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7 MIN READ - Given that inflation is big news lately and will remain so for a while longer, the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff submits a brief history of American inflations.
Correspondent’s note: The U.S. has suffered many episodes of inflation higher than the current official 8.6% CPI (for now) and this column is by no means meant to serve as a complete history.
As we can see from the attached chart, America has experienced double-digit inflation six times as an independent country, once more during the Revolutionary War, and several times while it was a loose assemblage of British colonies.
1) 1650-1764: The colonies discover paper money.
The Economics Correspondent can’t comment on the inflation of the 1670’s.
However, in 1690 the Massachusetts Bay Colony gained the distinction of issuing the western world’s first government paper money. The inflation arose from King William’s War (known as the Nine Years War in Europe) that spread from Europe to proxy fighting between the American colonies and French settlers in Quebec and Nova Scotia.
The Economics Correspondent will provide more details on the 1690’s inflation in a future column, but the basic story is as follows:
Once Massachusetts discovered it could print unbacked paper money, with only a vague promise of metallic redemption in the future and few short-term consequences, it quickly became addicted to the printing press to fund all its past debts and future expenses.
Word spread of this seemingly magical new method of financing government expenditures and the other colonies quickly followed suit.
Predictably, they all soon learned that printing money writ large doesn’t remain consequence-free for long. Over the next half-century the colonies were rocked by wave after wave of high inflation, compounded by the disappearance/outflow of silver and gold coinage due to the unwelcome monetary phenomenon of Gresham’s Law (more on Gresham’s Law in another column too).
By the 1750’s Britain’s patience was at an end and Parliament began enacting a series of currency reforms forbidding the issuance of unbacked colonial money, culminating in the final Currency Act of 1764.
2) 1775-1781: The American Revolution.
To finance the Revolutionary War against Great Britain the Continental Congress authorized the issuance of “Continental” paper notes, backed only by the anticipation of future taxes should the revolution survive. Overissuance and high inflation quickly ensued, and in a sad irony patriotic Americans who accepted the notes and held them lost nearly everything while Tories (loyal to the Crown) who refused the notes and insisted on gold or silver coin protected most of their wealth.
As the Constitution was drafted America’s founders remembered the painful experience of the Continentals well. In 1792 they established the dollar as the official currency of the United States, defining it as a unit weight of both gold and silver.
Distrustful of government paper money, the framers inserted into the Constitution clauses that granted Congress the “power to coin money” (Article I, Section 8: Note that they did not grant Congress the “power to print money”) and forbade the states from making “any Thing but gold and silver Coin a Tender in Payment of Debts.” (Article I, Section 10)
3) 1793-1796: Antebellum central banking.
Alexander Hamilton’s Bank of the United States (BUS), America’s first central bank, launched a deliberate campaign of paper inflation following Hamilton’s theory that inflation would promote greater prosperity. However, as the BUS was forced to redeem more and more of its notes using its dwindling gold and silver coin reserves, the bank soon found itself overstretched and abruptly contracted paper money and credit in 1796, triggering the Panic and Depression of 1797.
The Economics Correspondent has written in more detail about the inflation and panics of the 1790’s at:
4) 1814-1818: The War of 1812 and postwar Second Bank of the United States.
To finance the War of 1812, Congress and the states annulled American private banks’ contractual obligations to redeem their notes and deposits in gold or silver coin. The subsequent inflation produced more wartime credit for Congress to tap into, and at war’s end the Second Bank of the United States (SBUS) was chartered by Congress with a mandate to buy up private state banknotes and coordinate a slow, controlled return to metallic convertibility.
However, the SBUS launched a massive inflation of its own notes instead which peaked in 1818 when the SBUS was forced to make good on coinage withdrawals by the U.S Treasury to repay European investors for debts related to the Louisiana Purchase. The SBUS contraction produced the Panic and Depression of 1819.
The Economics Correspondent has written in detail about the inflation of the mid-1810’s and the Panic of 1819 at:
5) The Civil War.
The Union chose several concurrent methods to finance the Civil War: borrowing, taxation, printing unbacked “greenback” government paper notes, and forcing the nation’s banks to buy U.S. government bonds and participate in a government-conceived credit pyramiding scheme: the National Banking System. The latter two created another major inflation.
The Economics Correspondent will post an article with more specifics on the Civil War-era National Banking System and its inflationary consequences soon.
6) 1916-1920: World War I.
Once again, to finance a war the federal government employed inflation, only this time it turned to its new central bank, the Federal Reserve System, for help.
Although the Federal Reserve was still operating on a gold coin standard, it halved bank reserve requirements and prohibited the export of gold, placing America on a de jure domestic-only gold standard. The belligerent European powers also borrowed heavily from the United States and immediately spent the proceeds on U.S. war materiel and food, creating large international gold flows into the country.
The result was the greatest inflation of the 20th century.
Although most Americans believe the 1970’s stagflation era was the worst bout of 20th century inflation, the 1916-1920 period was considerably worse. The annualized inflation rate exceeded 20% in eight different months, peaking at 23.7% in June of 1920.
By mid-1920 New York Fed Governor Benjamin Strong decided a sharp increase in interest rates was needed, pushing the country into the Depression of 1920-21. Although the slump was the second worst of the 20th century, sharp, and painful, the inflation quickly fell and the country recovered very rapidly to enter a boom decade.
The Economics Correspondent plans to post a column on the Depression of 1920-21 at a future date.
7) 1942-1948: World War II.
Once again, the federal government turned to a combination of taxes, borrowing, and inflation to finance a profoundly expensive war. The domestic gold standard had been aborted in 1933 and the international gold standard was also suspended, freeing the Federal Reserve to run the printing presses.
Inflation quickly hit double-digits in 1942, but the Roosevelt administration enacted price controls which led to widespread shortages. In early 1946 price controls were lifted and five years of previously capped, but now freed, monetary inflation sent prices soaring. By 1946 monthly annualized inflation rates were surpassing 18%.
8.) 1970-1982: The Stagflation Era.
The Nixon/Ford/Carter stagflation era was one of only two peacetime episodes in the independent United States’ history when inflation reached double digits (the other being the Bank of the United States inflation of 1793-1796).
Athough Jay Powell is working hard to add a third.
By the 1970’s worldwide governments and central bankers had become captured by Keynesian economic theories: the belief that recessions and unemployment can be defeated with more inflation.
President Richard Nixon demanded a lowering of interest rates in 1972 to create an economic “sugar rush” that would secure his re-election, and Federal Reserve Chairman Arthur Burns concurred (although he was opposed to Nixon’s price controls).
However, “in theory” turned out to be a very different thing from in practice. Unemployment and high inflation both set in by late 1973 (ie. “stagflation”) and persisted for years—something the Keynesian theory claimed was impossible.
After five more years of failed Fed attempts to print the nation's way out of the slump, the Carter Administration appointed G. William Miller to chair the Federal Reserve.
Miller, a Textron executive with no banking or monetary policy experience, quickly proved to be a passive policy dove, voting with the FOMC minority against raising rates even as inflation reached 13% by late 1979.
Jimmy Carter sensed worsening stagflation was jeopardizing his reelection chances and reversed course, “kicking Miller upstairs” to head the Treasury Department and nominating Paul Volcker as new Fed Chairman.
Volcker committed himself to end what had by then become nearly a decade of inflation-by-design insanity. In an Oval Office meeting to discuss his nomination, Volcker gestured with his cigar to Miller who was in the room. “You have to understand,” he then told President Carter, “If you appoint me, I favor a tighter policy than that fellow.”
By early 1980 the inflation rate was 15% and new Fed Chair Volcker hiked the Fed Funds policy rate to 18%, peaking near 20% by early 1981.
The policy worked and inflation came down, but it created a sharp recession in 1982-83. Unemployment peaked at 11% (versus 10% after the 2008 financial crisis) and by 1983 a 1970 dollar’s purchasing power had been whittled down to just 38 cents.
However, just as was the case during the Depression of 1920-21, the recession ended quickly and the blowing out of untenable enterprises started in an environment of cheap credit and high inflation laid the groundwork for a decade of real, rational economic growth. Incredibly, in a four-consecutive quarter period during 1983-84 real GDP growth consistently exceeded 8%.
Ultimately the 1980’s was one of the top five GDP-growth decades in American history, both real and nominal, even when including the Volcker recession.
Postscript: Note that all of America’s 10%+ inflations coincide with one or both of two necessary conditions:
1. The suspension of the gold and/or silver standard
2. A privileged or monopoly central bank executing government policy
During those periods in U.S. history when neither condition was satisfied—that is, the country was on the gold standard and no central bank existed—inflation has never exceeded single digits.
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