Money Mischief_ Episodes in Monetary History - Milton Friedman [27]
Figure 1
Ratio of Price of Gold to Price of Silver, Annually, 1800–1914
By joining the movement to gold, the United States added to the upward pressure on the gold-silver price ratio, both by absorbing gold that would otherwise have been available for monetary use in the rest of the world and by failing to absorb silver. The effects were far from trivial. In preparation for resumption, the U.S. Treasury began accumulating gold; by 1879 the stock of monetary gold in the United States, both in the Treasury and in private hands, already amounted to nearly 7 percent of the world's stock. By 1889 the U.S. share had risen to nearly 20 percent. Even more dramatically, the increase from 1879 to 1889 in the U.S. stock of monetary gold exceeded the increase in the world's stock. The monetary gold holdings of the rest of the world declined from 1879 to 1883; then they rose, but did not surpass the earlier level until 1890.
For silver, the failure to absorb the metal via free coinage was offset to some extent by repeated special legislation for the benefit of silver interests. The legislation required the federal government to buy silver at market prices, and the first such measure, which preceded resumption, was the Bland-Allison Act of 1878. It authorized the Treasury to buy between $2 million and $4 million of silver each month at the market price and led to regular purchases from 1878 to 1890. Then the silver purchases were stepped up drastically, under the Sherman Silver Purchase Act, until the silver purchase clause was repealed in 1893.
Interestingly enough, the number of ounces of silver purchased under these acts was almost equal to 16 times the number of ounces of fine gold added to the country's monetary gold stock. On first blush, it looks as if political measures had absorbed as much silver as free coinage would have. However, that was not the case. As will become apparent in what follows, had the United States been on silver, the stock of money would have risen faster than it did, and hence the ounces of silver brought to the mint would have substantially exceeded 16 times the ounces of gold actually acquired.*
The most obvious, but by no means the most important, consequence of the U.S. return to gold rather than to a bimetallic standard was the sharp rise in the gold-silver price ratio. A far more important consequence was the effect on the nominal prices of goods and services in general. The increased world demand for gold for monetary purposes coincided with a slowing in the rate of increase of the world's stock of gold and a rising output of goods and services. These forces put downward pressure on the price level. Stated differently, with gold scarcer in relation to output in general, the price of gold in terms of goods went up and the nominal price level (under a gold standard, the price level in terms of gold) went down. The downward pressure was relieved somewhat by a rapid expansion of the banking system, which increased the amount of money that could be pyramided on each ounce of gold. On the other hand, rising real income, plus the spreading monetization of economic activities, plus the declining price level itself, increased the downward pressure on prices by leading the public to hold larger cash balances relative to their income (that is, velocity declined).
The outcome was deflation from 1875 to 1896, at a rate of roughly 1.7 percent a year in the United States and 0.8 percent a year in the United Kingdom (which means in the gold-standard world). In the United States, the 1875–96 deflation followed the even sharper deflation after the Civil War. That sharper deflation was an essential requisite for successful resumption on gold at the prewar parity between the U.S. dollar and the British pound. It also produced wide unrest and dissatisfaction, particularly in rural areas. The unrest led to the formation in 1876 of the Greenback party, to