[Dewayne-Net] Re: Report: biggest decline in prices since

Andrew M. Odlyzko odlyzko at dtc.umn.edu
Sat Jan 24 08:10:10 PST 2009

the Great Depression


Some economic historians would claim that the depression of the
late 1830s and early 1840s was more severe than that of the 1930s,
but it is hard to compare over such long time distances, with very
different economies and societies.

Your statement that

Market success--characterized by stable and sustainable growth levels,
generally falling price levels, and increasing real incomes--is the
norm in the absence of state intervention.

could be regarded as true, but only to the extent that it is vacuously
true, as it applies to the empty set.  The complete "absence of state
intervention" has not been observed in recorded history, which makes the
extreme free marketers free to refuse to acknowledge all inconvenient
statistics, and blame them on the government.

But early Victorian Britain is probably the closest any economy has come
to "the absence of state intervention." The worship of private  
and denigration of government actions were on a scale that even Ayn
Rand would have applauded.  And it was on a gold standard, with
the Peel Act of 1844 making it about as pure a gold standard as even
a purist might want.  Yet what do we see?  Here are some statistics,
taken from B. R. Mitchell, "International Historical Statistics: Europe,
1750-1988," 3rd ed., 1992, and W. L. Thorp, "Business Annals," 1926
(all for the UK alone):

year	GDP	price index	brief characterization

1835	471	84.5	prosperity; stock exchange panic
1836	508	95	prosperity; financial panic
1837	484	94	recession; panic; depression
1838	519	98	depression
1839	549	104	depression
1840	510	102.5	depression
1841	481	98	depression
1842	459	89	depression
1843	459	80	depression; revival
1844	506	81	mild prosperity
1845	537	83	prosperity

(GDP is in current prices, in millions of pounds, Table J1 of Mitchell,
price index is the whole sale price index, Table H1 of Mitchell, and
the "brief characterization" is from Thorp)

The main point is that that the economy was subject to pretty strong
fluctuations, far more dramatic than what we have seen in recent decades
(so that the Great Moderation was definitely real, at least up until
last year).  But there is more to this story, and the fluctuations
can't be blamed on the gold standard.

You may object that the table is inconsistent, with the "brief
characterization" not supported by the numbers.  Well, yes, and this
brings up an important point that I expect only some readers of this  
will appreciate, primarily the ones who were raised in the India of a
couple of decades ago, where the prosperity depended on the monsoon.
The UK of the early 19th century was still heavily dependent on
agriculture (and other countries even more so).  And no monetary policy
can compensate for harvest failure if the population depends heavily
on the harvest, especially in those early days, when transportation
options were limited.  (The Irish Potato Famine starts just about
when the table above ends, in which about a million people die.  That
is an extreme example, and there are many aspects to the Famine, so
I won't go into that.)

As a simplistic illustration, suppose you and
one other chap live on an island, and he does all the farming, while
you produce the tools, clothing, etc. for this small economy of two
people, but that you use a fixed stock of gold as a medium of exchange.
Some kind of equilibrium exists under normal conditions.  But suppose
that one year the harvest fails, and the other chap gets in only half
the wheat, corn, chickens, ..., that he normally can spare for  
Your work just as hard as always, and produce just as much.  Naturally,
in your little economy, food prices will go up, with each spade you make
fetching fewer chickens than it used to under normal circumstances.
So in money terms, there will be wild fluctuations, difficult to capture
in statistics (especially if statistics collection is fragmentary or
non-existent, as it often was in the UK then).  The main point, though,
is that while the farmer will get more of your output than he normally
gets, both of you will see a much diminished standard of living, since
there is half as much food available.

So under the gold standard there was price stability, but only over very
long periods of time.  Over intervals of a few years, meaning half a
dozen or more, you would normally see extreme fluctuations, ones that
affected different segments of the society in different ways, and which
made it hard to tell just what was happening.

And of course, on top of the fluctuations coming from agriculture,
there were the fluctuations caused by the internal dynamics of the
free markets, which led to booms and busts of their own.

Just a couple of additional (amusing ?, instructive ?) points:

1.  The era of the gold standard provides some of the strongest  
evidence of the benefits of low inflation.  New gold discoveries, such
as the California Gold Rush, preceded the periods of fastest and  
economic growth.  (This is obviously a great simplification of a  
story that can be presented in other ways, too.)

2.  One noticeable development over the last couple of centuries is that
the financial industry has gotten much better at extracting money from
taxpayers.  When the mid-1820s mania in Britain burst, the merchants
and bankers went hat in hand to the government, asking for help.  They
were told to go fly a kite, and a painful depression followed.  But just
a few years after the 1844 act that made the gold standard very strict,
there was a major financial crisis in October 1847, and the British
government authorized the Bank of England to break the law.  That did
the trick (plus the Keynes-like stimulus that was provided to the
economy by railway investors pouring money into their lines in the
(vain) hopes of making a fortune in the Railway Mania that was still
raging), but it did not involve any government expenditure.  What's
happening today, with a US Secretary of the Treasury asking for
$700 billion to put into banks, and asking for it in a matter of
days, was inconceivable then.

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