------ The Crime of 1873 - animated GIF banner

Macroeconomic Consequences
Political Constituencies
The Cross of Gold Speech
The Elections
Gold Inflation
The Wonderful Wizard of Oz
Monetary History
Macroeconomic Consequences

The decision to remove the American dollar from bimetallism in 1873 did not have immediate consequences, for, as we've seen before, silver was undervalued at the legal ratio and nobody used it anyway. But as one country after the other switched to the Gold Standard at the end of the century, the demand for gold rose tremendously and a flow of silver was freed from monetary purposes in France, England, Germany and most other big countries. (More on this).

The result was that the dollar (and so the American monetary mass and ultimately output and employment) was linked to a metal that was getting scarcer and scarcer, because between 1879 and 1897 the rate of increase in gold output slowed, and the demand increased at the same time. The monetary mass could not keep pace with the strongly expanding economy, and price measured in gold declined strongly. This deflationary effect was hindered to some extent by the spreading monetization of the American economy and a more efficient banking system that allowed to pile up more paper money on a given currency base (that is, gold). (more on this)

We see between 1875 and 1896 a deflation of about 1% a year in the general CPI. A the same time the output rose by 6 % a year. Economists reader should not say, <<Gee what a growth even with those declining prices!>>. It's precisely this growth that made the prices go down. With a fixed quantity of money if the number of transactions rises and the velocity cannot rise sufficiently, then prices have to fall.

All this led to a depression so great that you would have to wait for 1932 to see the same again. Unemployment peaked at 18 % in 1894. But some people suffered more than others (more on this).

On the monetary side, this deflation made many bank loans turn sour, as the debtors struggled to honor their obligations with rising real value of their debts. Some famous banking panics occurred (1892) , but globally the trust of the public in the banking system increased. The ratio of deposits to reserves rose from 2 to 4 at the end of the period.

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A chart showing the evolution of monetary magnitudes in the USA between 1867 and 1879
This poorly scanned graphic shows you the dreadful evolution of prices during the 70's
Source : Milton Friedman's Monetary History of the United States

In a currency standard, you can write the total money stock as a function of the amount of reserves kept by banks, the currency (or specie) kept by the public and the total of deposits. This give us a way to make sense of the evolution of the money stock by linking it to behavioral parameters we can better grasp.


Total money stock in a specie standard

M = Total money stock
S = Specie in the hands of the public
S’ = Total specie in the system
R = Banks cash reserve
D = Deposits

Total money stock to currency base ratio

= Deposits to specie held by the public ratio
= Deposits to reserve ratio




How much money can you pile up on a given currency base ?


In the graph above you see that the total money stock that a monetary system can build on a given currency base is an increasing function of to ratio, at a decreasing rate.

  • First the deposits to currency held by the public ratio, which can be interpreted as a measure of trust in the banking system. When it rises, it means that the public is willing to lend more money to the banks and keep less at home. During the period it rose from 2 to 4.
  • Second, the deposits to reserve ratio, is often interpreted as a measure of banking sector prudence. The higher it is, the less reserve the banking sector keeps. The first ratio falls dramatically during banking panics, followed by the second as banks try to call their loans and to satisfy people during runs and raise their reserves. During the period it rose from 5 to 6.

Note that this decomposition is made only to make the evolution of the ratios more understandable to the mind. You could make other decompositions too.


Much of this material, except for the the 3D graph comes from this excellent book by Milton Friedman and Anna Schwartz.