Private Issues (4): Growth

Measuringworth provides numbers on Real GDP:

My graph uses a log scale, which accounts for the ridiculous numbers visible on the vertical axis. Anyway, the graph shows slowdowns that begin around 1839 and 1848 and 1857. The spreadsheet shows related peak growth rates occuring in 1835, 1846, and 1855. Clearly these dates are associated with the Panics of 1837, 1847, and 1857.

Looking at a later period of U.S. history, FTAlphaville provides Deflationary periods in US history, with a chart from the St. Louis Fed and these words (also from the Fed):

The vertical lines on the chart mark the approximate dates of the 1890, 1893, 1907, and early-1930s financial crises. These crises led to bank failures and a reduced money supply as depositors withdrew money, preferring to hold cash.

and these:

Inflation, output, and (as noted) the money supply fell during or shortly after each crisis. The international experience has been similar...

Crises are associated with declines in the quantity of money.

I can imagine people reacting -- perhaps to a perceived shortage of gold, created by the relative increase in use of paper money -- by demanding gold, and holding gold, creating the situation where there was in fact a shortage of circulating gold and a shortage of gold backing for paper money.

I can imagine too that people would remember their experience with past business cycles, for several 10-year cycles fit will in a lifetime. In our day, or at least in the post-WWII Keynesian era, business cycles have not been accompanied by crisis¹. In the free banking era, they were. People would start to notice less gold and more paper in their pockets, and their reaction would bring crisis to a head.

NOTE 1: Kindleberger's Appendix B lists no U.S. crises between the Great Depression and 1973. David Moss's Figure 1 (PDF) shows a comparable absence of bank failures.

It is not so easy today to notice a shortage of base money and an excess of credit use, because none of that is gold. But very little of our spending today involves the use of greenbacks, for example, and everyone has a lot of debt.

The crisis is a re-balancing. The economy uses bad debt (and the resulting reduction of total debt) as a way to reduce the quantity of private-issue money. The economy seeks balance between private-issue money and base money. Excess private money is destroyed.

Thus some people say preventing economic collapse prolongs the problem.

During the Free Banking era, crisis reduced the quantity of money and caused deflation. This counteracted inflationary pressures of the boom, and kept prices roughly stable during the period. There may also have been confidence created by the gold standard, just as today there is a lack of confidence generated by the lack of that standard in a time of troubles.

That confidence contributed to price stability whereas our lack of confidence contributes to inflation. However, the problem is not that a gold standard is now absent. The problem is the growing disparity between gold-backed money and unbacked demand deposits, or between gold-backed money and private-issue money, or between base money and private-issue money, or between money and debt.

It is this disparity that creates the condition that is resolved by inflation or by panic.