johnston and Williamson 2003a and b. Industrial production and iron and steel:Historical Statistics 1975, Series P17 and P270.
For most of the years after World War II, inflation was the main worry of monetary economists. Today, the United States, as well as other industrial countries such as Japan, faces the prospect of deflation. Is deflation always a bad thing? Many people assume so, perhaps because of the correlation between falling prices and hard times during the 1930s. The experience of the United States after the Civil War shows that deflation, at least a mild form of it, may not be such a bad thing. Between 1865 and 1896, the price level in the United States fell at an annual rate of about 2.1 percent per year, but real GDP per capita rose at an annual rate of 1.4 percent per year, and total industrial production rose at 4.8 percent per year. Iron and steel production,
The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend. He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighboring office of a bank for such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference.
However, the gold standard had costs as well as benefits. Resources were used to mine gold in South Africa and the Klondike and to dredge gold from the rivers of California. A paper standard would have permitted those resources to be used elsewhere. The rates of growth of the world’s money supplies, moreover, were determined by the individual decisions of miners and chemists and by the forces of nature that had sewn the rare seams of gold into the earth. During the years after 1896, the net result was that the world’s stock of monetary gold grew at a satisfactory rate. But this was not true for the years before 1896. During financial crises, moreover, adherence to the gold standard made it difficult to supply additional money to financial markets. In any case, there was always the hope that central bankers backed by reams of scientific analysis could do a better job of controlling the money supply than an automatic mechanism such as the gold standard.
The debate over the net benefits of the gold standard continues unabated. Historical comparisons, however, can narrow the range of debate. Michael D. Bordo (1981) has shown that along many dimensions (most important, average unemployment), the gold standard was inferior to modern monetary standards. Only with respect to long-term price stability could the gold standard be declared clearly superior. Once again we see the value of testing conjectures with evidence (Economic Reasoning Proposition 5, evidence and theory give value to opinions).
World History
