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Friday, August 9, 2013

Cairnes and the gold discoveries

Cairnes's main contribution to positive economic analysis has been neglected by recent historians, though it was once considered a particularly ‘admirable illustration of economic thought and inquiry’. The sudden gold discoveries in California in the late 1840s, followed rapidly by Australia in 1851, and the consequent enormous increase in gold production, raised important questions on their economic consequences in Britain, as well as whether or not the gold pound would depreciate in terms of commodities. Politically, gold standard anti-inflationists tried to minimize the impact of this increased supply on prices, while the inflationists chortled that at least prices would rise greatly. Among economists, men such as Mill and Torrens, previously in the forefront of currency and banking school struggles, displayed remarkably little interest in the entire process. Most of the interested economists took a primitive, proto-Keynesian position that the new gold money would increase capital and employment and therefore would have little effect on prices. If was as if monetary theory had never been discovered!

Perhaps the most banal and absurd paean to the new gold discoveries was emitted by William Newmarch, the disciple of Thomas Tooke. In an address delivered to the British Association for the Advancement of Science in 1853, Newmarch exulted that in Australia ‘the effect of the new gold has been to add the stimulus of a very low rate of interest, and of an abundance of capital, to the other great and manifold causes of rapid development’.
Newmarch concluded that

generally, we are justified in describing the effects of the new gold as almost wholly beneficial. It has led to the development of new branches of enterprise, to new discoveries... In our own country it has already elevated the condition of the working and poorer classes; it has quickened and extended trade; and exerted an influence which thus far is beneficial wherever it has been felt.

Newmarch's inflationist (i.e. monetary inflationist) twaddle was echoed in the Tory Blackwood's Magazine by Sir Archibald Alison (1792–1867), a  leading Scottish attorney, protectionist and arch-inflationist. Even Professor Henry Fawcett continued the same line, managing to use the wages fund theory for inflationist conclusions. Blithely assuming that the new gold constitutes new capital, Fawcett concluded that therefore the wages fund will increase, raising wages. In fact, it was Fawcett's paper on this question in 1859, his biographer Leslie Stephen tells us, that led ‘to the discovery of Fawcett’. From his own perspective, Marx agreed with Fawcett's article, lamenting that the new gold discoveries in California and Australia had lengthened the viability of capitalism, and delayed its revolutionary crisis. Also excited about Fawcett's ‘discovery’ was the now Bagehot-run Economist, which extravagantly hailed the paper as one of those ‘very rare occasions’ when ‘an absolutely new truth can be propounded to such a body’.

On the other hand, there was still a corps of economists pointing out the home truths of the ‘quantity theory’, namely that the effect of the new gold discoveries would be a rise in prices roughly proportionate to the increase in gold production, accompanied by unfortunate distribution effects, as well as a waste of resources in mining an increased amount of gold.19 The most important voice, warning of the price-inflationary consequences of the gold discoveries, was the prominent French economist and free trader Michel Chevalier (1806–79). Chevalier raised his voice on the issue throughout the 1850s, his book On the Probable Fall in the Value of Gold being translated by Richard Cobden and published in 1859. The veteran and devoted Ricardian essayist and poet, Thomas De Quincey (1785–1859) denounced ‘California and the Gold-Digging Mania’, in 1852, charging that ‘every ounce of Australian gold... should locally be so much more than is wanted’. Bonamy Price, a banking school theorist who had succeeded Senior to the chair of political economy at Oxford, denounced “The Great City Apostasy on Gold’, in 1863, noting that the dominant financial opinion hailing the gold discoveries constituted an aberrant reversion to mercantilist-inflationist fallacy.

The most important response to the gold discoveries was that of John Cairnes, whose interest in the problem was piqued in 1856 by the ‘ignorant and preposterous assertion(s)’ by William Newmarch and other inflationists. In a series of articles published between 1857 and 1863, Cairnes set forth the quantity analysis, but he also brilliantly went beyond it to resurrect the scholastic-Cantillon process analysis, realizing that the ‘distribution’ effects of the monetary change process were important parts of the picture that should not be swept under the rug. Cairnes pointed out that the country with new gold mines will be the first to feel their bad effects – the price increases and the waste of resources – after which, as the new gold flows abroad in return for goods, these bad effects become gradually ‘exported’ to the other countries of the world. In contrast to the gushing of the inflationists, Cairnes showed that the first country to suffer waste of resources  from the new gold was Australia, where previously flourishing agriculture was virtually ruined.

The British public and press, however, lost interest in the entire issue by the end of the 1850s. The reason was that prices, after the financial panic of 1857, fell back to being only a little bit higher than ten years earlier. Cairnes pointed out quite correctly, however, that this slight rise in prices masked what amounted to a considerable depreciation of the gold pound, perhaps 20 or 25 per cent. For he noted that ‘considering the propitiousness of the seasons, the action of free trade, the absence of war, the contraction of credit [after the crisis of 1857], and the general tendencies to a reduction of cost proceeding from the progress of knowledge, were there no other causes in operation’, there would have been a ‘very considerable fall of prices at the present time, as compared with, say eight or ten years ago’. In short, without the gold inflation, there would have ben a substantial fall in prices, and the slight rise reflected instead a substantial inflationary depreciation of the gold pound. Profound and correct, indeed; but far too theoretical a consideration for the British public, who were content to let the problem go, so long as the effects of depreciation were not starkly visible.
Austrian Perspective on the History of Economic Thought (2 volume set)

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