Money, Value, and Monetary History

after Milton Friedman

One of the rights which the freeman has always guarded with most jealous care is that of enjoying the rewards of his own industry. Realizing the power to tax is the power to destroy, and that the power to take a certain amount of property or of income is only another way of saying that for a certain proportion of his time a citizen must work for the government, authority to impose a tax upon the people must be carefully guarded.... It condemns the citizen to servitude.

President Calvin Coolidge, 1924

Practices of the unscrupulous money-changers stand indicted in the court of public opinion....Yes, the money-changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. The measure of that restoration lies in the extent to which we apply social values more noble than mere monetary profit.

Franklin Roosevelt, First Inaugural Address, 1933 [note]

ἔδει οὖν σε βαλεῖν τὸ ἀργύριόν μου τοῖς τραπεζίταις,
καὶ ἐλθὼν ἐγὼ ἐκομισάμην ἂν τὸ ἐμὸν σὺν τόκῳ.

Oportuit ergo te mittere pecuniam meam nummulariis,
et veniens ego recepissem utique quod meum est cum usura.

Then you ought to have invested my money with the bankers, and at my coming I should have recieved what was my own with interest.

Matthew 25:27; see "bankers' tables" in the Apology

Business activity in the euro zone expanded at an accelerated pace at the start of the second quarter, a closely watched business survey showed. But companies cut the prices they charged customers, indicating that the European Central Bank's worries over low inflation are far from over...

The PMI [Purchasing Manager's Index] survey suggest that the currency area's economy is growing too slowly to quickly return the inflation rate to the ECB's target of just below 2%...

Low rates of inflation make it more difficult for governments and households to pay down their debts.

"Euro-Zone Prices Under Pressure," The Wall Street Journal, Thursday, April 24, 2014, All

Fed Chairwoman Janet Yellen recently admitted that the central bank doesn't have a good model of inflation. It relies on the Phillips Curve [!], which charts what economist Alban William Phillips in the late 1950s saw as a tendency for inflation to rise when unemployment is low and to fall when unemployment is high. Two of the most successful Fed chairman, Paul Volcker and Alan Greenspan, considered the Phillips Curve unreliable. The Fed's forecasts of inflation ignore Milton Friedman's dictum that "inflation is always and everywhere" a result of excessive money growth relative to the growth of real output.

Allan H. Meltzer, "How the Fed Fuels the Coming Inflation," The Wall Street Journal, May 7, 2014, A19

Daily Princetonian:  [D]oes high inflation matter as long as it's expected?

Paul Volcker:  It sure does, if the market's stable... The responsibility of the government is to have a stable currency. This kind of stuff that you're being taught at Princeton disturbs me. Your teachers must be telling you that if you've got expected inflation, then everybody adjusts and then it's OK. Is that what they're telling you? Where did the question come from?...

Daily Princetonian:  And to get back to the central banking a little bit, given the trade-off between inflation and unemployment --

Paul Volcker:  I don't believe that. That's my answer to that question. That is a scenario and a delusion, which economists have gotten Nobel Prizes twenty years ago to disprove.

The Daily Princetonian, May 30, 2014, "Notable & Quotable," The Wall Street Journal, July 9, 2014, A13, color added

With European inflation declining to 0.3%, and U.S. inflation slowing, a specter now haunts the Western world. Deflation, the Economist [!] recently proclaimed, is a "pernicious threat" and "the world's biggest economic problem." Christine Lagarde [disinvited to speak at Smith College in 2014, evidently for being a capitalist], managing director of the Internationl Monetary Fund, called deflation an "ogre" that could "prove disastrous for the recovery"...

Milton Friedman long ago recognized slight deflation as the "optimal" monetary policy, since people and businesses can hold lots of cash without worrying about it losing value. So why do people think deflation, by itself, is a big problem?

John H. Cochrane, "Who's Afraid of a Little Deflation?" The Wall Street Journal, November 14, 2014, A15

Some countries are already into deflation. But for the moment, it's more sustained low inflation, which is equally bad.

Christine Lagarde, The Wall Street Journal, December 9, 2014, R1

The eurozone's economy will fall further behind that of the U.S. without a concerted effort to boost demand through increased government spending and lower taxes, rid banks of bad loans and make labor markets more flexible, the International Monetary Fund said...

At that rate, the IMF said inflation will be below the European Central Bank's target of just under 2% through 2020, while unemployment will stay high.

"IMF Urges Eurozone To Boost Spending," The Wall Street Journal, July 28, 2015, A8 , on spending and the inflation "target," , on taxes and deregulation

That analysis derives from the Fed's continued belief in the Philips curve [!], the theory that there is an inverse relationship between the unemployment rate and the inflation rate. Like many economists, I think the reasoning behind the Philipps curve theory is flawed and has been discredited by the work of numerous researchers, of which Milton Friedman is the most notable. But it is fundamentally the Fed's model.

Gerald P. O'Driscoll Jr., "The Fed's Uncertain Leap Forward," The Wall Street Journal, December 17, 2015, A19 -- the "stag-flation" of the '70's, which involved high inflation, high unemployment, and poor growth refuted the Philips Curve -- and elected Ronald Reagan.

In the Kingdom of Ends everything has either a price or a dignity. Whatever has a price can be replaced by something else as its equivalent; on the other hand, whatever is above all price, and therefore admits of no equivalent, has a dignity.

Im Rieche der Zwecke hat alles entweder einen Preis, oder eine Würde. Was einein Preis had, an dessen Stelle kann auch etwas anderes, als Äquivalent, gesetzt werden; was dagegen über allen Preis erhaben ist, mithin kein Äquivalent verstattet, das hat eine Würde.

Immanuel Kant, Foundations of the Metaphysics of Morals [Lewis White Beck translation, The Liberary of the Liberal Arts, Bobbs-Merrill, 1959, p.53]; Grundlegung zur Metaphysik der Sitten, A/B 77 [Band VII der Werkausgabe, Herausgaben von Wilhelm Weischedel, Suhrkamp Taschenbuch Wissenschaft, Erste Auflage, 1974, 1995, p.68] -- note, only fungible things with prices can be replaced by something equivalent; things with dignity are never fungible.

The Federal Reserve and Bank of Japan issued new policy statements on Wednesday [9/21/2016], and the common message is that the central bankers aren't sure what to do...

Not even the Fed's dominant Keynesians [!] are promising they can still elevate the economy, after years of asserting the opposite.

The slow growth raises questions about whether the Fed will raise rates even in December. The best Chair Janet Yellen could muster in her press conference is a version of the Fed's familiar Phillips Curve [!] calculation that the jobless rate is low and inflation rises when labor markets are tight.

"Central Bankers at Wit's End," The Wall Street Journal, September 22, 2016, A18, color added

Although GDP growth slowed to about 2% in 2015, the unemployment rate stood at 4.9% in August -- essentially full employment. That is causing inflation to rise, with the core consumer-price index inflation rate at 2.3% between August 2015 and August 2016, up from 1.8% over the previous year.

Martin Feldstein, "Why the Fed Should Raise Rates New," The Wall Street Journal, October 7, 2016, A13, color added; two problems here:  4.9% is not "full employment," especially when the labor force participation is at historic lows; and Milton Friedman, who showed that inflation is always a monetary phenomenon, would sharply deny that low unemployment can cause inflation -- with us now apparently forgetting the massive money creation through "Quantitative Easing." Nevertheless, Feldstein is right about the need to raise interest rates.

REPORTER PETER DOOCY: "Do you think inflation is a political liability?"

PRESIDENT JOE BIDEN: "No, its a great asset -- more inflation. What a stupid son of a bitch."

24 January 2022; inflation hit a 40-year high of 7 percent in December 2021; was Biden actually saying that inflation is "a great asset"?

Editorial Note, 2014

The principles and history recounted and discussed below demonstrate that massive economic growth is possible during deflationary times, i.e. when prices are generally falling. The United States grew into the largest economy in the world during just such an era, when prices fell from 1865 to 1894. Why the deflation occurred is easily understood, since the money supply (under the Gold Standard) did not grow fast enough to cover the growth in transactions, so less money had to do more. Prices fell, which precisely allowed less money to do more. Thus, growth caused the deflation. Britain similarly experienced its greatest growth, and became the first industrial power, when the monetary basis of silver and/or gold precluded any long term inflation.

Nevertheless, the simple truth of this has been lost on much economic and most political analysis since the Great Depression. It has become widely believed -- the conventional Keynesian wisdom -- that either economic growth itself causes inflation or inflation can cause, or is necessary for, economic growth, while deflation prevents growth. None of these is true, as is easily ascertained, not merely from economic argument, but from the historical record [cf. Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 18671960, Princeton University Press, 1963, 1971]; yet we have seen such fallacies widely voiced in the period of recession and slow growth since the collapse of the US housing mortgage market in 2008. The "stagflation" experience of the 1970's, when inflation was deliberately created in the expectation it would stimulate growth -- which then didn't happen -- is forgotten. The result was simply inflation and stagnation -- and high unemployment as well.

We find a current expression of these fallacies and confusions in the quote above from The Wall Street Journal of 24 April 2014. I had long suspected that the Federal Reserve System, after defeating the inflation of the 1970's, nevertheless continued to allow a small degree of inflation in the 1980's and afterwards for the purposes of (1) undoing the damage to the labor market caused by political pressure to manipulate or force wages upwards, and (2) to devalue the debt of governments, imposing an implicit tax on all holders of money, whose trust in money as a "store of value" then becomes a means for governments to steal from them, as governments always have through the debasement of the currency. At the present moment, the policy of central banks to maintain inflation has come to be openly stated in the European Union, where a "target of just below 2%" is now shamelessly placed on the public record. This seems to be less openly admitted by the Federal Reserve -- although now I do see it admitted. Fear of deflation, and complacency or enthusiasm about inflation, has been widely expressed and discussed in the financial and popular press.

The rationale for engineering inflation follows from various Keynesian follies, but we also get an explicit statement in the article in question, where it is asserted that, "Low rates of inflation make it more difficult for governments and households to pay down their debts." Well, of course. It will be less "difficult for governments and households" to pay down their debts if you steal from the lenders by making the debts less valuable. Since interest rates are then manipulated to low levels, one should not be surprised to see less lending as the return on lending is beaten down from two directions. Again, the ignorance of recent history in this is stunning. After the collapse of its inflated real estate market in the early 1990's, Japan kept interest rates near zero for the better part of two decades, on the theory that somehow this would encourage lending, coupled with large "stimulus" public spending, only to experience economic stagnation through the whole period, as China surpassed a mortified Japan and grew into the second largest economy in the world. After 2008, the United States and Europe, with eyes wide open, undertook to repeat this experience, with the same policies, including high profile "stimulus" spending, which to the surprise of no one with any wit faithfully have reproduced the results (with a 2014 unemployment rate below 7% in the United States concealing an unprecedented massive loss in labor force participation).

Apart from monetary policy, the "stimulus" spending contributed to the perfect Keynesian storm, ignoring the circumstance that "stimulus" spending is almost always for wasteful and corrupt political purposes, while the money, which is borrowed, taxed, or stolen through inflation, is in each case pulled from the private economy, reducing the stock of capital for productive investment. In those terms, the maxim of Milton Friedman should be remembered, that the primary evil to be monitored is not borrowing or taxing as such, but the level of spending that manifests the combination. On the other hand, inflation at least has the marginally valuable side effect of devaluing that spending. Either way, many people who should know better have become stupid in these matters.

At it happens, a few days after the reference above, The Wall Street Journal contained a similar article about inflation in Europe:

Annual inflation in the euro zone accelerated slightly in April but remained far below the European Central Bank's target, in the latest sign that the region faces a long period of super-low inflation.

Yet weak prices so far don't appear to be upending the euro zone's gradual economic recovery, as some economists have warned...

For individual companies, the low prices can hurt...

Low and stable price pressures are typically good for the economy. Borrowing costs stay low, making it easier for governments, companies, and households to borrow and spend.

It is when consumer prices stagnate or fall persistently -- known as deflation -- that these effects shift into reverse. The private and public sectors have a harder time servicing debts and consumers put off spending in hope of a better bargain. That sets off a vicious cycle of weak demand and falling profits.

"I think it's very important for the euro area to escape the low-growth, lowflation trap," said José Vinals, the International Monetary Fund's top financial counselor, said in an interview Monday, using a term the IMF coined in March to highlight the risk of too-low inflation in the euro zone. ["Inflation Picks Up in Europe But Remains Far Below Target," May 1, 1014, A9]

There is a mixture here of some truth and considerable falsehood. José Vinals perhaps is not aware of the history detailed below, that high economic growth can occur, at an epic scale, not just with "lowflation," but with actual, severe deflation. Of course deflation is bad and unfair to borrowers; but a modern regime of fiat money, which enables us to avoid deflation, unfortunately opens the possibility and the temptation of constant inflation, for which there is always an excuse.

While the article admits that "Low and stable price pressures are typically good for the economy," it omits the principle reason for this, which is that prices to consumers do not increase. Indeed, we expect consumer prices to fall in a dynamic economy, even as kerosene prices did under John D. Rockefeller and as prices for computers did, steadily, through the 1980's, '90's, and beyond. These falling prices reflect economic progress in the form of greater capitalization of production, new products, and increased productivity. If computer prices had not fallen in aboslute terms, the ubiquitous computer assisted devices in the contemporary world would be impossible. It is not clear how much of an impact, if any, it had on the computer industry that "consumers put off spending in hope of a better bargain." After printers dropped from $1000 to $300, I personally thought this was good enough -- for devices that now sometimes can be had for $20.

On the other hand, alarm bells should ring when the article says, "For individual companies, the low prices can hurt..." Indeed, low prices mean that the companies must work to be competitive, productive, and efficient. Instead, I get the sense from this statement that we shouldn't require such things from companies, certainly not in Europe, and that the reasonable expectation is that companies should be able to raise prices and thereby increase profits. This is a grotesque approach in any economic understanding; and it contains grim overtones of Mercantilism and a violation of the principle affirmed by Adam Smith, that "the purpose of production is consumption." It sounds like José Vinals might think that the purpose of an economy, and of central banking, is to prevent "falling profits." Complaints about "weak demand," of course, reflect the perennial worry of Keynesians, who don't understand the workings of Say's Law or of capital itself. Unfortunately, so far the 21th Century has been a time of Mercantilist (i.e. protectionist, "crony capitalist") and Keynesian fairy tales.

Editorial Note, 2016

As we see in the last epigraph quote above, the central bankers now pretty much don't know what to do. All the Keynesian "stimulus" stuff has run out of any steam that it ever had. The joint statement by the Federal Reserve and the Bank of Japan embodies the irony that, after the Recession of 2009, the bankers have all followed the practices that Japan had been following, to little good effect, for close to the previous twenty years. Japanese Prime Mintister Shinzô Abe had promised supply side reforms, but then he has still never delivered on them.

The most recent brainstorm in Europe and Japan has been negative interest rates -- something no one had previously ever heard of -- which means that lenders lose money by lending. "Here, I'll pay you to take my money." This is a Keynesianism that has finally completely lost its mind. The reasoning seems to be that if low interest rates encourage borrowing, then if you pay people to borrow, that will be even better. Meanwhile, of course, the low interest rates that discourage lending will then actually penalize lending. Why anyone would ever want to lend under such circumstances remains mysterious. And this is what we have seen where the negative interest rates have been applied. It has been no help to moribund growth in Europe and Japan. But the bien pensants of Europe and Japan apparently despise Supply Side economics (and Reagan and Thatcher) so much, that they simply cannot conceive of doing anything of the sort. So there must be some Keynesian trick that they have missed. The negative interest rates are their desperate try for something of the sort. But they do know that raising interest rates is bad. We just cannot have lenders making money off of lending. That is just "justly discredited." This is as vicious and stupid as the recent Time magazine cover story about how capitalism and markets -- not government -- are responsible for poor growth everywhere.

As Milton Friedman (1912-2006) says in Money Mischief [HBJ, 1992], anything can be money:  stones, iron, gold, tobacco, silver, shells, cigarettes, copper, paper, nickel, etc. What makes these things money is not what they are, but what they are used for. They may have value in themselves, like gold ("commodity" money), or they may not ("credit" money, which means banknotes, bank deposits, tokens, markers, etc.); but their value as money is separate from their intrinsic value. What gives money value as such is that it is, or can be, used for exchange, replacing the original human system of trade, which was barter. The value of money is thus the value people attribute to what they want to exchange, no more, no less. As a medium of exchange, all money is in effect "credit" money:  credit on an incomplete barter, like an IOU. An IOU can also be anything, as long as it is recognized as a contractual obligation on an incomplete exchange. Commodity money was originally the most natural money, but the value of money is not always the same as its value as a commodity. The intrinsic value of commodity money and its value as money can actually interfere with each other. The independent and conflicting values of gold and silver led Britian to introduce the Gold Standard, which in effect demonitized silver. As a medium of exchange, money also establishes a standard of value (e.g. items A and B may both be worth $5, £5, ¥5, etc.), and as money is held in between exchanges, money becomes a store of value [note]. When governments debase or inflate the money supply, they are in a practical sense stealing money from those who hold it for its value.

What the value of money actually is (i.e. what units of the standard will buy, in general) depends on 1) how much money there is, 2) how much money is held out of circulation, and 3) how many exchanges circulating money is used to cover. This is the "quantity theory of money" and can be expressed in a famous equation by the American astronomer and economist Simon Newcomb:  MV = PT.  "M" signifies the actual quantity of money; "V" signifies the "velocity," which is the rate at which money circulates or how long money is held out of circulation; "T" is the number of transactions, or exchanges; and "P" is the level of prices. This equation easily illuminates most questions about inflation or deflation, which is how money becomes less or more valuable over time. The evidence for the "quantity theory" is that historically inflation and deflation have occurred independently of economic growth and recession, as can be seen in the data from Friedman and Schwartz given below [note].

Inflation is where the aggregate level of prices goes up and deflation where the aggregate level of prices goes down. Inflation will occur if V and T remain constant but M goes up, i.e. the supply of money increases without any other changes. Inflation can also occur if V goes up (people spend money more quickly) or T declines (the economy shrinks), as the other variables are constant. Most inflations, however, occur because of independent increases in the money supply. That can happen either with commodity money or credit money. A flood of silver from the New World caused a devastating inflation in 16th and 17th century Spain; and gold strikes in California, Australia, South Africa, and the Yukon produced inflations in the 19th and early 20th centuries. Now inflations are always the result of increases in the supply of credit money:  it is easy to print paper, and governments that have begun issuing paper money have always eventually fallen to the temptation of just printing and spending new money [note]. Paper money achieved legitimacy in the first place only because the Bank of England, which was privately owned (founded in 1694 and nationalized in 1946) [note], was the first note issuing agency in history that behaved responsibly and restrained its issue of paper money. Consequently, Bank of England notes were "as good as gold." Inflation does not occur because of a "wage-price spiral," an "overheated" economy, excessive economic growth, or through any other natural mechanism of the market. A government debasing the currency would not have fooled anyone a century ago. Now, through deception, a government can try to blame inflation on anything but its own irresponsible actions.

Deflation usually occurs from one of two causes. Either the economy grows and the volume of transactions (T) increases, or the quantity of money (M) decreases. After the Civil War, when the United States issued hundreds of millions of dollars in paper money ("greenbacks") to spend on the war [note], greenbacks and gold dollars circulated side by side:  but gold dollars were worth several greenback dollars.

UNITED STATES PRICE LEVELS:  1929=100% [data from Milton Friedman, Money Mischief, Episodes in Monetary History, Harcourt Brace Jovanovich, 1992; and Milton Friedman and Anna. J. Schwartz, Monetary Trends in the United States and the United Kingdom, U. of Chicago Press, 1982, pp.122-137]. Divide by 2.162 to convert to 1967 prices.

     40%  45%  50%  55%  60%  65%  70%  75%  80%  85%  90%  95%  100% 105%
1865------Withdrawal of Greenbacks started---------86.5
1866                                           82.6
1867                                      77.6
1868-------------------------------------76.2---Withdrawal of Greenbacks
1869                                 72.7                  stopped
1870                             68.7
1871                              69.8
1872                           66.3
1873-----banking Panic--------65.5----Gold Standard adopted
1874                         64.8
1875     Depression         63.3      Era of Greenback agitation
1876      1873-79        60.4
1877                   58.2
1878--------------53.9---Bland-Allison Act, silver dollars & certificates;
1879             52.0            Greenbacks redeemed in gold.
1880                  57.4
1881                 56.3
1882                   58.1           Depression 1882-85
1883                  57.4
1884---Panic-------54.4-----hydraulic gold mining ended in California
1885           50.8
1886-----------50.1----gold discovered in South Africa; Haymarket Riot
1887           50.6
1888            51.5            Era of Free Silver agitation
1889            51.8
1890-----------50.8---Sherman Silver Purchase Act
1891           50.3                           Depression 1893-94, 95-97
1892---------48.3-------Homestead Strike
1893--Panic---49.5------Sherman Act repealed; 156 railroads go bankrupt
1894-------46.4----18.4% unemployment; Pullman Strike
1895      45.7
1896-----44.4---"Cross of Gold" William Jennings Bryan defeated; end of
1897     44.6       free silver agitation; gold discovered in the Yukon
1898      45.9
1899        47.1
1900----------49.6-------Gold Standard Act, reaffirms Gold Standard
1901          49.3
1902            51.0
1903            51.5
1904             52.3
1905              53.4
1906---------------54.5----1.7% unemployment; Upton Sinclair's The Jungle
1907-----------------56.8----banking Panic
1908-----------------56.7-----Aldrich-Vreeland Act expands money supply
1909                   58.7
1910                     60.2
1911                    59.7
1912                       62.3
1913-----------------------62.6-----Federal Reserve Act creates
1914                        63.5            Federal Reserve System
1915                          65.5
1916                                   74.0
1917-----World War I Inflation--------------------------91.4
1918            World War I, 1917-1918                                105.1
1919                                                                   106.7

The government determined to deflate the greenbacks until they could trade at par with gold [note]. There was considerable political opposition to this. Deflation is bad for borrowers, whose debts become worth more over time. They would rather have inflation, which reduces the value of debts over time [note]. This turned farmers, who are commonly in debt and were a significant part of the population in those days, in favor of the Greenback Party, which promoted paper inflation, and the Free Silver movement, which wanted both gold and silver used for money (instead of just gold, as on the Gold Standard) [note]. This political opposition prevented too many greenbacks from actually being withdrawn from circulation, but deflation occurred anyway because the economy grew into the money supply. By 1878 greenbacks traded at par with gold dollars, and the Treasury began to redeem them in gold ("resumed specie payments"). The entire period from the Civil War to the late 1890's was a era of deflation, simply because the economy grew so much (see table). Nevertheless, this was not well appreciated at the time. Falling prices mean falling wages; and it was hard for workers to understand that if their wages were being cut, those same wages might nevertheless be worth more. That is what happened, but the fact of falling wages led to terrible labor strife. Employers knew that they had to cut wages, but even they didn't understand quite why, and wouldn't have been believed anyway.

Deflation also occurs because the money supply shrinks. One way that can happen is because of trade. If there are more imports into an economy than exports out of it, then there will be a net outflow of money to pay for the imports. In the Mercantilist 17th century and the protectionist 20th century this has been regarded as bad; but David Hume (in "Of the Balance of Trade," 1752) had already recognized that it really didn't make any difference:  the outflow of money would inflate foreign prices and deflate domestic prices, rendering foreign goods less attractive and domestic goods more attractive, both for domestic and foreign markets. Thus, before too long, imports would naturally decrease and exports would naturally increase, until money flowed back in to rebalance prices. As Hume put it in a letter to Montesquieu in 1749:  "It does not seem that money, any more than water, can be raised or lowered anywhere much beyond the level it has in places where communication is open, but that it must rise and fall in proportion to the goods and labor contained in each state." A trade deficit is thus a sign of nothing except the export of a certain kind of commodity, money. When money can simply be printed by the government, exporting it is an extraordinarily profitable business.

Another way that deflation can occur is because of banking. A bank receives money on deposit, holds part of it as a cash reserve, and loans out the rest. In effect this increases the supply of money since both the loaned cash and the credited deposit at the bank function as money. The result could be inflationary, but the system tends to be self-balancing because bank loans, especially commercial loans which are used to create or expand businesses, multiply transactions. A loan is also a kind of deposit, as a bank credits itself with the money it has loaned. A bad loan, to an unsuccessful person or business, cannot be paid off and so at some point must be written off as a loss by the bank. Thus the bank's "deposit" is simply lost, and the money supply thereby decreases by that amount. Banking therefore can stimulate the growth of an economy through loans but usually will not produce an inflation, as bad loans balance the transactions created by the good loans. Instead of inflation, sometimes loans and credit get overextended and their abrupt collapse can decrease the money supply to produce a conspicuous deflation [note]. This was particularly severe in 1929. Such credit crises previously had healed themselves in a year or two, as bad loans were written off and the extension of new loans began again, without causing a Depression [note]. Herbert Hoover and Franklin Roosevelt, however, both thought that high wages were the key to healing the economy. They promoted high wages all through the Thirties. But, in a deflationary period, that far overvalued labor, which in effect was priced out of the market. People with jobs, especially union jobs, were very well paid in the Thirties, but unemployment peaked at 28.3% in 1933 and was still up at 20% in 1939 -- it had previously never been higher than 18.4% (in 1894). The inflation and price controls of World War II broke the logjam of wages, and unemployment didn't return after the War (to everyone's surprise).

UNITED STATES PRICE LEVELS:  1929=100% [data from Friedman & Schwartz, op. cit.; unemployment figures from Richard K. Vedder & Lowell E. Gallaway, Out of Work, Unemployment and Government in Twentieth-Century America, Holmes & Meier, 1993]. Divide by 2.162 to convert to 1967 prices.

     70%  75%  80%  85%  90%  95%  100% 105% 110% 115% 120% 125% 130% 135%
1920                                                    121.7
1921---11.7% Unemployment-------------103.7---Recession
1922                             98.6
1923----2.4% Unemployment----------100.9
1924----5.0% Unemployment---------99.6
1925      Roaring Twenties          101.6
1926----1.8% Unemployment------------102.1
1927                              99.4
1928                               100.1
1929----3.2% Unemployment----------100.0
1930----8.0% Unemployment-----95.5
1931---------------84.0----Great Depression Deflation
1932     74.3
1933----73.3-------24.9% Unemployment
1934         78.1
1935        77.1   Great Depression, 1929-1940
1936           80.3
1937            81.0
1938-----------80.6----19.0% Unemployment
1939-----------80.0----17.2% Unemployment
1940-----------80.9----14.6% Unemployment
1941------------------87.3-----9.9% Unemployment
1942---4.7% Unemployment---------98.7----World War II Inflation
1943                                          111.7
1944        World War II, 1941-1945                    120.0
1945                                                        125.3
1946------4.0% Unemployment----------------------------------126.4
1947------3.9% Unemployment-------Post-War Inflation-------------------136.6

Actual prices of individual commodities depend on how much they are wanted (demand) and how much is available (supply). This then is a relationship whose terms cannot be set by suppliers or consumers independently. Suppliers, of course, always want higher prices, as consumers want lower prices. The price that consumers are willing or able to pay for a certain volume of a commodity that coincides with the price that suppliers are willing or able to sell that volume for is the "equilibrium" or "market clearing" price. The free market allows prices to move towards market clearing levels. Price fixing, which never works without an application of force (either government force or gangsterism), produces either surpluses or shortages:  surpluses (as in "farm surpluses" and unemployment, a surplus of labor) occur where prices are set too high and there is excess supply; shortages (as with rental housing in Santa Monica and New York City, or with everything in the Soviet Union) occur where prices are set too low and there is deficient supply.

The return of prosperity in the 50's and early 60's meant good economic growth but with a couple of qualifications:  There was steady, if low, inflation; and unemployment, although negligible by Depression standards, was not as low as in previous periods of growth. There also occurred three recessions in a ten year period. It now appears that the high tax rates of the time, retained by President Eisenhower for the fiscally responsible purpose of paying down the debt from World War II, may have been responsible for the recessions. But the steady inflation, almost invisible at the time, may also have been a wise corrective to the political power of the labor unions, who otherwise exercised steady pressure to drive up wages. The result, overall, was optimism and growth such as had not been seen since the 20's and, at last, a decisive answer on the part of the democracies to the claims that had been made for economic success by the totalitarian regimes. Unfortunately, this success at the same time nurtured a generation that took economic growth for granted, would still find the claims of totalitarian ideologies attractive, and sometimes would not even be exposed to the new defenses of capitalism that post-war prosperity motivated.

UNITED STATES PRICE LEVELS:  1929=100% [data from Friedman & Schwartz, op. cit.; unemployment figures from Vedder & Gallaway, Op. cit.]. Divide by 2.162 to convert to 1967 prices.

     135% 140% 145% 150% 155% 160% 165% 170% 175% 180% 185% 190% 195% 200%
1948           145.6
1950            146.5
1951                      156.1
1952                        158.0
1954                            162.6
1955                                166.1
1956    Average Unemployment=5.0%       170.8
1957                                          176.6
1959                                                 183.1
1960                                                    186.4
1961                                                      188.3
1962    Average Unemployment=5.7%                             192.2
1963                                                             195.2
1964-----5.2% Unemployment------------------------------------------198.5

President Kennedy came to believe, despite the opposition of crypto-socialist economists like John Kenneth Galbraith, that high tax rates were what had hampered the economy in the 50's. After his death, President Johnson pushed through the tax cuts, and soon the economy took off as never before, pushing unemployment below 4% for the first time in a while. Unfortunately, why the tax cuts worked was open to different interpretations. Rather than unleashing supply-side production according to Say's Law, the effect was largely taken to be the result of a Keynesian demand-side stimulation. Along with this the idea also began to develop, which Keynes had not believed, that inflation itself, by stimulating demand, created prosperity. Since President Johnson also had the War in Vietnam to pay for, it became a convenient thought that inflationary money creation, by which wars had usually been financed, now could be used, not just for that purpose, but to promote civilian prosperity as well. This made it possible, as it was said, to have both "guns and butter."

Such a policy was continued by President Nixon, who famously said, "We are all Keynesians now." However, inflation soon seemed to be getting positively out of control. Since inflation erodes the value of savings and reduces the return on loans (in a period when many usury laws capped interest rates), the damage being done began to outweigh the perceived benefits. Also, vast money creation began to mean that the United States might be unable to redeem dollars in gold for uncooperative countries, like France, that might want to cash in their dollar holdings. Nixon responded with wage and price controls and by "closing the gold window," so that dollars could no longer be redeemed by anyone, even foreign governments, for gold.

     200% 205% 210% 215% 220% 225% 230% 235% 240% 245% 250% 255% 260% 265%
1965----203.2-----4.5% Unemployment
1966          209.9                 "Guns & Butter" Keynesian Inflation
1968-----3.6% Unemployment----225.8--------------Richard Nixon elected:
1969-----3.5% Unemployment---------------236.8  "We are all Keynesians now."
1970-----4.9% Unemployment----------------------------249.7
1971-----August: Wage & Price "Controls" to stop inflation----------263.2

Wage and price controls -- a wartime expedient that now went with wartime levels of inflation -- could not end inflation, only temporarily mask it. That inflation was now thought to be something that could be "cooled off" by simply not allowing people to raise prices shows how far people had gotten out of touch with the ancient wisdom that a debased currency is worth less, even if prices are controlled by law. As it happened, the wage and price controls, although copied by others, like Britain, had little overall effect on inflation. At the same time, detaching the dollar from gold meant that money could be created more freely than ever before, which was the real engine of inflation. The clueless President Ford was persuaded that a farcical campaign of moral exhortation ("Whip Inflation Now," or WIN) was the answer. Even worse, the "Phillips Curve" relation of inflation to employment began to break down:  The boom in inflation by 1975 was suddenly attended with elevated levels of unemployment and with poor economic growth. The stagnation of the economy despite massive money creation was dubbed "stagflation." This was the "malaise" -- his own word -- of the years of President Carter. This began to indicate to the perceptive that the demand-side interpretation of the 60's prosperity was a mistake. Since inflation had also raised many people into higher tax brackets, the Kennedy-Johnson tax cuts had also been wiped out in the process in the 70's.

     275% 280% 285% 290% 295% 300% 305% 310% 315% 320% 325% 330% 335% 340% 345%
1972-----279.8--------5.6% Unemployment           The Collapse of
1973---4.9% Unemployment----298.9               Keynesian Economics
1974----------5.6% Unemployment--------------------321.7
1975----8.5% Unemployment = "Stagflation" = Inflation + Unemployment--------346.5  

The theory that inflation was caused by money creation, rather than by an "overheated" economy, and that economic growth is caused by capital investment in the free market, rather than by high taxes and the demand-side effects of government spending, led to the tax cuts promoted by President Reagan, the fiscal conservatism of the Volker-Greenspan Federal Reserve System, and the economic prosperity of the 80's and, evidently, the 90's. This was little more than a vindication of common sense and Classical Economics. However, the political constituency for high taxes and government spending, regardless of their justification, has not disappeared. On the contrary. The massive "social" spending and expansion of the government in the 70's created whole classes of people who were dependents of that spending and who really knew or cared little about the sources of growth or prosperity. Indeed, since they didn't have to engage in economically productive activity, just in politics, they perpetuated the Leftist fantasy that politics alone is responsible for wealth.

This is now the greatest problem in American politics:  the promotion of essentially Marxist ideas, which are so discredited by history and science and morality as to be laughable, by an educated intelligentsia, among academia, the press, and the literati, who depend only on the power of their own sophistry. This makes them perfect shills for interest-group politics, where the only real interest is in getting money out of the government. For this to work, taxes and spending must be as high as possible. But then it was discovered, during the Reagan years, that spending could be run up far beyond the tax base without immediate consequences. The deficit spending that had been the animus of conservatives since the New Deal now was sold to conservatives on the principle that the relatively low tax rates did promote prosperity, while the high spending bought off the interest groups. The future, evidently, could take care of itself.

Nevertheless, interest-group politicians, meaning all Democrats and most Republicans (or at least most Republicans in office), retained an instinctive love of taxes. The credulous President Bush was thus duped, with old fashioned fiscally conservative arguments, to break his only meaningful campaign promise of 1988, and his only real link to the Reagan political constituency, by raising taxes. A Democratic Congress then never bothered providing the promised spending reductions. President Clinton, under the deceptive "New Democrat" banner, but still a whole-hearted believer in taxes, spending, and socialist command-economy devices for politically hot areas like "health care" and "child care," slowed the recovery from Bush's 90-91 recession with his own tax increases.

A new Republican Congress in 1995 derailed, somewhat, where that was all headed; but it is now clear that the Republicans have been corrupted both by the same interest group politics and by fear of the self-righteous disdain of the intelligentsia. They thus cooperated with Clinton in the lie that hemorrhaging "social" spending, whose liabilities are kept off budget, does not count and that a "balanced budget" will soon arrive. They have also joined in the despicable practice of transferring expenses from the government to private business by mandating uneconomic "benefits," like "family leave." The government thus can hand out goodies by law rather than by taxing and spending. This evades the truth that, as Walter Williams says, "businesses are tax collectors, not tax payers," which means that people will be paying for these "benefits" anyway, in higher prices, higher unemployment, lower wages, or in whatever ways that businesses will need to use to finance them. It is only the foreseeable bankruptcies of Social Security and Medicare, hurried by any unforeseen problems with the economy, that will put an end to the continuation of this era of political dishonesty and looting.

The warm glow of memory has now settled over the Clinton Administration, whose fiscal house was maintained in some order by the Republican Congress; but the slippage of discipline under President George Bush was increasingly evident. The relative discipline even of George Bush, however, was revealed when a Democrat Congress and the Democrat President Obama came to power in 2009. The floodgates of spending, mandates, and corruption were loosened, and a regime of poor growth, high debt, and tyranny has been unleashed on the American people, including the remarkable Federal mandate that everyone buy health insurance. All this was to make the United States like France (if not Cuba), where meanwhile, with the same ideas, unemployment has surged above 11%. This gives no pause to the ideological Left, whose confidence in socialism has not declined in the least for decades now. It is a disheartening time, as American voters have continued to fall for brazen and demonstrable lies, such as Obama's "You can keep your doctor" (etc.) assurances.

"Justly Discredited," Trade, Moneylending, & Capital

A Simple Deflator

British Coins before the Florin, Compared to French Coins of the Ancien Régime

American Dollars

Six Kinds of United States Paper Currency

Political Economy, Money

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Copyright (c) 1996, 1997, 1998, 2001, 2003, 2006, 2013, 2014, 2015, 2016, 2017, 2022 Kelley L. Ross, Ph.D. All Rights Reserved

Money, Note 1

The "money-changers" in the Temple were, of course, Jews. Franklin Roosevelt is usually not thought of as anti-Semitic; but Paul Johnson, in his A History of the Jews [HarperPerennial, 1987], says of him:

He was both anti-Semitic, in a mild way, and ill informed. When the topic came up at the Casablanca Conference, he spoke of "the understandable complaints which the Germans bore towards the Jews in Germany, namely that while they represented a small part of the population, over 50 per cent of the lawyers, doctors, schoolteachers, college professors in Germany were Jews" (the actual figures were 16.3, 10.9, 2.6 and 0.5 per cent). [p. 504]

Even if it were not disturbing that Roosevelt should have held such views, at the time an actual genocide was being carried out against the Jews in Eastern Europe, it should be suspicious that Roosevelt in our "money-changers" quote is clearly laying the blame for the Depression on financiers and on the profit motive. The "ancient truths" he speaks of turn out to be the principles of mediaeval economics, things like the "just price," the "just wage," and a Guild (i.e. union) monopoly over labor. Such principles, dressed up as "Progressivism," created the Depression under Hoover, prolonged it under Roosevelt, and have haunted American politics ever since with destructive and corrupting devices like the minimum wage, "collective bargaining," and Social Security.

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Money, Note 2

As the value of money is not always the same as its value as a commodity, it can certainly be worth less as money than as a commodity, as is now the case with pre-1964 US silver (or gold) coins, which are worth much more than their face value. Also, see note [9] below.

An artifact of banking is that, as banks credit deposited money to the accounts of depositors, they then lend the deposited money out as loans. Thus, the loans add money to the economy, while meanwhile the depositors may write checks on their accounts, which also circulate as money. Banking therefore multiplies the quantity of money, and we can express this in the equation M = C + D, where "M" is the quantity of money, which is equal to "C," cash, plus "D," deposits. "M" is then differentiated between "demand" deposits, like checking accounts, where the money can be readily withdrawn, and other kinds of deposits, generally savings accounts, where the money, which earns interest, cannot be withdrawn, or cannot be withdrawn beyond a certain amount, without a penalty. "M1" is traditionally the subcategory of "M" for demand deposits. The classical form of this began to be muddled when some checking accounts began to pay interest and varieties of savings accounts, certificates of deposit, money market accounts, and such fourishes began to be introduced. But the basic principle of "cash + deposits" remains the same, as a means of multiplying money, so I will only consider how that works.

One fourish that requires attention is that cash and deposits do not account for all the money in the bank. This is because of reserve holdings, i.e. the money that a bank holds back and does not loan, in order to secure its financial position against bad loans (which must be written off as losses of money), panics, and runs on the bank. The equation H = R + C thus defines the quantity "H" as the sum of "R," reserves, plus "C," the cash that exists to be loaned. While a bank may prudently estimate the amount of reserves that it needs, over time this comes to be defined by law. The "broken banks" of the pre-Civil War era seemed to show that banks could not estimate their reserve requirements very well, or that, some banks being dishonest, all banks should be required to hold a minimum reserve. The National Banks created during the Civil War would then have their reserve requirements set by the Comptroller of the Currency in the Treasury Department. Factoring reserves into the matter, we can then redefine "M" as M = H + D - R.

After the creation of the Federal Reserve System to support the banks in a panic, with the expectation that the System would supply cash in the event of a surge of bad loans and a loss of liquidity, reserve requirements in the 1920's were lowered for National Banks. This did not turn out well, for when the Great Depression hit, and banks ran out of money from bad loans and runs, not only did the Federal Reserve fail to provide liquidity as originally intended, but the both the System and the Treasury Department did not allow the banks to use their own reserves to maintain their integrity. Thus, not only did the Federal Reserve forget what it was supposed to be doing, but the banking authorities forgot what reserves were supposed to be for in the first place. Having failed, all the broken banks could do with their reserves was to pay off the creditors of the banks, at a discount, in their own bankruptcy.

This is an excellent lesson how a government intervention, introduced to "fix" a problem with the market, i.e. in this case with free banking, ends up creating a corresponding problem, whose effects, like the Great Depression, may actually be worse than the original "problem" with the market. Such examples can be multiplied without end, but one notices in American politics the perpetuation of a narrative that government intervention not only is necessary for every evil but that it is the successful remedy for such evils. As Thomas Sowell frequently notes, the lack of success in such matters, or the generation of appalling unintented consequences, is commonly ignored in political discourse (particularly by Democrats), or dismissed on the principle that only the good intention of the action counts.

Given the definitions, we can combine the equations. Thus , , , and . These may be of limited usefulness, but juggling them is a bit of fun.

While we might worry that expanding the money supply through deposits would be inflationary, this process is self-correcting. The loans generate transactions, which themselves compensate for the expansion and prevent deflation, while the bad loans, when liquidated, automatically reduce "M" again. Some Austrian economists (e.g. Murray Rothbard) don't like fractional reserve banking, but the system of fractional reserves and loans is all a salutary process. The danger has come from things like the failure of the Federal Reserve to do what it was designed to do. That failure probably was the result of the System responding to political pressures rather than being accountable to its member banks -- although some people like to think that the System itself is a conspiracy of the member banks.

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Money, Note 3

From recent news [meaning 2003!], the economies of Argentina and Venezuela were for a while shrinking, one might even say nearly collapsing. According to The Economist of March 1st-7th, 2003, the GDP of Argentina was 10.1% smaller from one year previously, and that of Venezuela was 16.7% smaller. Nevertheless, Argentina was experiencing 39.6% inflation, and Venezuela 33.8% inflation. When the United States entered the Great Depression, however, from 1929 to 1933, with the economy collapsing, there was steady deflation. Prices dropped by 26.7%. This drop was arrested, but prices did not return to 1929 levels until 1942. Recently, Venezuela and Argentina have recovered and are growing again, as discussed elsewhere, but still with heavy inflation.

By 2014 Venezuela has been reporting economic growth for some time (1.1% according to The Economist of April 19th-25th, 2014, with 7.2% unemployment), but inflation is still extremely high (57.4%!) and there is widespread evidence of the unavailablity of consumer goods, including toilet paper. The current socialist/communist government,increasingly dictatorial and repressive, despite the death of Hugo Chavez, has no clue how to remedy this. Argentina has joined the club, again in the grip of Peronist idiocy, now defaulting on its debts (but with reported 5.5% growth and 6.4% unemployment). Both regimes, in line with the Obama Administration, consistently vilify, assault, and obstruct business and finance, with the claim that the socialism and corruption that have caused their economic evils are actually the effect of capitalism rather than their own policites.

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Money, Note 4

With the United States government this occurs through a kind of shell game. The Treasury was wisely prohibited from just printing and spending money. It sells bonds to get extra money, i.e. borrows it from the public. However, the Federal Reserve System can buy Treasury bonds, both directly and indirectly. The effect of that is for the Federal Reserve to print the money and then give it to the Treasury. The Federal Reserve then holds the bonds and collects interest on the debt, which it then turns over, with all its earnings, to the Treasury. The Federal Reserve can also buy any bonds or securities on the public market, which is the same as printing money and loaning it to anyone. When the Federal Reserve loans money directly to member banks of the Federal Reserve System, the interest rate it charges is called the "discount rate." The discount rate is the only link between interest rates and inflation, since a higher rate discourages banks from borrowing (newly created) money from the Fed and a lower rate encourages it. Encouraging such borrowing could stimulate both economic growth and inflation, or just inflation, resulting in the common link made by press and politicians between an "overheated" economy and inflation. But a growing economy itself has absolutely nothing to do with inflation. Economic growth without devices for increasing the money supply actually results in deflation, as it did from the end of the Civil War until 1896.

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Money, Note 5

The Federal Reserve System is theoretically "owned" by its member banks; but the true state of affairs is revealed by the fact that its profits, beyond a certain minimum return, are paid to the Treasury and by the fact that it is controlled by political appointees on the Board of Governors. When the Bank of England was entirely in private hands, from 1694 to 1946, it could always be counted on to keep its note "as good as gold." The difference there, of course, is politics and political control, which has proved to be a fiction in the ostensively "independent" Federal Reserve System.

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Money, Note 6

Congress simply gave the Treasury the power to print money. This was subsequently found to be unconstitutional. Then the decision was reversed. But finally Congress decided that it didn't want the Treasury to have that power. Eventually, in 1913, the Federal Reserve System was created. Its power to issue Federal Reserve Notes led to our present currency.

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Money, Note 7

The Federal Government knew that it was unconstitutional, and politically impossible, to try and "call in" (i.e. confiscate) the gold coinage, as Franklin Roosevelt did in 1933. Roosevelt himself said that he was going to confiscate gold whether the Supreme Court judged it Constitutional or not. The Court, however, complied and found the action Constitutional, even thought it characterized the unilateral voiding of the gold clauses in private contracts and United States securities as "immoral."

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Money, Note 8

That the government is the biggest borrower of all and thus has the greatest interest in inflation is a tribute to the responsibility of American government in the post-Civil War era, as it is an indictment of most government since, which has been perfectly willing to inflate the currency to devalue the national debt -- although this steals money right out of the pockets and hard-earned savings of every American.

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Money, Note 9

The Gold Standard was introduced by Great Britain in 1816 because of the conflict that was always occurring between the relative values of gold and silver, as commodities, and their value as money. A gold strike would make gold relatively less valuable in relation to silver, which meant that a gold unit of value would have to be marked down in terms of a silver unit of value. Between 1670 and 1717, the British gold coin, the Guinea, bounced around between a value of 20 shillings (in silver) and 30 shillings, as gold became relatively more valuable. It was settled at 21 shillings in 1717, which was slightly overvalued (against the advice of Issac Newton, Master of the Mint at the time, who said that it should be no more than 20 shillings and 8 pence). That drew gold into England for the following century, as speculators sold gold there to obtain a greater profit in silver. The Gold Standard ended all those kinds of problems, although it did then limit the rate at which the money supply could grow naturally.

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Money, Note 10

Also, writing off bad loans can put banks into bad financial shape themselves. Before deposit insurance, rumors could start a "run" on a bank, as people would try to withdraw their money. A bank's reserves could never cover all deposits, so a serious run could cause a bank to default and fail. A failed bank takes with it a lot more of the money supply than a few failed loans. In the banking panic of 1907, banks briefly suspended cash payments to stop runs on them. That was illegal, but it was tolerated and succeeded in ending the panic.

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Money, Note 11

The Federal Reserve System, which had been created to support the banks during credit crises (to replace ad hoc devices like the suspension of cash payments in 1907), failed to do so in the early 30's, allowing banks to fail in unprecedented numbers. This was particularly egregious because in the 1920's the Fed had encouraged banks to extend their credit further than ever before. The banks did, with confidence, since they understood that the System had been created to stand behind them if they might be threatened in a credit collapse. But when the collapse came, with all the force of a fall from an unprecedented height, and a banking panic began, the Federal Reserve mostly stood idly by and let the banks fail. By 1933 40% of all the nation's commercial banks had gone bankrupt or been closed by regulators. Nothing like that had ever happened before, in part because the banks had not let it happen. But the ability of the banks to protect themselves, and the public, had been taken from them and given to irresponsible bureaucrats whose only real interest was to protect themselves, not the banks or the public. The result was that the savings of businesses and individuals were wiped out, the currency deflated tremendously, and debts, mortgages, and taxes were suddenly many times more valuable than before. Countless bankruptcies and foreclosures followed. Thus, Franklin Roosevelt's "money-changers" (see quote above) were not the cause of the Depression but in fact its first victims. But it was easy to blame the victims, since most people didn't even know that the Federal Reserve System existed, much less what it was supposed to do.

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