(This item originally appeared at Forbes.com on July 27, 2022.)
In our new book Inflation, we talked about the example of Henry VIII of England, who, in 1544, undertook the “Great Debasement” of the long-reliable British silver penny. The silver content of the coin was reduced from 92.5% to a mere 25%. Or, it took about 3.7x more pennies to buy an ounce of silver. Not very surprisingly, prices in Britain soon soared about three times higher.
Henry didn’t invent coinage debasement. The Greeks were doing it in the fifth century BC. The Romans debased the denarius so much that, over a period of decades, the price of wheat eventually rose two million times higher. Today, central banks do the same basic thing, but it is virtual. The value of the US dollar, compared to its old $35/oz. benchmark during the Bretton Woods gold standard era, has declined by about 50:1. It now takes about fifty times as many dollars to buy an ounce of gold.
The most recent step down in the dollar vs. gold took place in 2019-2020, when, in response to extremely aggressive base money expansion by the Federal Reserve, the dollar’s value fell from about $1200/oz. to about $1800. This roughly 50% increase in the “price of gold” would imply roughly a 50% increase in the price of everything else, “all else being equal,” as markets adjusted to the apparent new lower value of the dollar. This 50% rise in general prices doesn’t happen all at once. It takes time — a number of years — for it to slowly flush through the pricing system. This process has been called “cost-push,” “wage-pull,” or a “wage-price spiral.” We are experiencing this today.
In Inflation, we also mentioned the example of Mexico. In the early 1990s, it took about three Mexican pesos to buy a dollar. Today, it takes about 20. During this time, the price of a $5 beer in Cancun has risen from about 15 pesos to about 100 pesos. The reason for this is obvious to everyone.
If you want to halt this monetary type of inflation, you just have to stop the currency from falling any further. This is very obvious in the case of hyperinflationary situations, like Argentina in 1991 or Bulgaria in 1997. Argentina adopted a currency board based on the dollar, fixing the value of the peso to the dollar. Bulgaria did the same, fixing to the German mark and then the euro. In both cases, “inflation” — even hyperinflation — ended in a matter of days. We saw the same thing happen in the early 1980s with Paul Volcker. Volcker stabilized the dollar vs. gold and commodities. The “inflation” of the 1970s ended.
This is a very simple model. The value of a currency declines. This sets off a market adjustment process, as prices gradually accommodate the new value of the currency. If you just stop doing that, then the “inflationary” process comes to a halt, although prices may still adjust higher for several years afterwards.
This is why Stable Value was an important principle throughout US history. For nearly two centuries, until 1971, we achieved Stable Value by tying the value of the dollar to gold. It was the same basic idea that led Argentina to tie the value of the peso to the dollar in 1991. And it worked great: During that time, as long as we stuck to that principle (which was not all the time), we never had an inflation problem. Also, we became the wealthiest country in the history of the world.
Thus, today, if you don’t want to have any more inflation, then you just have to keep the dollar’s value from falling. This could be done in a clumsy, ad-hoc, but nevertheless effective fashion, as Volcker and Greenspan did in the 1980s and 1990s. Or, it could be institutionalized and formalized, as the US did in 1789 by writing the dollar’s gold (and silver) link directly in to the Constitution (it’s in Article I Section 10), or as Bulgaria did in 1997, in that case using the German mark as a Standard of Value instead of gold.
This is not a very hard concept.
But, notice that you never hear about it today. Over the past six months, we’ve had a deluge of commentary about “inflation” in every media outlet. We’ve had the usual parade of experts. Did any of them mention that the dollar’s value fell in 2019-2020, as a result of aggressive central bank expansionism, thus causing (when combined with the real nonmonetary “supply-chain”-type factors) today’s inflation problem? There has been a lot of mention of “money supply” and quotes from Milton Friedman, but nothing about the value of the currency, which is the most important thing, and always has been.
Also, you never hear about the obvious solution, the one that worked for Elizabeth I (Henry’s daughter and the one who, as Queen of England, got the job of cleaning up Henry’s messes), the US in 1789 (after a terrible fiat money hyperinflation in the 1780s), or Argentina or Bulgaria. Just stabilize the value of the currency.
Because, if you started to talk about that, you would soon conclude that the best thing to do would be to once again link the value of the dollar to gold, as we did for nearly two centuries until 1971. It made us the wealthiest country in world history.
