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The price of gold might have remained constant, but that's hardly the binding factor here. All inflation is measured with respect to a basket of goods and if you choose "an ounce of gold" as your basket of goods then under a gold standard you'll get 0 inflation by definition.

But the relevant basket of goods here is the inputs in materials and labor that go into a bottle of Coke, and that ought to be fairly close to the CPI, which rose from 27 to 50.2[1] from 1886 to 1930. Now, of course, I presume they found ways to economize and automate but it's still rather impressive that they could hold the product price down over that timeframe.

[1] According to estimates from the Minneapolis Fed http://www.minneapolisfed.org/community_education/teacher/ca...?

Inflation was a net 0 up until 1914, when the US switched to a fiat money system. There was about 85% inflation between 1914 and 1929, yet the government maintained a fixed exchange rate between the dollar and gold.

This imbalance I'm pretty sure led to all the runs on the banks in the banking collapse, as people finally realized they could nearly double their money by converting it to gold. This collapse continued until the government suspended gold exchanges.

What I find peculiar is I never see this mentioned in explanations for the banking crisis.

So true. The reason the head of Coca-Cola, a successful major corporation would do something as apparently outrageous as to agree to sell syrup at a price guaranteed forever was that the history of the US currency from its creation to 1899, when he made this contract, was one of a rock-solid dollar. According to the Federal Reserve itself (http://www.minneapolisfed.org/community_education/teacher/ca...), prices for goods fell over the decades as the dollar stayed solid and the industrial revolution increased productivity every year. It was clear to any intelligent person that, while prices for specific things fluctuated with supply and demand, a constant, reliable dollar combined with increasing productivity (due to technological improvements) made overall prices something that would go down over the long run forever. Why not agree to sell at today's prices forever?

Then the Federal Reserve was created in 1913 to allow the Federal Government to play a more active role in the economy and all that "solid as the US dollar" stuff became a quaint historical relic. According to the Fed itself (link above), prices that had gradually come down from $50 (for a basket of goods sized to show the index value as dollars) in 1800 to $29 when the Fed was created, suddenly turned around and shot up to ABOVE $700 today (est. Nov. 2012 value).

In other words, since the Federal Government decided to take a more active role in "managing" the dollar instead of merely guaranteeing it, they have managed to destroy more than 95% of its value.

It wasn't the CEO of Coke who was incompetent at managing finances; it was that he couldn't imagine a day when the US Federal Government would become so utterly incompetent at managing finances.

Something you gold fetishists might like to keep in mind is that for the first century of the US (and arguably quite a bit longer), the country was benefitting from massive amounts of virtually free capital, if you discount the fairly minor cost of driving Native American tribes off the land. When the US government needed to raise money in earlier times, it just sold off vast tracts of land for cheap. Obviously, this strategy couldn't go on forever, and by the time the west coast was properly settled the country needed to switch to a more conventional form of public financing, ie a central bank.

Seriously, if you have an entire continent at your disposal, running an economy is easy. Likewise, after WW2 most of the the rest of the developed world was in a shambles, and the US was the only industrial economy that hadn't been bombed heavily. Unsurprisingly, a long period of great economic growth followed, in time with the Bretton Woods system but not necessarily because of it.

I'm very interested in monetary theory, but a lot of gold fans seem to attribute stability or growth to the use of gold rather than extremely favorable economic conditions. If you back and read the the Wealth of Nations, there's a very worthwhile (if long-winded) explanation by Smith of how hard currency can act as a limit upon economic growth, as well as being corruptible in its own right.

Seriously, if you have an entire continent at your disposal, running an economy is easy.

Which is why Australia has such a remarkably stable economy, right? Oh, wait... http://www.abc.net.au/news/linkableblob/3873450/thumbnail/je...

See http://www.abc.net.au/unleashed/3872646.html for context, and in particular the bit about "mad boom and bust cycles".

Australia has a tiny population relative to its landmass. While it's rich in extractive resources (mining, minerals) from which much of its present wealth derives, it lacks both water and fertile land for agricultural production.

This itself is interesting: because Australia is an island continent, with few or no internal volcanoes or rift zones, the land is, literally, ancient, with many nutrients vital for ag production missing (one estimate I saw was that seeding land with an infinitesimal amount of iron would greatly increase production). Much productivity is due to windblown dust from the Indian subcontinent and south-east Asia. Even where irrigation is possible, evaporation causes accumulation of salts which degrade ag values. The first settlements in Sydney very nearly starved due to difficulties in producing sufficient food.

The vast majority of the Australasian landmass is desert.

I do not even how you can call paper dollar a currency. You cannot use something as a currency if: - it can be manufactured easily - it can change value from one day to another - it is not dense in physical space (i.e. you do not need to carry buckets of it to buy something).

The paper money clearly does not respect ANY of these principles nowadays. The FED can print (and does) as much as they want to buy back toxic assets (remember the Krugman clown advising after the Net bubble in 2001 that we should create a housing bubble to stimulate the economy ? That really worked well for everyone, did it not?). The US Dollar is constantly losing value versus Gold since its parity was dropped for good in the 70s, and now you have such a galoping inflation than looking at movies 30 years ago make you feel old: then the bad guys were asking for "a million dollars" as something highly valuable/desirable, while nowadays if you do not cross the billion mark it is not considered as much anymore (Austin Powers made this very good point in a clever way).

Why do you think China is buying all the Gold it can currently to replace its stinky dollars?

> I do not even how you can call paper dollar a currency. You cannot use something as a currency if [...]

Currency is based entirely on concensus. Anything (ivory, sheep, even bits of paper) could be currency; the only requirement is that there are people willing to use it as a basis for trade. In other words, it doesn't really matter if you don't believe in paper currency as long as everyone else does.

Well, currency is based on consensus, certainly, but that is not enough to create value. A paper has not value intrinsically speaking. Gold and other metals have always had value for various reasons (either because of their physical/chemical properties or because of their rarity). So, the day the Dollar loses its consensus, you are left with worthless paper and you might as well use them in the toilet. The day Gold, Silver and other lose all actual value is not in sight. Net, you are safer saving some of your assets in those.

Another instance of Poe's Law...

It's meaningless to say that the value of a dollar has been destroyed, because a dollar does not have a value. It is merely a unit for denominating, measuring, and comparing value. Only actual assets have value, like gold, or real estate, or companies.

That the size of the unit has changed over time does not mean than any value has been destroyed. It's like saying that the creation of the centimeter destroyed the length of the inch.

Your premise that inflation ("DESTROYING THE VALUE OF THE DOLLAR!") is always bad is hardly accepted enough to just throw out there and assume that everyone will agree with you. How many libertarians are there in this country? Not a majority.

Correlation does not equal causation.

There was a world war going on in the period from 1914-1917, when inflation of the dollar was at it's highest ever [1]. It's possible that the effect could have been much worse if we were still on the gold standard, as total war tends to drive up the price of precious metals.

Fiat currency isn't a bad thing. You can't build the largest economic empire in history when your currency is tied to the price of shiny rocks.

[1] http://www.usinflationcalculator.com/inflation/historical-in...

It's the same reason that you never see the press mention congress's role in the subprime meltdown.

Politicians that are liked by the media say "Bankers! Wall Street!". That's what gets shown on the nightly news and repeated. Most voters don't care to dig further. Partly because the truth is more complicated. Partly because it causes cognitive dissonance to think contrarily to the narrative being told in the media. Mostly because looking into details would take people away from Monday Night Football, American Idol, and Dancing with the Stars.

As one who works "on Wall Street" (remotely) I can assure you that we caused the financial crash deliberately. I personally spent a lot of time working on it and I am now back at it again! You just wait 10 years for the next cycle!


That's a fairly narrow part of the story as there was also ~85% inflation between 1914 and 1942. Due to significant deflation in the 1930's.

> This imbalance I'm pretty sure led to all the runs on the banks in the banking collapse, as people finally realized they could nearly double their money by converting it to gold.


> under the gold standard America had no major financial panics other than in 1873, 1884, 1890, 1893, 1907, 1930, 1931, 1932, and 1933.


More to the point:

> Countries that were not on the gold standard in 1929--or that quickly abandoned the gold standard--by and large escaped the Great Depression

> Countries that abandoned the gold standard in 1930 and 1931 suffered from the Great Depression, but escaped its worst ravages.

> Countries that held to the gold standard through 1933 (like the United States) or 1936 (like France) suffered the worst from the Great Depression


Advocating a return to the gold standard is historically and economically illiterate.

That's not what I said. I suggested that trying to maintain a fixed gold standard while inflating the money is going to cause a collapse.

I should add that many countries have tried to do something similar - pegging their currency to another, and then inflating their own currency. It always leads to a collapse.

The price of gold might have remained constant, but that's hardly the binding factor here. All inflation is measured with respect to a basket of goods and if you choose "an ounce of gold" as your basket of goods then under a gold standard you'll get 0 inflation by definition.

Exactly. If you define a new basket of goods to be "one bottle of coca-cola" (let's call it's a "Coka"), then there has been no inflation since coke was first sold! One bottle of coke still costs the same as 1 Coka!

To elaborate, it would be a basket of goods comprised only of Coke, measured using the Coka currency.

It's something like ∂Coke/∂Coka, and historically when gold presumed to be a neutral measurement of value, the price of labor and the price of land still varied with respect to each other.

I am reminded of The Economist's "Big Mac Index", comparing currencies' purchasing power to buy a Big Mac in different countries. The index "seeks to make exchange-rate theory a bit more digestible". ;)



That is incorrect. Inflation is defined as the expansion of the money supply, CPI is measured as the change in price of a basket of goods minus volatile things like energy and food.

I agree that inflation should be officially defined as an expansion of the money supply, with rising prices being simply a result of that rather than the definition of it.

But the actual textbook definition is, simply, a rise in the general price level of goods and services [1].

This unfortunately makes discussions of inflation ambiguous - is it being caused by expansion of the money supply, or increase in demand, or decrease in supply, or falling interest rates... etc?

[1]: http://en.wikipedia.org/wiki/Inflation

Confusingly, while rises in the general price level are called inflation and that's what pretty much everybody means when they talk about inflation a proper term for an increase in the money supply is also inflation[1]. I would strongly recommend people not use the term "inflation" that way unless you're careful to distinguish the sense in which you're using it, since you'll usually just end up confusing everybody otherwise.


An increase in the volume of a helium-filled balloon is also "inflation." As an economist, I can assure you that I mean "price inflation" when I say "inflation" without a qualifier. So does everyone I talk to. It doesn't need to be confusing.

This is a nitpick I have about economics - the language you use for this doesn't distinguish the causes of inflation, just lumps them all together.

Obviously it works well enough for mainstream economics, but why does no one explicitly qualify inflation as "price inflation", "demand inflation", or "monetary inflation"?

There's clearly a need for a word that means, "increase in the price level" and that word is "inflation." Your nitpick almost reads like a criticism of the word "fever": it doesn't distinguish the causes of the fever but lumps them together.

Economists have been studying inflation long before they really understood its causes and there are surely more refinements that are left, so it's vital to be able to talk about the observed phenomenon in a cause-agnostic way. Just like it's vital that doctors can talk about "fevers" without having to know about the exact underlying cause.

Economists do distinguish and discuss the causes of inflation. Search for "demand pull inflation", "cost push inflation" or "imported inflation". You won't see "monetary inflation" that much in modern economics discussions because it simply isn't that relevant empirically for understanding the development of the price level.

Was Friedman wrong then? Is inflation not always and everywhere a monetary phenomenon?

He was wrong. Certainly even the bit of truth that is left in his statement is mostly misleading. Inflation is always better understood by looking at prices: What is it that leads businesses to change their prices? Why do they raise prices, and why do they get away with it?

For a bit of back story: What this quote of Friedman is intended to convey is the incorrect idea that there is always a causal link from an increase of the money supply to a rise in the price level. The rise in the price level is explained by a prior increase of the money supply, and this increase of the money supply is supposed to be the prime cause.

This is wrong on several counts: (1) there can be a causal link from the price level to an increase of the money supply, because money is endogenous; (2) as neither the real size of the economy nor the velocity of money (Q and V in MV = PQ) are constant, the price level and the money supply can move independently from each other; (3) in practice, growth in the money supply and rises in the price level are both caused together by other causes (such as rising cost of imports or institutionalized wage increases).

The most important thing to understand is that our monetary system is endogenous: How much money is out there is decided by banks and debtors. Every time a business goes to a bank and takes out a loan, the money supply grows. Every time a business pays a loan back, the money supply shrinks.

This explains why the causality tends to go the other way from what monetarists believe: When wages rise or the cost of inputs of production rises, businesses take out larger loans to cover their upcoming production, hence the money supply grows as a consequence of inflation.

Friedman and other monetarists are very much working from a gold standard and hence exogenous money mind set, so it is no surprise that they get this wrong: they are starting off from incorrect assumptions about how our monetary system works.

That is not to say that it cannot go the other direction. It can go both ways. Which is why what one should really look at is how prices are set in the economy. Since most prices are administered somehow, usually controlled by longer term contracts, you need to understand how the negotiation of those contracts works.

Great explanation, thanks for the writeup.

Essentially, yes. An overview is here:


and the original interview is informative too. (tl;dr: Great Inflation)

This has always irritated me. Normal people and economists use the same word to describe two different albeit somewhat related things. If you include debt (and I think you have to), we had some pretty severe deflation starting 2008. But the prices people pay for the things they buy went up during that time period, something that can happen while you're in a deflationary economy.

>Normal people and economists use the same word to describe two different albeit somewhat related things.

It's actually worse because economists themselves use the same word to describe the two different concepts.

I agree with Symmetry above that the simplest 90% solution is just use "inflation" for general rise in price levels regardless of cause, and "monetary inflation" for money supply expansion.

Falling interest rates usually result in increases in circulating money supply. Supply/demand definitely has an effect, but then so do increased living standards (more taxes, more pay to those who stock coke machines). Coke in Switzerland is not expensive because of inflation. With increased living standards, lower end goods necessarily become more expensive while higher end goods become cheaper (or at least don't rise so much).

> Inflation is defined as the expansion of the money supply

That's not accurate. Inflation is the expansion of the money supply WITHOUT also the expansion of the money demand (from population growth and economic expansion).

Which is why the gold standard is so problematic - it would freeze the money supply, but the demand keeps going up, so gold would cause deflation with all it's concomitant problems.

Perhaps they shrunk the size of the product to match? I know Hershey resized their chocolate bars to keep the price paid per bar constant for a while.

This was covered by the story. They didn't do that. In fact, they made efforts to discourage individual shops from doing it.

Hence why the 4-lb. bag of sugar seems to have become the norm around where I live, and what used to be a pound of coffee in a can is now around 11 oz.

And a pint of Haagen-Dazs ice cream is slightly less than a pint.

Maybe they are using metric units like 500ml?

A (UK Imperial) pint is 568ml. I don't know what a US Customary pint is. (Fun fact: UK and US customary/imperial units aren't the same! Every country used to have it's own system. That's why the metric system was invented)

No, they're just being cheap. A pint of Ben & Jerry's is still a pint.

a US pint is like 450ml.

Wikipedia tells me it's 473ml. God I hate the imperial systems

This was covered in the podcast, if you'd listened to it. They didn't.

And the appearance of "59oz" half-gallons of orange juice.

And the disappearance of "20% more free!" in your bag of chips, after 10 years of that "temporary" bonus.

Interesting. I always assumed the cost of the actual product for things like this was next-to-nothing, with marketing/profit/administration/distribution making up the vast majority - thus making portion sizes basically irrelevant.

Depends on the product. For coke that's probably true. But cocoa beans are getting more expensive since demand is up, and supply isn't changing much.

Cost is nothing, but with a smaller portion size, demand can be forced up.

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