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The most commonly used source of price information
for the U.S. before 1920 is a series compiled by two academics, George Warren
and Frank Pearson, from Cornell University. The U.S. government only began
collecting such data in 1919, with the Bureau of Labor Statistics wholesale
price index. This was not what we would consider a "consumer price
index" today, but more of a commodity price index. The CPI as we know it
was first introduced in 1940.
Warren and Pearson produced a book called Prices, published in 1933.
In it, they introduce a price index going back to 1749. My main point today
is that this price index, which is the most commonly used reference for
"the price level" or "purchasing power" before 1920, is
basically a commodity price index. The index is made up of eleven subindexes. The subindexes and
their weightings are found below. The weightings apparently changed over
time. The first number is the weighting in 1799, and the second number is the
weighting in 1889.
Farm Products (35%/25%)
Foods (27%/25%)
Hides and Leather (5%/4%)
Textiles (8%/10%)
Fuel and Lighting (4%/10%)
Metals and Metal Products (4%/10%)
Building Materials (10%/10%)
Chemicals and Drugs (0.5%/1.0%)
House Furnishings (1.0%/1.0%)
Spirits (5%/3%)
Miscellaneous (1.5%/1.0%)
From this we can see that Farm Products and Foods were 62%/50% of the index.
So, it is mainly a measure of farm prices. Energy, Metals, and Building
Materials (mostly lumber) are another 18%/30%. Leather and textiles are
13%/14%. Everything else -- mostly booze -- is 8%/6%. The index was based on
prices in New York. It was not a nationwide index. In the days of horse-drawn
wagons on dirt roads, commodity prices would have quite a lot of regional
variation due to the inability to cheaply transport them, especially farm
commodities.
Obviously, this is nothing -- nothing at all --
like today's Consumer Price Index. Today's CPI-U has the following
weightings:
Food and Beverages: 15%
Housing: 43%
Apparel: 3.7%
Transportation: 17%
Medical Care: 6.2%
Recreation: 5.6%
Education and Communication: 6.0%
Other: 3.5%
Here is what the Warren-Pearson Index looks like:
 
What do we see here? This is about what a commodity index would be expected
to look like, in my opinion, if gold were stable in value. It ends at roughly
the same level as it begins. There are three big spikes. The first (around
1780) corresponds to the devaluation of the Continental Dollar.
November 27,
2011: The End of the 1970s Gold Bull (includes
bonus graph of the devaluation of the Continental Dollar).
The second is a plateau corresponding to the Napoleonic Wars in Europe
(possibly creating demand for commodities), leading to the War of 1812 in the
U.S. which involved a partial devaluation of the dollar. Then there is a
slow, decades-long return to roughly 1770-era prices. Of course there is a
big spike in the Civil War, related to the devaluation of the dollar during
that time, and then a return to prewar prices right in line with the return
to the gold standard system in 1879.
Here is a longer commodities price series, which we've seen before. It looks
like they also used the Warren-Pearson index before 1914.
I bring this up in part to show additional war-related rises in commodity
prices, particularly in World War I. This was a combination of both demand
for commodities from Europe, and also some devaluation of the dollar during
the war years.
The dollar was, of course, devalued in 1933, to $35/oz. from $20.67/oz., but
the effects of that devaluation didn't fully pass through to commodity prices
until the demand created by World War II. We have a new plateau during the
Bretton Woods years, and then of course the chaos of
the floating currency era since 1971.
If you mentally compensate for some of these episodes of war and devaluation,
I have to say the index looks remarkably stable to me. Remember the time
frames we are dealing with here. A decade fits into a centimeter. Yes, the
index might move 30% over a decade, but that averages less than 3% per year.
Also, these are commodity prices, not today's CPI, so it is supposed to have
a fair amount of volatility.
The declines in commodity prices to relatively low levels in the 1840-1860 period and the 1880-1900 period are related to the
expansion of farmed acreage during those placid peacetime years, especially
in the U.S. This was exacerbated by the rapid expansion of railroads, which
allowed these farm products to be effectively moved to a central market such
as New York. While the huge expansion of farm produce was of great benefit to
non-farmers, many farmers got themselves into trouble due to the heavy new
supply and resulting low prices. Thus, there is something of a business cycle
here: somewhat higher prices for farm products encourages people to put more
acreage under cultivation; the increased supply and consequent falling prices
puts an end to the overexpansion of farmed acres. People can only eat so
much, you know.
I will have some interesting statistics on this business cycle, regarding the
1880-1914 period. Here are some preliminary details to whet your appetite:
June 5,
2011: Gold Is Stable In Value 4: More Commodities Prices, and Commodity
Baskets
Unfortunately, these price indices are put to rather stupid uses. It is an
old rhetorical trick of the Keynesians to claim that "prices during the
gold standard era were highly volatile." They are trying to imply that
this commodity price index bounces around a lot more, year to year, than
today's CPI index. Well, of course it does. They are measuring different
things.
Another rhetorical trick is to imply that the "value of gold" was
bouncing up and down, basically as the reciprocal of this price index. The
"value" of gold is immediately equated with the "purchasing
power" of gold, and the "purchasing power" of gold is
immediately equated to the price of corn and wheat in New York. We are supposed
to believe that a 30% rise in the price of wheat and corn (remember, the
Warren Pearson index is mostly farm products) is thus equivalent to a
"30% decline in the value of gold," or that a 30% decline in the
price of wheat and corn is a "30% rise in the value of gold."
Obviously, this is stupid. But, it has served its purpose over the years, as
a means to influence public policy along Keynesian lines. Actually, it hasn't
served so much as an influence of public policy, but more of a justification
for what politicians wanted to do anyway, which was devalue the dollar during
recession.
The better classical economists have been pointing out this fallacy for
literally centuries:
Here's David Ricardo in 1817:
It has been my endeavor carefully to distinguish
between a low value of money and a high value of corn, or any other commodity
with which money may be compared. These have been generally considered as
meaning the same thing; but it is evident that when corn rises from five to
ten shillings a bushel, it may be owing either to a fall in the value of
money or to a rise in the value of corn …
The effects resulting from a high price of corn when
produced by the rise in the value of corn, and when caused by a fall in the
value of money, are totally different.
Remember that David Ricardo didn't just dig this out of the ether, he was
responding to the intellectual debates of his day. Things haven't changed
much, have they?
Here’s a similar passage from Ludwig Von Mises, dating from 1949:
Changes in the purchasing power of money, i.e., in
the exchange ratio between money and vendible goods and commodities, can
originate either from the side of money or from the side of the vendible
goods and commodities. The change in the data which provokes them can occur
either in the demand for and supply of money or in the demand for and supply
of the other goods and services.
Political justification was the main purpose of Warren and Pearson's book.
Note the publication date: 1933. That was the year that the dollar was
permanently devalued for the first time in U.S. history. If Warren and
Pearson were actually influencing and leading public policy, the book would
have been published in 1920, and it would have taken thirteen years for its
intellectual effect to spread. Its publication after the process of dollar
devaluation had already begun shows us that its main purpose was
political justification, rather than innovation or inspiration.
January 26,
2012: Gold Standard Vs. a Commodity Basket Standard
This was not the first time such rhetorical tricks had been used. The 1890s
were another time of declining commodity prices due to oversupply, causing
marginal farmers to default on their mortgages. The Democratic Party wanted
to fix this with a 50% dollar devaluation, which goes by the term "free
coinage of silver." So, in a sense, this was the second time around for
the Democratic Party, this time via Roosevelt rather than William Jennings
Bryan.
Of course, the Great Depression was another time of collapsing commodity
prices. Warren and Pearson wanted to "stabilize prices" by way of
managed dollar devaluation. They speak glowingly of a proposal at that time
by John Maynard Keynes:
Keynes proposes that the central bank keep gold
reserves in bar form, but that there be no fixed ratios of reserves to note
circulation. The central bank would change its buying and selling price for
gold just as it regulates the discount rate. The intelligence necessary to
operate one of these could operate the other. The bank would use both these
methods to keep commodity prices stable. ...
I bet that was a popular notion, considering that the Roosevelt
administration had already begun just that.
Warren and Pearson then quote Keynes for more details:
"Whilst it would not be advisable to postpone action until it was called
for by an actual movement of prices, it would promote confidence and furnish
an objective standard of value, if, an official index number having been
compiled of such a character as to register the price of a standard composite
commodity, the authorities were to adopt this composite commodity as their
standard of value in the sense that they would employ all their resources to
prevent a movement of its price by more than a certain percentage in either
direction away from the normal ... Actual price movements must of course
provide the most important datum; but the state of employment, the volume of
production, the effective demand for credit as felt by the banks, the rate of
interest on investments of various types, the volume of new issues, the flow
of cash into circulation, the statistics of foreign trade and the level of
the [stock] exchanges must all be taken into account. The main point is that the
objective of the authorities, pursued with such means as are at their
command, should be the stability of prices."
Obviously, what we are talking about here is currency manipulation in
response to economic conditions. However, you can imagine that, after 144
years of a dollar worth $20.67/oz. (with some lapses), not to mention a
dollar worth the same during the Colonial period, many people weren't so
gung-ho about currency devaluation as Mr. Keynes. Thus, we see an adoption of
vaguely classical, gold-standard rhetoric ("stable prices") as a
justification for currency manipulation and devaluation. Actually, the goal
of a gold standard system was never "stable prices," which is
silly, but rather a stable value of the currency. Prices would be free to go
up and down, in response to supply and demand factors, as measured in a
currency of stable value.
Even gold standard advocates get a little caught up in this sort of
silliness. I would note Roy Jastram's book The
Golden Constant, which, although somewhat gold-friendly, tends to make
the same mistake of equating gold's value with its "purchasing
power" vs. a basket of commodities.
Fortunately, we aren't so stupid today. At least, I'm not.
Nathan Lewis
(This item
originally appeared at Forbes.com
on February 3, 2012.)
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