Economics / History / Warfare

Aggregate Demand Dominance: Millennia-Long Price Manipulation Misadventure

The Utter Failure and Stupidity of the Gold and Silver Standards: Part 1

I cannot really pinpoint why I am so infuriated by the infantile stupidity of gold standard and the silver-based price controls that preceded it, seeing that this system expired 41 years ago; but no one reads this blog so why not rail obsessively about the insanity of this system? However, I have reason to bloviate about this economic crime perpetuated for so long against the whole of humanity—the last vestiges of the gold standard refuse to die.

It is no secret some of a particular persuasion see gold as the solution to all that ails us; though if the evidence Gordon Chang presents is correct and China has decided to make a bid to establish a 21st century gold standard priced in renminbi/yuan, I’m sure I won’t be the only person questioning the sanity of Beijing’s technocrats. Yet the same stupidity infects the writing of otherwise non-stupid people such as Matthew Yglesias:

Unfortunately, we don’t seem to have any way of estimating the total amount of gold knocking around Middle Earth so it’s difficult to know how large the impact would be [from killing Smaug the dragon and seizing his apparently vast stockpile of gold]. But this is essentially how the pre–World War I gold standard worked. Whenever a bunch of new gold mines were discovered, you’d get inflation. When existing mines lost their productivity, you’d get deflation. Most of the time this worked OK because gold shocks were relatively rare. But they did happen. Basing the monetary system on precious metal didn’t make inflation impossible, it simply meant it was a by-product of mining activity.

Nope. Measuring Worth has a tool for ascertaining historical gold prices, which show that Britain instituted gold price controls at £4.25 per troy ounce in 1717 and did not change that valuation ever again. After adopting a de jure gold standard in 1821, the London market price never rose above the controlled ceiling until 1919. How on Earth could changing gold mining output trigger inflation or deflation if the price stayed between £4.23 and £4.25 for 98 years?

Gold Mining or Iron and Lead Mining?

The quantity of gold never mattered—the official price set by the English/British government mattered. I’ve argued at length before that warfare is the chief cause of inflation, but evidence supporting my view is far more extensive than just the modern collapse of Bretton Woods coinciding with the largest bombing campaign in history.  History itself is replete with an inflation/bloodshed connection.

Going back centuries before Adam Smith ever picked up a pen, the evidence seems to suggest that blood spilled on the battlefield was the common denominator whenever the controlled gold price that would eventually set the standard in 1717 for Britain and in the 1870s worldwide was revalued. Measuring Worth lists the official price set by London going back as far as 1257, and examining the data reveals that price changes invariably coincided with major wars.

The first increase, from £0.89 to £1.07 in 1265, occurred amidst the Second Baron’s War.

The next increases were in 1343 and 1346, occurring early in the War of Breton Succession and ’46 coinciding with the Battle of Crecy.

The next increase was in 1351, followed the decisive English victory at the Battle of Winchelsea and coincided with English setbacks at the Battle of Ardres and the Combat of the Thirty.

In the following century, gold price increases in 1409, 1412 and 1464 happened to coincide with the Glyndŵr Rising in Wales and the Battles of Hedgeley Moor and Hexham. Perhaps none of these inflationary effects were due to the Hundred Years’ War (1337-1453) or the War of the Roses (1455-1487), but I highly doubt that. In the sixteenth century, gold rose in 1526, 1544-1546, 1549 and 1578 while the Italian War of 1521-26, War of the League Cognac, the Italian War of 1542-46, the Rough Wooing, Prayer Book Rebellion of 1549 and the Eighty Years’ War (1566-1648) were all raging.

The evidence that inflation is the byproduct of warfare instead of mining activity might be best exemplified in British history by the Nine Years’ War. The seventeenth century opened with the 1594-1603 war in Ireland still raging, perhaps causing a rise in gold prices in 1601 and the eighteenth century was nearly rung in by the 1688-1697 continent-wide war which coincided with gold being brought to £4.45 an ounce in 1696. England quickly found itself fighting the Great Northern War (1700-1721) and the War of the Spanish Succession (1701-1714), but never again saw warfare forcing the price of English gold to rise. £4.45 was the zenith.

Newton’s Folly

Sir Isaac Newton set the pre-World Wars standard £4.25 per troy ounce of gold in 1717:

1717 September 21

Report of Sir Isaac Newton, Master of the Royal Mint, to the Lords Commissioners of His Majesty’s Treasury, on the price and relationship of gold to silver and the consequences for the coinage of the kingdom.

Newton prepared the report in response to the Treasury’s request for an account of the large amounts of gold coming in to the Mint and the flight of silver to India. In his report, Newton devalued the guinea, coined in standard gold at 916 parts out of 1000 fine, to £1.1s.6d. This was equivalent to a price of £3.17s.10½d. per standard ounce of gold and £4.4s.11½d. per ounce of fine gold. Except for the period of the Napoleonic wars when cash payment in gold was suspended, this price persisted until the early 20th century.

Yes, that Newton. History’s greatest scientist also bequeathed £4.25, which remained in place for 228 years. Here is where myth and reality collide. To some, the gold standard ensured/ensures price stability, principally through restricting government expenditures. To be frank, that assertion is complete bull**** After £4.25 was instituted permanently, inflation swung about wildly for decades:

1797 -10.00%  
1796 6.40%  
1795 11.60%  
1794 7.70%  
1793 2.80%  
1792 1.50%  
1791 -0.10%  
1790 1.80%  
1789 -1.30%  
1788 4.00%  
1787 -0.60%  
1786 0.00%  
1785 -4.00%  
1784 0.60%  
1783 12.00%  
1782 2.10%  
1781 4.10%  
1780 -3.40%  
1779 -8.50%  
1778 4.00%  
1777 -0.40%  
1776 -2.20%  
1775 -5.60%  
1774 0.90%  
1773 -0.30%  
1772 10.70%  
1771 8.50%  
1770 -0.40%  
1769 -8.20%  
1768 -1.10%  
1767 5.80%  
1766 1.20%  
1765 3.50%  
1764 8.90%  
1763 2.70%  
1762 3.90%  
1761 -4.50%  
1760 -4.50%  
1759 -7.90%  
1758 -0.30%  
1757 21.80%  
1756 4.20%  
1755 -6.00%  
1754 5.10%  
1753 -2.70%  
1752 4.70%  
1751 -2.70%  

 (yes, these figures are unofficial, but they’re good enough for me considering my eyes are the only ones that peruse this blog).

What caused such swings? Well, there is the matter of the Seven Years’ War, the Third Carnatic War, the American Revolution, and the start of the Napoleonic Wars. Besides that, there appeared to be an inability for 18th century market prices to conform to price controls:

Year British Official Price
(British pounds per fine ounce
end of year)
London Market Price
(British £ [1718-1949] or
U.S. $ [1950-Present] per fine ounce)
1751 4.25 £ 4.25
1752 4.25 £ 4.26
1753 4.25 £ 4.27
1754 4.25 £ 4.25
1755 4.25 £ 4.25
1756 4.25 £ 4.25
1757 4.25 £ 4.25
1758 4.25 £ 4.30
1759 4.25 £ 4.33
1760 4.25 £ 4.30
1761 4.25 £ 4.35
1762 4.25 £ 4.32
1763 4.25 £ 4.37
1764 4.25 £ 4.26
1765 4.25 £ 4.26
1766 4.25 £ 4.31
1767 4.25 £ 4.34
1768 4.25 £ 4.32
1769 4.25 £ 4.38
1770 4.25 £ 4.37
1771 4.25 £ 4.35
1772 4.25 £ 4.35
1773 4.25 £ 4.25
1774 4.25 £ 4.24
1775 4.25 £ 4.23
1776 4.25 £ 4.23
1777 4.25 £ 4.23
1778 4.25 £ 4.23
1779 4.25 £ 4.23
1780 4.25 £ 4.23
1781 4.25 £ 4.23
1782 4.25 £ 4.23
1783 4.25 £ 4.25
1784 4.25 £ 4.25
1785 4.25 £ 4.24
1786 4.25 £ 4.23
1787 4.25 £ 4.23
1788 4.25 £ 4.23
1789 4.25 £ 4.23
1790 4.25 £ 4.23
1791 4.25 £ 4.23
1792 4.25 £ 4.23
1793 4.25 £ 4.23
1794 4.25 £ 4.23
1795 4.25 £ 4.23
1796 4.25 £ 4.23
1797 4.25 £ 4.23

Wait, why 1797? Because war. Given the profound effect England’s wars had on its gold price controls dating back to the Middle Ages, it shouldn’t be any surprise specie payment had to be suspended between 1797 and 1821 for the spectacularly violent Napoleonic Wars. This, however, was very odd:

Year British Official Price
(British pounds per fine ounce
end of year)
London Market Price
(British £ [1718-1949] or
U.S. $ [1950-Present] per fine ounce)
1813 4.25 £ 5.76
1814 4.25 £ 5.21
1815 4.25 £ 4.99
1816 4.25 £ 4.36
1817 4.25 £ 4.33
1818 4.25 £ 4.44
1819 4.25 £ 4.36
1820 4.25 £ 4.25
1821 4.25 £ 4.25
1822 4.25 £ 4.24

Instead of raising the price control ceiling as was customary, the British economy was crushed back to £4.25:

1823 6.80%
1822 -13.50%
1821 -12.00%
1820 -9.30%
1819 -2.50%
1818 0.30%
1817 13.50%
1816 -8.40%
1815 -10.70%
1814 -12.70%

Deflation looks like a wrench in this circumstance, a lever to ratchet the overall price level into line with a 104-year old set of price controls.  Preventing the nine-year depression probably would have required instituting a new ceiling of £5.76, but that was out of the question. Instead, both the Corn Laws and the gold standard de jure were imposed.

The British economy took off after the Corn Laws were repealed in 1846, but the insane gold price controls remained in effect. Amidst gold rushes, the Civil War, the Crime of ’73 and the six years it would take the United States to implement a de facto gold standard…

Year U.S. Official Price
(U.S. dollars per fine ounce
end of year)
New York Market Price
(U.S. dollars per fine ounce)
1861 20.67 20.67
1862 20.67 23.42
1863 20.67 30.02
1864 20.67 42.03
1865 20.67 32.52
1866 20.67 29.13
1867 20.67 28.57
1868 20.67 28.88
1869 20.67 27.49
1870 20.67 23.75
1871 20.67 23.09
1872 20.67 23.24
1873 20.67 23.52
1874 20.67 22.99
1875 20.67 23.75
1876 20.67 23.05
1877 20.67 21.66
1878 20.67 20.84
1879 20.67 20.67
1880 20.67 20.67

…the corresponding Long Depression began. The price control ceiling remained stubbornly lodged at £4.25, but now had the company of $20.67 as well. The two decades after 1873 were consistently deflationary, which shouldn’t be that surprising given Germ Theory had finally vindicated Ignaz Semmelweis and ushered in a massive worldwide population expansion and the deflation ratchet was required to counteract the inflationary byproducts (the St. Louis Fed even refers to the gold standard as “mean reverting). Naturally, today this instead has become the conventional wisdom even amongst the saltwater schools:

Just to take the most obvious point: the late 19th century was marked by rapid population growth in the “zones of recent settlement” (basically places where Europeans were moving in, displacing or wiping out the locals). In the United States, population grew 2 percent a year from 1880-1910, sustaining high investment demand. And the zones of recent settlement also offered an outlet for very large capital outflows from Europe. In other words, the global situation was conducive to a high natural real rate of interest, making mild deflation much more sustainable than in today’s world.

Uh-huh…right. The statement is true, but ignores the elephant in the room.  I would argue high population growth triggered significant aggregate demand growth all on its own, and the £4.25 and $20.67 price control ceilings (and the deflationary ratchet) hid a massive groundswell of inflation right beneath the surface, but what do I know. Well, I do know this…

Year British Official Price
(British pounds per fine ounce
end of year)
London Market Price
(British £ [1718-1949] or
U.S. $ [1950-Present] per fine ounce)
1914 4.25 £ 4.24
1915 4.25 £ 4.24
1916 4.25 £ 4.24
1917 4.25 £ 4.24
1918 4.25 £ 4.24
1919 4.25 £ 4.50
1920 4.25 £ 5.65
1921 4.25 £ 5.35
1922 4.25 £ 4.67
1923 4.25 £ 4.51
1924 4.25 £ 4.69
1925 4.25 £ 4.27
1926 4.25 £ 4.25
1927 4.25 £ 4.25
1928 4.25 £ 4.25
1929 4.25 £ 4.25
1930 4.25 £ 4.25
Year U.S. Official Price
(U.S. dollars per fine ounce
end of year)
New York Market Price
(U.S. dollars per fine ounce)
1914 20.67 20.67
1915 20.67 20.67
1916 20.67 20.67
1917 20.67 20.67
1918 20.67 20.67
1919 20.67 20.67
1920 20.67 20.67
1921 20.67 20.67
1922 20.67 20.67
1923 20.67 20.67
1924 20.67 20.67
1925 20.67 20.67
1926 20.67 20.67
1927 20.67 20.67
1928 20.67 20.67
1929 20.67 20.67
1930 20.67 20.67

…is very strange, as British gold prices never hit Napoleonic War levels while American gold price controls were completely unaffected.  How was that possible given that the Great War was the largest war ever fought until 1939?  Were prices remaining “stable” during the course of World War I?

Historical Data ChartI’m going with no, and I’ll also postulate the price control disparities indicates a very rough ride ahead. 

Addendum:

Perhaps this only grows out of my psychotic hatred of the gold standard, but I wonder if the 1914 financial crisis played a role in the iniquities preceding the Great Depression.

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3 thoughts on “Aggregate Demand Dominance: Millennia-Long Price Manipulation Misadventure

  1. Pingback: Aggregate Demand Dominance: 300 Years of War Finance | In The Corner, Mumbling and Drooling

  2. Pingback: Aggregate Demand Dominance: The Deflation Ratchet and the Great Depression | In The Corner, Mumbling and Drooling

  3. Pingback: Aggregate Demand Dominance: MIC and the Death of the Deflation Ratchet | In The Corner, Mumbling and Drooling

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