Ron Paul’s chances of making it to the White House may be small, but his campaign is a wonderful gift to econ profs, since his ideas are particularly popular among young people. Those who like his ideas generally are willing to advance them in classes, producing many “teachable moments”:
What would happen if we abolished the Fed and had no central bank at all? Would we be better off if money only consisted of gold and silver? Did the return to the gold standard after the Civil War touch off a period of exceptional prosperity that was forfeited with the Federal Reserve Act in 1913?
That last assertion is part of Paul’s stump speech, and so students and readers frequently ask if it is true. My answer is a typical economist’s one – yes and no. But the details illustrate some of the challenges we would face if Paul’s dream ever became reality.
The candidate’s assertion usually includes three elements: Inflation has been higher since 1913 than in the half century before. The U.S. economy grew a great deal between the Civil War and the outbreak of World War I. Prices actually fell for much of that period.
All of this is true. The Consumer Price Index is now 22 times as high as it was in 1913, for an average annual inflation rate of 3.2 percent. The U.S. did grow enormously in the period in question. Prices did fall over much of it, so that the CPI in 1914 was still down a third from its peak in the Civil War inflation.
However, there are also less positive facts. Much of the economic growth came from four factors: high immigration, settlement of land west of the Mississippi, large inflows of capital from Europe and technological change in industry and transportation. None of these necessarily depended on the gold standard.
Moreover, while total output grew, the economy frequently was in recession, with business failures, high unemployment and harsh conditions for many working people. The National Bureau of Economic Research lists 12 recessions totaling 312 months out of the 588 months from 1865 through 1914.
Moreover, it was a period of frequent financial crises. There were at least seven national banking panics, with some banks failing and many others suspending withdrawals and payments of checks for some period.
In contrast, there have been only two financial crises since 1913, in 1929-1933 and the current one, which began in 2007. Indeed, the 73-year run without a financial crisis that ended in 2007 is without precedent in modern history. In the past 50 years, there have been eight NBER-defined recessions totaling 91 months.
So while adding new land, labor and capital did make the economy grow in the period Paul admires, it was also in recession nearly half the time. And these recessions often stemmed from the monetary regime in force. The 65-month recession from 1873-1879 was a direct result of a deliberate shrinkage of the money supply necessary to return to the gold standard.
Moreover, the straitjacket imposed by that system meant that the money supply could not grow as fast as overall output. As Milton Friedman would have predicted, this forced consumer prices down by another 25 percent from 1877 to 1900. That may sound great to Paul, but it wasn’t for many people.
Wages shrank by a quarter in the 1870s and in some industrial states like Pennsylvania by 50 percent. The effects on households dependent on natural resource production, i.e.,farmers, miners and lumbermen, were often more severe. Prices of their products fell by 30 percent to more than 50 percent. And such households still constituted well over half of the population.
As in any deflation, anyone who took out a mortgage, including those for farms, mines and sawmills, before or during the decline was punished severely. So the agrarian protests of the era and the call for ending deflation by coining more silver had a basis in real human hardship.
Unfortunately, the data we have for this era are not as reliable as the scientific statistical series like unemployment, the CPI and gross domestic product that were introduced since 1913. And there is very little information on income distribution back then. So we cannot specify exactly which groups were hurt most and which benefited from the gold standard during this era. But the general perception back then that it primarily benefited middle- and upper-class urbanites, particularly the financial classes in cities like Chicago, Philadelphia, New York and Boston, and that it hurt industrial workers and rural people was largely correct.
A general who ruled Brazil in the 1970s got into trouble for truthfully saying, “The economy is doing well, but the people are doing badly.” That is a pretty good description of the situation for our nation during the period to which some now want to return.