Money Mischief_ Episodes in Monetary History - Milton Friedman [41]
McKinley's career was quite different: politically successful, personally tragic. He was assassinated by an anarchist in 1901, but he also presided over the Spanish-American War, was reelected in 1900 by a substantially wider margin than he had achieved in 1896, and witnessed a rapid economic revival—indeed, something close to a boom—in the United States.
The Triumph of the Gold Standard
Both the free-silver movement and the incentives that spurred the development and application of the cyanide process for mining gold have their roots in monetary developments of the 1870s and even further back, after the Napoleonic wars, in Britain's adoption of a gold standard in 1816 and resumption of specie payments on the basis of gold in 1821. Britain's subsequent rise to world economic dominance doubtless played a major role in endowing the gold standard with an aura of superiority and in inducing other countries to follow Britain's example.
France successfully maintained a bimetallic standard at a ratio of 15.5 to 1 from 1803 on. However, it was forced off that standard in 1873 by its defeat in the Franco-Prussian War. Germany exacted a huge indemnity, which it used to finance the adoption of a gold standard. In the process, Germany disposed of large amounts of silver, simultaneously putting upward pressure on the price of gold and downward pressure on the price of silver. The combination made it impossible for France to continue maintaining the price ratio of 15.5 to 1. France and most other European countries subsequently replaced bimetallic or silver standards with gold standards.
At the time, the United States was still on the paper standard—the greenback standard—that it had adopted not long after the outbreak of the Civil War. Chapter 3 tells the detailed story of the developments that led the United States to resume specie payments in 1879 on the basis of gold. The U.S. action was the final step, and a major one, in the transition of the Western world to a gold standard.
Figure 1
U.S. and U.K. Price Level, Annually, 1865–1914
SOURCES: Data from 1869 on for the U.S. and 1868 on for the U.K. from Friedman and Schwartz (1982, tables 4.8 and 4.9). Earlier data extrapolated from later data by the use of a number of available indexes.
The resulting sharp increase in the demand for gold for monetary purposes was superimposed on a slowing supply, as the flood of gold from the California and Australia discoveries of the 1840s and 1850s started to ebb. The inevitable result was worldwide deflation. (Figure 1 plots the price level in the United States and the United Kingdom from 1865 fo 1914.)
The price decline was particularly severe in the United States because of the aftermath of the Civil War greenback inflation. By 1879, when the United States resumed specie payments, prices were already less than half their level at the end of the Civil War. That sharp price decline was what made resumption possible at the pre-Civil War parity between the dollar and the British pound sterling. In its turn, resumption brought temporary relief from the falling prices. However, within a few years deflation began again, accelerating after 1889 as the growing political agitation for free silver spread doubts that the United States would stay on the gold standard.
Deflation and the Cyanide Process
Deflation meant a decline in prices expressed in gold. It was equivalent to a rise in the real price of gold, that is, in the quantity of goods that an ounce of gold would purchase on the market. Put differently, the prices that were declining included those entering into the cost of producing gold, so that gold mining became more profitable. Worldwide prices in terms of gold, as measured by the British price index, fell by more than 20 percent from 1873 to 1896, and that meant a similar reduction in the cost of mining gold. Such a reduction in cost must have multiplied the profit margin at prior levels of production severalfold. In other words, it justified the spending of up to 20 percent more to extract additional