Money Mischief_ Episodes in Monetary History - Milton Friedman [34]
The reason for expressing the money stock as the product of the real stock and the price level is because the price level is what we are seeking to estimate. The second form of stating the right-hand side of equation (6) introduces the hypothetical real price of silver in place of the nominal price level. From that, we can readily estimate the hypothetical nominal price level by using the counterpart of equation (1).
In computing the actual values in equation (5), we regarded silver in circulation or held by the Treasury as monetary silver. However, in estimating hypothetical values of the specie reserve ratio and of specie reserves for the gold-standard period, we cannot treat monetary silver as part of specie reserves, though it would have had that status under a bimetallic or silver standard. It was simply a governmental asset accumulated as part of an attempt to prop up the price of silver (like government stocks of wheat at present).
Accordingly, we have used only monetary gold stocks for the present purpose. Figure 1 plots the gold reserve ratio (the ratio of the dollar value of monetary gold to the quantity of money), the real value of the stock of money, and the real value of gold reserves (actual gold k1). The rapid rise in the reserve ratio during the first five years after the passage of the Resumption Act (1875 through 1879) was to be expected in preparation for resumption. Presumably, a similar rise would have occurred if resumption had been on silver instead of gold, with the sole difference that silver would have been accumulated rather than gold. In either case, the accumulation of reserves required a surplus on the current account of the balance of payment or capital inflows. And a sizable surplus was generated from 1876 to 1881, followed by sizable capital inflows. I see no reason to suppose that the initial buildup of reserves would have been different under silver than it was under gold.
Figure 1
Gold Reserve Ratio, Real M2, and Gold Reserves, 1875–1914 (Money amounts in billions of 1929 dollars)
By 1879, the specie reserve ratio reached roughly the same level as in the early 1900s, after the end of the period of uncertainty generated by the monetary disturbances of the 1880s and 1890s. The further rise after 1879 was prompted by an effort to persuade the public, not only at home but equally abroad, that the gold standard was here to stay. As agitation for a more expansive monetary policy mounted, however, that effort failed and, especially after the pro-silver movement gained steam, led to continuous pressures on gold reserves, producing a sharp decline in the reserve ratio and a slightly declining level of real reserves. After the defeat of Bryan in 1896, there was a temporary spurt in the reserve ratio and an even sharper rise in real reserves, as the higher reserve ratio was reinforced by a rapid increase in the real money supply—itself partly a consequence of a return of confidence that both lowered velocity and fostered a higher real income. Reasonably steady conditions were not attained until the end of the period.
After trying many alternative ways of estimating what specie reserves would have been under an unchallenged and fully accepted silver standard, I finally settled on a purely empirical expedient: a straight-line trend between the average values of gold reserves during the first five and the last five years of the period from 1875 to 1914. As Figure 2 shows, such a trend eliminates both the initial bulge and the later decline that, in the previous paragraph, I attributed to the monetary disturbances and their aftermath. For 1875–79 and 1901–14, it approximates the actual pattern.
The U.S. hypothetical annual monetary demand for silver is simply the increment in the U.S. hypothetical silver stock:
The possible errors in this approach are numerous. Some simply affect the year-to-year movements as a result of the use of