How I was converted to Monetarism
The biggest change in my beliefs in my lifetime – and indeed the foundation for this book – was my conversion to what I suppose one must call ‘monetarism’. My discovery of monetarism was something of a ‘Road to Damascus’ conversion. I can even date it precisely, to the 6th Sept 1974. It was a time of political crisis: unemployment was raging, inflation was rising, and the Tories in opposition were beginning to have a lot of new ideas as to what should be done. At this juncture, Sir Keith Joseph, the political guru and mentor to Margaret Thatcher, delivered a series of three speeches which outlined the new philosophy. Of these, the most important was that delivered at Preston, on September 5th 1974, saying that inflation was caused by governments. This was quite contrary to the prevailing Keynesian consensus, but it was immediately recognised to be a major statement: the next day, the Times published it in full. I read and reread it, and was immediately converted: I became a monetarist. (It is available on-line in the Margaret Thatcher archive).
Hitherto I had been a Keynesian of sorts. I had read and in places re-read his General Theory, but with considerable suspicion, not quite understanding it, but suspecting it to be too clever by half. Keith Joseph provide the antidote, and thereafter for the next half a dozen or more years, I immersed myself in the works of the two great sources of monetarism – Hayek and Milton Friedman. From Hayek I read The Road to Serfdom, and in particular The Constitution of Liberty, which remains the bible of my beliefs. And I read Milton Friedman, at first his splendid little Capitalism and Freedom, and then I tackled his magnum opus, The Monetary History of the United States 1867-1960, which he wrote with Anna Schwartz. As a historian, this was a book that changed my world, as it showed how money, and economics, underlay much of the history of the United States in the 19th and 20th centuries. Some of the details were beyond me, as they would be beyond anyone not totally immersed in the economic history of the United States in the 19th century. But it showed me how history should, and indeed must, be written – always keeping an eye on what is happening with money.
I learnt for instance that one of the problems of the American Civil War was that it was followed by inflation which the victorious North visited on the defeated South: the second half of the film Gone with the Wind suddenly made sense. I learnt about the agricultural depression in both America and Britain from the 1870s to 1896. I learnt too of the impact of the discovery of the gold mines in South Africa and elsewhere in 1896, and how in a gold-based economy, inflation or deflation can depend on the supply of gold: in the late 19th century, no gold was discovered and how this led to mild depression of the late Victorian era; and how the discovery of gold reversed this, and led in turn to the mild inflation that we know as the Edwardian era, which helped to lead to the over-confidence that led to the first World War. And I learnt too of Friedman’s reassessment of the Great Depression of 1929-1933, when the newly established Federal Reserve Bank, in sheer ignorance, contracted the money supply by a third, and therefore brought about the depression that spread to the whole world.
I learnt too of the limits of monetarism. Money does not explain everything in history – not by a long way. It is one of those underlying factors that may be implicated in perhaps a third of the story of our past. For long periods, when money was stable, it played no role. In the rise of Rome for instance, and in the industrial revolution, money only serves as a footnote. But in other periods, in the rise of Greece, and in the decline and fall of the Roman empire, – to say nothing of the French Revolution and the rise of the Nazis in 20th century, money and inflation played a major role: if you fail to understand the importance of money in these periods, the periods do not make sense. The story of money is one of the most important sources to which the historian must pay attention, and is one of the bases of our investigations into Barbarism and Civilisation.
But how does monetarism work in practice? Monetarism is the traditional quantity theory of money updated. This states that if the quantity in money in circulation is increased, then the price of the goods goes up. In other words if there is only one loaf of bread available to be purchased and only one coin to purchase it, then the loaf of bread is worth one coin. If however a second coin is discovered, then the price of the loaf is liable to increase to two coins. The trouble is that this process takes time. There is a lag between the increase in the amount of money available and the increase in prices. In modern economies, this lag tends to be around 18 months to two years, but in the past it could be much longer. Indeed in the Roman Empire it took a generation or so for the difference to be noted.
The quantity of money can be increased in many ways. In a gold-based economy it can be increased by the discovery of more gold. The classical example of this was the Spanish empire in the 16th century when gold poured in from their discoveries in the New World and this caused the inflation that ruined the Empire. This is sometimes suspected that the gold that Alexander the Great amassed in his conquests caused inflation which aggravated the subsequent instability, – though the economy was not sufficiently sophisticated at the time to prove this.
In a silver based economy such as the Romans it is possible to debase the coinage as happened in the third century. It is far easier to disguise the debasement of silver by mixing in copper than it is to disguise the purity of gold. And of course in the modern paper-based economy it is possible simply to print more money, or to make it easier for the banks to make loans by reducing the rate of interest. The story is seen in the French Revolution and in Germany in the 1920s – and in reverse in America in the 1930s when the contraction of the money base caused the great depression.
Monetarism is a difficult to apply in the modern world, for how does one define money? In those heady early days of the 1970s, we all believed that money could be defined fairly precisely by observing M1 or M3, but the banks soon devised new ways of making loans that were not covered by the official statistics and these soon proved to be a false guide in forecasting inflation, and today central bankers look at a wide range of information in trying to intuit the money supply. But monetarism still rules, for the central; banks use changes in the official bank rate of interest to control inflation, and as a result, at the time of writing (2006) banks around the world seem fairly successful in controlling inflation. (2012 update: since then, by keeping interest rates artificially low, they appear to be aggravating a prolonged depression).
A more subtle approach is needed in applying monetarism to the past. Certainly there are a number of occasions when inflation – or deflation – dominates history, and it is vital in all ages since money was invented to keep a weather eye out for what is happening to money, for even gentle inflation or deflation can throw a rosy glow or a grey pall over a period; if historians ignores money, they are likely to make nonsense of the period under consideration. Far more important, however, is to recognise the difference between money economies and pre-money economies operating by gift exchange. The way they operate is totally different and this difference is the main subject of this essay.
(I should also mention the great influence of Karl Polanyi, and his insistence that the ancient economy worked in a totally different way to the modern economy. In a way this concept is the basis of this whole book. I discuss his work here)