A Tale of Two "Deflationary" Booms — The Gilded Age vs. Today
The forces of globalization during the past two decades have been stronger than at any time since the era of “the Great Deflation” which started in the aftermaths of the US Civil War and the Franco-Prussian War, and continued through the 1880s. During the earlier period, the US economy enjoyed record growth in prosperity. But, during the present era of globalization, the US and most advanced economies have grown fitfully and overall slowly. An obvious question is whether that divergence in outcomes is due to the very different monetary environments (The US and most of Europe were on gold in the first era with prices falling, while monetary experimentation under a global 2% inflation standard prevailed in the second).
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In searching for the answer there are two channels to follow, both involving counterfactual analysis. The first is to study the early episode (the early 1870s to the end of the1880s) and determine whether it would have been less glorious if the monetary environment had been the same as in the present episode (the mid-1990s to now). The other channel is an investigation of the present episode so as to determine whether a sound money regime — as in the earlier episode — would have produced a much better outcome. In conducting the latter search, the analyst should be alert to hints of the world which might have been in the actual world and indeed there are positive findings here.
Comparing Two Periods
The globalization forces in the early episode included progress in telegraphy especially intercontinental (shortening the time of communication from weeks to minutes or hours), the building of the Suez Canal, and the Bessemer steel revolution (making possible huge improvements in transportation – especially railroads, ocean shipping). This occurred alongside massive migration flows occurred, most of all from Europe to the US. The parallels in the present include the communication revolution related to the internet and more broadly digitalization, and the shale-gas and renewable energy revolution. Meanwhile, vast migratory flows and offshoring of production have occurred in the context of falling barriers (China’s accession to WTO and the fall of the Iron curtain, for example).
Both episodes included a long period of falling wage share (1873-1880 and 2010-17), but the early one also included many years of rapidly rising real wages (1880-90) accompanied by capital spending boom. Both episodes featured a sinister element — a powerful rise in monopoly power and its abuse, especially prominent in the new economy of the time. This monopoly power was found in railroads and steel during the first period, and the big tech companies in the second. Correspondingly, crony capitalism flourished in both periods.
The Boom of the 1870s and 1880s
Milton Friedman and Murray Rothbard in their US histories of the 1870s and 80s were dazzled by the brilliance of the outcome, most of all in the second decade. They cite the annual decline of prices in the 1870s as 3-4% p.a. (in part explained by the passage away from the greenback to the resumption of specie payments in 1878) and 1-2% p.a. in the 1880s (when growth of per capital real incomes reached a record of around 4% p.a.). If hedonic price accounting had applied as today the measured declines would have been significantly greater.
The early episode was certainly scarred by financial crises. On its eve there was the panic of 1873 and related recession which accompanied the beginning of the end for the greenback President Grant signaled the passage back to gold starting with the demonetization of sliver. Significantly this ex-civil war general was adamant in his refusal to implement legislation which would have allowed the resumption of greenback issuance in response to the crisis.
The “semi-panic” of 1884 (and the “depression” of 1882-5 — in fact a period of stagnation in real terms — stemmed from instabilities in the national bank system (especially the pyramiding of reserve requirements as set up during the Civil War) and was accentuated by natural rhythm in the capital spending cycle. The crisis and economic weakness was of a much smaller order of magnitude than the panic and economic downturn of 2007-10 and was followed by the fastest period ever of US growth unlike the slowest ever expansion following the Great Recession of 2009-17.
One can only imagine the size of bubble and bust which might have occurred by the late 1870s or early 1880s if the prevailing monetary standard had been the 2% inflation standard of today. That would have meant continuation of the greenback and perhaps the adoption of a silver standard ultimately. Yes, the growth of cities and the development of the railroad grid produced waves of regional speculation. But vast increases in the supply of land and stable monetary background meant no nationwide bubble and bust. How different this might have been under anything like present monetary conditions.
Our Modern Stagnation
The second era of globalization like the first emerged after an inflationary boom had turned to bust (the monetary boom of the mid-late 1980s starting with the Reagan-Volcker devaluation of the dollar, spreading to Europe and Japan and culminating in the 1990-2/3 economic downturn). But Chair Greenspan (taking office in August 1987) was not under the orders of General Grant. Instead he launched a monetary reflation, briefly paused in 1994-5 as retail price inflation spiked, and then resumed (with the gradual adoption of a 2 per cent inflation standard starting with the notorious Yellen paper at the July 1997 FOMC meeting).
The result was the Great Asset Price Inflation of 1997-2000 ending in the 2000 bust and subsequent economic downturn; subsequently the Federal Reserve policy during 2003-5 of “breathing in inflation” led on to the Great Panic and Recession of 2007-10, followed by widely diagnosed secular stagnation. The fear of eventual new bubble bursting in the context of the Grand Monetary Experiment (including QE) weighed on many businesses and translated into an eerie sluggishness of aggregate investment spending (albeit accompanied by booms in some sectors including shale oil/gas and Silicon Valley).
The counterfactual history would start with the launch of sound money in the first half of the 1990s even if meaning perhaps a more serious recession and financial crisis at that time. The apologists of the central bankers club and their political masters (and appointers) might claim that there would have been no economic rebound let alone economic miracle. Contradicting that claim has been the robustness of speculative narratives in the asset price inflations of 2003-7 and of 2012 to the present time.
In this article at the Quarterly Journal of Austrian Economics, I have described both recent asset price inflations as depression-type in that there was no accompanying economic prosperity and the essential driver to the process has been desperation for yield induced by monetary experimentation. Yet for such long periods without prosperity, the sheer strength, popularity and frequency of speculative narrative has been striking (in comparison, say, with a previous period of depression-type asset price inflation as 1934-7). If the writers about secular stagnation were correct it is implausible that new and sometimes the same speculative narrative could have bounced back with such force from the fading of the old.