Frank Shostak recently wrote that an increase in the supply of gold by itself cannot cause a boom-bust cycle as described by the Austrian Business Cycle Theory (ABCT). If that were true, then Austrians would have no explanation for booms and busts prior to central banking.
Shostak cites Robert Murphy, who wrote that mined money could enter the loan market and lead to a boom. Believing Murphy is in error, Shostak counters with,
Murray Rothbard disagreed with this. He held that increases in the supply of gold could not set in motion the boom-bust cycle. For him, the key reason behind the boom-bust cycle is the act of embezzlement brought about by the expansionary monetary policy of the central bank, which sets in motion an increase in the money supply out of “thin air.”
Later, he again put words in Rothbard’s mouth, “For Rothbard, then, the boom-bust cycle emerges because of the expansionary policies of the central bank, which set in motion the act of embezzlement.”
However, in Economic Controversies Rothbard wrote, “inflationary bank credit can only lead to a destructive boom-bust business cycle…Any bank credit expansion in commercial loans is sufficient to generate the business cycle, whether a central bank exists or not.”
Rothbard chaired the committee, which included Hans-Hermann Hoppe, for this writer’s thesis containing the quirky notion that a speculative bubble—Tulipmania—was engendered by an increase in sound money. Rothbard, as I wrote in the introduction to the 4th Expanded Edition of Early Speculative Bubbles & Increases in the Supply of Money, “embraced and encouraged” my Austrian-business-cycle-theoretic analysis of Tulipmania, and “believed I had made a real contribution.”
In a paper entitled “Explaining the Timing of Tulipmania’s Boom and Bust: Historical Context, Sequestered Capital and Market Signals,” published in Financial History Review, authors James E. McClure and David Chandler Thomas wrote, “We agree with French that the boom was ‘engendered’ by monetary expansion…”
Gottfried Haberler, whose article “The Austrian Theory of the Trade Cycle,” is included in The Austrian Theory of the Trade Cycle and Other Essays, also held the view that a business cycle is caused by monetary interventions including, “An increase in gold and legal tender money.”
Thus, the need to expand my thesis to include the Panic of 1857. Until the 4th expanded edition, Austrians had neglected an episode that saw 5,000 business failures. The boom that preceded the bust began with the discovery of gold at Sutter’s Mill in California in 1848. Michael Shapiro wrote in “Panic of 1857,” included in Encyclopedia of American Recessions and Depressions, that there was widespread prosperity from 1850 to 1856. “People invested in western lands and railroads at unprecedented rates, based partly on a massive influx of gold from California” (emphasis added).
The Gold Rush began with less than 13,000 ounces mined in 1848 and peaked at over 3,900,000 ounces mined in 1852. As gold became more capital intensive, the number of ounces mined declined but remained over 2,000,000 per year through 1858. Most of the gold found its way to financial centers in New York and London, where interest rates were driven down to 3 percent or less from 1848 to 1853. While consumer prices increased, the most specular boom in the prices was in midwest land—which in some cases increased 10 times—and railroad stocks.
Also, the number of banks more than doubled to 1,500 between 1850 and 1857. Kenneth M. Stampp wrote in America in 1857: A Nation on the Brink, “In addition, the flow of gold from California increased specie reserves and thus enlarged the basis for bank loans to railroads, industry, and agriculture.” Banks then pyramided paper deposits atop these gold reserves. The amount of specie from California grew exponentially, but the amount of money-substitutes grew even more.
This episode from 1849 to 1857 embodied the Austrian Business Cycle Theory. More money was created, rates fell below the natural rate, and money flowed into higher-order goods like land and railroad construction. When the panic arrived via a run on an important institution operating via fractional reserves, money market rates soared if liquidity was available at all.
Quoting Rothbard from America’s Great Depression,
The problem of the business cycle is one of general boom and depression: it is not a problem of exploring specific industries and wondering what factors make each one of them relatively prosperous or depressed…. What we are trying to explain are general booms and busts in business. In considering general movements in business, then, it is immediately evident that such movements must be transmitted through the general medium of exchange—money.
To that end, the October 25, 2024 edition of Grant’s Interest Rate Observer published an edited text of remarks by Jim Grant for delivery before the Value Intelligence Conference in Zurich on October 23, discussing historic business cycle events, which included the remark, “under the classic gold standard, mining was monetary stimulus.”
Austrians don’t require a villainous central bank to prove the Austrian Business Cycle Theory. Could a significant gold strike stimulate a boom-bust cycle today? Of course not. But when gold was money? Absolutely.
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