Front Page Titles (by Subject) CHAPTER 5: PRICE LEVELS AND THE GOLD STANDARD - Economics, vol. 2: Modern Economic Problems
The Online Library of Liberty
A project of Liberty Fund, Inc.
CHAPTER 5: PRICE LEVELS AND THE GOLD STANDARD - Frank A. Fetter, Economics, vol. 2: Modern Economic Problems 
Economics, vol. 2: Modern Economic Problems, 2nd edition, revised (New York: The Century Co., 1923).
Part of: Economics, 2 vols.
About Liberty Fund:
Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.
The text is in the public domain.
Fair use statement:
This material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in the Copyright Information section above, this material may be used freely for educational and academic purposes. It may not be used in any way for profit.
PRICE LEVELS AND THE GOLD STANDARD
§ 1. Concept of the general price level. § 2. Index numbers. § 3. Definition of the standard of deferred payments. § 4. Increasing importance of the standard. § 5. Defectiveness of the gold standard. § 6. Relative values of gold and silver. § 7. Gold production, 1800-1850. § 8. Gold production and price changes, 1850-1873. § 9. The great fall of prices, 1873-1896. § 10. Nature and object of bimetalism. § 11. The free-silver movement.
§ 1. Concept of the general price level. The price of any good is some other good or group of goods given for it in trade.1 The standard unit of money coming to be the most convenient expression for price (whether or not money be actually passed from hand to hand in any particular trade), prices usually are monetary prices, and more specifically are prices in gold, or in silver, or in whatever constitutes the standard money unit. But the price of each good is a definite, separate fact, which expresses the ratio at which that commodity is sold. The price of any particular kind of goods may fluctuate in either direction as compared with the prices of other goods at the same time. For example, iron and many other goods may rise while wheat and many other goods fall in price. There is, therefore, no such thing as an actual general change in the prices of goods in terms of money, but it may be seen that the prices of large classes of goods, often of nearly all goods, change upward or downward at the same time and in the same general direction. We thus have need to distinguish between changes in the valuations of particular kinds of goods in terms of each other and general changes in the valuation of a number of different goods in terms of the monetary unit.
To get some idea of whether such a general trend occurs, the algebraic sum of all the changes in the particular prices of a selected group of goods may be taken, and for convenience this may be reduced to an average price (by dividing the sum by the number of articles). Such an average is called a general price, and, when comparing it with the general price of another time, we speak of changes up or down in general prices, or in the general scale of prices, or in the price level.
When gold is the standard unit, its value is the converse of general prices; as prices go up the value of gold goes down, and gold is said to depreciate. As prices go down the value of gold goes up, and gold is said to appreciate. Rising prices mean falling value of gold (and at the same time falling purchasing power), and vice versa.
§ 2. Index numbers. The process of calculating general prices and changes in them has in it, inevitably, something of arbitrariness and incompleteness. For not all prices can be included, but only those of articles of somewhat standardized grades and those that are pretty regularly sold in markets where prices are publicly quoted. No list of articles that can be selected is of equal importance to different persons and classes of persons, at different places, at different times, and for different purposes. And yet the study of general prices as shown by any broadly selected list reveals changes that in some measure affect the interests of every member of the community.
General prices are conveniently compared from one time to another through the use of index numbers. An index number of any article is the per cent that its price at any certain date is of its price at another date (or of the average for a series of prices) taken as a base or standard. Thus if the average price of cotton in the base year were 10 cents (taken as 100) and the price rose to 12 cents, the index number would be 120. A tabular index number is the per cent that the price of a selected group of articles at any certain date is of the price of the same group of articles at a date that has been taken as the base. Numerous tabular index numbers have been worked out for different countries and periods.
A chart of the principal index numbers of the leading countries is shown in Figure 1. The fact that from 1862 to 1879 inclusive prices in the United States were expressed in an irredeemable paper standard makes comparisons for that period misleading. A better idea is obtained by using as the base for each of the several series the average of prices in each country for the years 1890 to 1899.
§ 3. Definition of the standard of deferred payments. As a medium of exchange, money comes to be the unit in which most prices are expressed and compared; in other words, it becomes the common denominator of prices.2 This makes it also the most convenient unit in which to express the amount of credit transactions and of existing debts.3 A credit transaction is a trade lengthened in time; one party fulfils his part of the contract by delivering the goods or money, the other party promises to give an equivalent at a later date. The equivalent may be in any kind of goods; for example, in barter one may part with a horse on the promise of a cow to be received later; or a small horse on the promise of a large one; or a flock of sheep on the promise of its return at the end of the year with a part of the increase of the flock. A simple standard in which to express the debt is the thing borrowed, as horse, sheep, wheat, house. Again, the thing to which the value of debts is referred may be a thing quite different from the goods borrowed, and, with the growth of the monetary economy and the use of the interest contract, money comes more and more to be used as the standard. At length the law declares that in the absence of any other agreement, the amount of a debt is to be payable in terms of the unit of standard money, which thus is made legal tender as well as the customary standard of deferred payments. A standard of deferred payments is the thing of value in which, by the law or by contract, the amount of a debt is expressed and payable.
§ 4. Increasing importance of the standard. Until the use of money develops, the use of credit is difficult and limited; it becomes easy when the value of all things is expressed in terms of a common circulating medium. It therefore generally is true that the importance of money as the standard of deferred payments increases with the use of money as a medium of trade. The volume of outstanding debts expressed in terms of money now very greatly exceeds the total value of the circulating medium. Changes in the general level of prices have, therefore, great effect upon all existing debts. The value of all debts changes in the same proportion as does that of the standard unit of money; when this rises or falls in value, it means increase or reduction, in the same ratio, of the purchasing power of every creditor. It is as if he had in his possession metal dollars equal in amount to the face of the debt, and they had changed by so much in purchasing power. The debtor’s interests in such changes are, of course, just the reverse of the creditor’s interests.
Outstanding contract debts may be roughly divided into two classes: short-time loans, running less than a year; and long-time loans, running for a year or more.4 Fluctuations are rarely rapid and great enough to affect appreciably the debtors and creditors in the case of short-time loans. The results are appreciable in the case of loans running from one to five years, and may be very great in the case of loans made for still longer periods, such as the bonded indebtedness of nations, states, municipalities, and business corporations, and as mortgages given by farmers on their land or by owners of city real estate. A multitude of interests are thus affected by a change in the value of money. When money rises in purchasing power, receivers of fixed incomes are gainers. When it falls in purchasing power, they lose. Receivers of fixed incomes from loans include not merely private investors, but also many educational and charitable institutions which dispense their incomes for public purposes. Wages and salaries of many kinds go up and down less rapidly than do other prices, and thus to some extent wage-earners are in the position of passive capitalists5 as regards changes in the monetary standard. In a capitalistic age, therefore, almost every individual is affected in some way by a change in the value of money.
§ 5. Defectiveness of the gold standard. Money is, in general, for both borrowers and lenders the most convenient standard of deferred payments. But from the usage of speaking of all things in terms of gold arises the popular notion that the value of gold is always the same, while the value of other things changes. In truth, a fixed objective standard of value is not possible of attainment. Although the value of gold is stable as compared with most things, it rests on the estimates made by men and is constantly changing with conditions. The current new supplies of gold are comparatively regular. For centuries at a time there was little change in the methods of mining gold and there were no radical changes in its output. The nature of the use of gold, likewise, is such as to make changes in the amount of it needed, under ordinary conditions, more stable than is that of most other goods. Moreover, the stock of gold in monetary uses is but slowly worn out; it is, therefore, a large reservoir into which flows a comparatively small stream of annual production; the existing stock is twenty or thirty times the annual output. The existing stock of precious metals, gold and silver, more than other products of mine and field, is at any time the accumulation of many years’ production, and is changed very little, proportionally, by a large change of output in any year or short period. It changes in volume as does a glacier fed by the snows of many years, not as does a river, filled by a single rainfall.
Yet the value of gold expressed in other things is never quite stable, and sometimes several influences combine to affect it greatly. At various times the discovery of gold deposits, and recently the invention of chemical and mechanical processes, have suddenly altered the conditions of gold production, causing revolutionary results in the field of prices and deferred payments. A brief survey of these changes will be helpful to an understanding of the problem involved.
§ 6. Relative values of gold and silver. Both gold and silver were used as moneys in Greece and Rome, and continued to be used in Europe in the Middle Ages, though silver was much the more common. The two metals continued in the seventeenth and eighteenth centuries to be used side by side in Europe and in the new settlements in America, silver for the smaller and gold for many of the larger transactions. Both were legal forms of money in units of specified weights and fineness, the weights bearing a certain ratio to each other. Thus it was possible for a debtor to discharge his obligations with that one of the two metals which at the moment was the cheaper at the legal ratio. Fluctuations in the prices of gold in terms of silver were at times such as to cause a large part of the full-weight coins of one or the other metal to leave circulation (in accordance with Gresham’s law). So from time to time the ratio was slightly changed by law in the various countries to permit the circulation or to bring back the kind of money that had been undervalued in terms of the other.
It is a remarkable fact that from the time of Xenophon until the discovery of America (a period of nearly two thousand years) the market ratio of silver to gold bullion in Europe had remained pretty close to ten to one, being only temporarily altered by sudden and unusual occurrences. From 1492 to 1660 the ratio changed to fifteen to one, where it remained with remarkable stability until about the year 1800. At the establishment of the mint of the United States in 1792 that ratio was found to exist. Men had come to look upon the ratio of fifteen to one as the natural order, determined (it was sometimes said) providentially by the deposit of the two metals in due proportion in the earth’s surface. But, as we now see it, this in part was mere chance and in part was due to the equalizing effect of the wide use of both metals, so that the one could be easily substituted for the other in case of a divergence of the market ratio from the legal ratio as money. From the year 1500 until 1800 the western hemisphere was the main source of the precious metals, the alluvial deposits were widely scattered, were gradually discovered, were usually found in small quantities, and were extracted in primitive ways. For a short time after the discovery of America (from 1493 to about 1544) the average coining value6 of the world’s production of gold, nearly all found in America, was about one and one-half times as great as that of silver; but thereafter for three centuries from about 1545, the annual value of silver produced was between one and one-half to four times as great as that of gold, averaging about twice as great. Silver was the money chiefly in use in the ordinary transactions in all of the principal countries of the world.
§ 7. Gold production, 1800-1850. The legal ratio of 15 to 1 in the United States, at which by the law of 1792 both metals were to be freely coined at the mint, proved to be an undervaluation of gold. The market ratio of the two metals had been gradually changing before 1792, and continued to change, gold becoming more valuable in terms of silver. Gold largely left circulation, and by 1818 silver and bank-notes formed nearly the whole of the circulating medium. Then the production of gold began to increase absolutely and relatively somewhat more than that of silver, and when the market ratio had become about 15½ to 1 in 1834, the legal ratio of the United States was changed to 16 to 1. This overvalued gold and brought a good deal of it back into circulation, gradually driving out most of the silver (the heavier coins disappearing first).
In the decade 1841-50 the average annual value of the gold production, for the first time since the early sixteenth century, exceeded that of silver. Then, from 1848 to 1850, came the great gold discoveries in California and in Australia. The value of gold produced in the world in 1851 was one and one half times that of silver, in 1852 three times, and in 1853 four times as great; and then slowly declined, but continued every year as late as 1870 to more than twice as great. Let us observe the effect on prices that was brought about by the discoveries of 1848-49.
§ 8. Gold production and price changes, 1850-1873. The unprecedented increase in gold production between 1849 and 1853, and the continuance of production in volume about fourfold as great as that of the decade 1840-49, caused the displacement of silver by gold in the United States and drove out a large proportion of the silver coins of smaller denominations. To make possible their retention the law of 1853 was passed, authorizing subsidiary coinage (on government account only) of lighter weight.7 Gold became then the one standard money actually in circulation in the United States, and the increased gold production was reflected at once in a rise of prices. This was the most revolutionary price change that had occurred since the sixteenth century. A period of prosperity in business culminated in the crisis of 1857, felt more or less in all the leading countries. This prosperity accelerated the effect of increasing quantities of the standard money. Credit was stimulated and the rate of circulation and the efficiency of money were increased. Prices rose to a temporary maximum in 1857, and then fell, as a great international financial crisis occurred.
Then the substitution of gold for silver in monetary uses made an additional market for gold, and at the same time the rapid growth of population, commerce, and industry in Europe and America began to take up (“absorb”) the new supplies of gold. The price movements in the United States between 1860 and 1879 are passed over here, for the excessive issues of greenbacks drove gold out of circulation and made greenbacks the standard money (except in California and elsewhere on the Pacific Coast, where, by public opinion, gold was retained as the circulating medium). In the European countries prices in terms of gold, though fluctuating somewhat, kept at about the same level from 1860 to 1870. The years 1871 and 1872 were very prosperous and showed rapidly rising prices, which reached a maximum in 1873, when a financial panic occurred.
§ 9. The great fall of prices, 1873-1896. In the year, 1873, notable in monetary history, just as the gold production for the first time since 1851 had fallen below $100,000,000, several notable changes in monetary legislation were effected which made gold more important in the circulation of a number of countries. In 1873 Germany made gold the standard throughout the new German Empire (having prepared the way by legislation in 1871 which made gold a legal tender alongside of silver), and provided that silver was thenceforth to be used only in the subsidiary coinage. The same year Belgium, and the next year the other countries of the Latin Union (France, Switzerland, and Italy) took steps that resulted in demonetizing silver, that is, in limiting its coinage to governmental account, and in making gold their one standard money.
In the United States at that time, and until 1879, greenbacks were standard money, and neither gold nor silver was regularly in circulation (except in California). There was a long-continued discussion of a “return to specie payments,” which meant the return to a metallic standard, and the redemption of greenbacks on demand. Meantime in 1873 a law was passed making the gold dollar “the unit of value” and dropping out the standard silver dollar from the list of coins authorized to be issued at the mint.8 From 1873 until 1879 prices (in greenbacks) were falling in this country very rapidly because the country, with the increase in population, wealth, and business, was “growing up to” its unchanging currency supply. For a like reason, at the same time gold prices throughout the world were falling. While this country was lowering its level of prices from an inflated paper money to a gold commodity basis, the gold basis itself was sinking to a lower level.9 Between 1864 and 1876 our own gold product had been nearly all exported; but, beginning in 1878 and continuing till 1888, the demand of our Treasury and banks for gold caused the retention of our own gold product in this country (nearly $400,000,000 worth, coining value, in the period of eleven years), and required an enormous net importation, amounting (in the same period) to $225,000,000 worth of gold. The combined effect of these causes is seen in the great fall of prices in all gold-standard countries in the period of 1873-1896.
The general price level fluctuated but on the whole tended downward between 1884 and 1893 (the year of panic), and reached a minimum in the year 1895 in Germany, 1896 in England, and 1897 in America. The resulting increase in the burden of outstanding debts was felt by all debtors, but particularly by great numbers of the agricultural classes both in Europe and in America. Their tribulations were aggravated by the fact that at that time (especially from about 1873 to 1896) the prices of their products were falling much more rapidly than were general prices, as a result of the very rapid extension of the agricultural land supply.10 There was complaint, agitation, and demand for relief on the part of many interests in France, Germany, England, and the United States. As a result, the money question became in this country a leading political issue and continued to be such between 1873 and 1900.
§ 10. Nature and object of bimetallism. First came the “greenback movement,” which lasted until after 1880.11 This then gave way to an agitation for bimetallism. Bimetallism is the plan of using two metals as standard moneys. Bimetallism is legally authorized when both metals are admitted to the mints for free coinage at an established ratio of weight. Bimetallism may be legally authorized, but not actually working; for if the market value long continues to vary appreciably from the legal ratio, only one of the metals may in fact be left in circulation. This situation is called limping bimetallism (or halting double standard), though this is a contradiction of terms. National bimetallism is confined to a single country, as was the case in the United States before the Civil War, and in France before 1867. International bimetallism is that resulting from an agreement among several nations to use two metals on the same terms.
The theory of bimetallism is that the government can act on the value of the two metals through the principle of substitution. The metal tending to become dearer will not be coined, the other will be coined in greater quantities. The degree of influence that can thus be exerted on the value of the two metals depends on the size of the reservoir of the metal that is rising in value. When it all leaves circulation, the law on the statute book permitting it to be coined becomes a mere phrase. In such a case there is bimetallism de jure, but monometallism de facto. The greater the league of states, the greater is the likelihood that the plan will continue to work. The only notable historical instance of international bimetallism is that of the Latin Union which united France, Belgium, Italy, and Switzerland in an agreement remaining actually in force from 1866 to 1874. A strong movement developed between 1878 and 1892 in favor of forming a great international bimetallic union of states.
One object of bimetallism was to put an end to the great fluctuations in the rates of exchange of money between the silver-using and gold-using countries, fluctuations that occasioned much uncertainty and loss to individuals engaged in foreign trade. The rise in the price of gold exchange in the silver-using countries (notably India) meant also an increase in their burden of taxation. These countries collected their revenues in silver, but they had to pay their debts, principal and interest, in gold. Another object of this movement was to prevent the burden of individual debts from increasing by reason of the rise in the value of the single standard, gold. It was, indeed, hoped that by bringing silver much more into use the value of gold would be reduced, thus bringing relief to the debtor classes. Still another object of the bimetallic movement was to aid the silver-miners and silver-producing districts by creating a larger market for silver.
Several international conferences were held, which were taken part in by some of the leading financiers of the world, representing their respective governments. The United States was foremost in advocating the policy; France at first favored it, as did in large measure the British Indian administration; though England was in the main opposed. The movement came to nothing.
§ 11. The free-silver movement. When all hope of international bimetallism failed, the efforts of many of its advocates were turned to the plan of legalizing national bimetallism in the United States at a ratio of 16 to 1. This was very different from the market ratio. Gold had become before 1860, in fact, the standard of our money system, and after 1873 it was the only metal admitted to free coinage. Silver, little by little, had been losing purchasing power in terms of gold, until from being worth in 1873 one sixteenth as much, ounce for ounce, it became in 1896 worth but one thirtieth as much as gold. The power of silver to purchase general commodities fell much less than the change in its ratio to gold would indicate, gold having risen in terms of most other goods as well as of silver. However, the “free-silver movement” to open the mints to the free coinage of silver at the ratio of 16 to 1, supported by one of the leading political parties in the year 1896, threatened a sudden and marked cheapening of money. Probably gold would have been entirely driven out as money for the time and silver would have taken its place as the standard. It is not impossible, however, that the substitution of silver for gold in the United States would have brought the two metals to parity at a level of prices much less than 100 per cent higher than the existing one, possibly not more than 20 or 30 per cent higher. In any event, “free silver” would have accomplished the purpose of making the standard of deferred payments cheaper. It was at first a debtors’ movement, but to succeed it had to enlist the support of other large classes of voters. And thus it developed into the more sweeping theory that wages, welfare, and prosperity were favored by a larger supply of money quite apart from the effect it would have upon debts.
In its extreme form the free-silver plan was a fiat scheme; for some of its supporters believed that by the mere passage of the law the two metals could be made to bear to each other any ratio desired. But its most intelligent advocates recognized that the force of the law was limited by economic conditions. The victory of the gold standard in the campaign of 1896 was, it would seem, due more to the well-founded fear that a sudden change of the money standard would cause a panic than to a popular understanding of the question.
[1 ]See Vol. I, p. 45 ff.
[2 ]See Vol. I, p. 262.
[3 ]See Vol. I, p. 263, on credit transactions, and p. 302, on interest contract.
[4 ]See Vol. I, p. 304.
[5 ]See Vol. I, p. 319.
[6 ]The amount of silver is here expressed at its coining value; this is not the commercial value, but rather the number of silver dollars 371.25 fine grains weight that could be made out of the silver produced. Silver and gold of equal coining value are, therefore, as to weight always in ratio of 16 to 1.
[7 ]See ch. 4, § 4.
[8 ]This change was what later was referred to in political discussions as “the crime of ’73.” The dollar referred to was the standard silver dollar; at the same time the coinage of a trade dollar was authorized (intended to be used only in foreign trade), which, after 1876, was not legal tender in the United States.
[9 ]See ch. 4, § 4.
[10 ]See Vol. I, on agricultural leases, p. 159, wheat prices, p. 436, and changes in the land supply, p. 442.
[11 ]See ch. 4, § 13.