From time to time, some smarty-pants
proposes that it makes sense to peg a currency to a commodity basket,
rather than to gold. The basic idea is the same, but they think that a
commodity basket is a better representation of stable monetary value
than gold is. Typically, Mr. Smarty Pants thinks this is a new insight,
and that he should win the Nobel Prize for his contribution to
humanity. Like most ideas in economics, it is a very old idea. Here is
William Stanley Jevons -- a commodity basket advocate -- discussing the
history of this idea in a book called Money
, published in 1875:
Lowe's proposed Table of Reference.
Among valuable books, which have been forgotten, is to be mentioned
that by Joseph Lowe on "The Present State of England in regard to
Agriculture, Trade, and Finance," published in 1822. This book contains
one of the ablest treatises on the variation of prices, the state of
the currency, the poor-law, population, finance, and other public
questions, of the time in which it was published, that I have ever met
with. In Chapter IX. Lowe treats, in a very enlightened manner, of the
fluctuations in the value of money, and proceeds to propound a scheme,
probably invented by him, for giving a steady value to money contracts.
He proposes that persons should be appointed to collect authentic
information concerning the prices at which the staple articles of
household consumption were sold. In regard to corn and sugar
authoritative returns were then, and have ever since been, published in
the London Gazette, and there seemed to be no difficulty in extending a
like system to other articles. Having regard to the comparative
quantities of commodities consumed in a household, he would then frame
a table of reference, showing in what degree a money contract must be
varied so as to make the purchasing power uniform. In principle the
scheme seems to be perfectly sound; but Lowe did not attempt to work
out the practical details, and his plan involves needless difficulties.
Poulett Scrope's Tabular Standard of Value.
A very similar scheme was independently proposed, about eleven years
later, by Mr. G. Poulett Scrope, the well-known writer on geology and
political economy. In a very able but now forgotten pamphlet, called
"An Examination of the Bank Charter Question, with an Inquiry into the
Nature of a Just Standard of Value" (London, 1833), Mr. Scrope suggests
(p. 26) that a standard might be formed by taking an average of the
mass of commodities which, even if not employed as the legal standard,
might serve to determine and correct the variations of the legal
standard. The scheme was also described in Mr. Scrope's interesting
book on the Principles of Political Economy, published in the same year
(p. 406), and in the second edition of the same book, called "Political
Economy for Plain People," issued two years ago, (p. 308). The late Mr.
G. R,. Porter, without referring to previous writers, gave the same
scheme in 1838, in the first edition of his well-known treatise on "The
Progress of the Nation," (Sections III, and IV. p. 235). He added a
table showing the average fluctuations of fifty commodities monthly
during the years 1833 to 1837.
The idea of a commodity basket is not, actually, the worst idea ever.
In principle it is very much like the idea of a gold standard. The goal
is the same: a currency of stable value. Unfortunately, Jevons and
other proponents typically confuse stable
with stable prices
same at all. (See my book for a discussion on that
topic. I don't think I've ever mentioned it on the website. Can you
believe that?) It makes perfect sense that the price of commodities
might rise during World War I or the Revolutionary War. What if a
currency basket system was used at that time? The value of the currency
would have to rise such that the prices would remain stable, or, in
other words, a disastrous deflation (currency rise) on top of all the
problems of warfare. Hmmm. That's why gold has always been the monetary
standard -- it is not subject to these kinds of supply/demand issues,
for reasons we began to look at last week.
Production and Supply
In the 1870s-1890s, another issue was the increasing industrialization
of the commodities production process. This was particularly related to
the expansion of train systems, which opened up large swathes of land
that could be used to produce agricultural commodities for trade.
Without a train connection, or some other means of low-cost bulk
transport like shipping, agricultural commodities couldn't be
practically exported from their production region. Farming tended to be
subsistence-oriented. The increasing supply tended to depress prices,
of course until they
got to the point at which nobody wanted to open new farmland anymore.
Another issue is: what commodities, and where? Prices in London might
vary from prices in New York, although that is not so much of a factor
today now that transportation costs have fallen dramatically, which
tends to equalize commodity prices globally. What would be the basket
weighting? Exactly which commodities? Most commodities come in a
variety of grades. There is not only "crude oil," but Saudi heavy,
Tapis light, and so forth. Basis delivery where? The basket weighting
would probably change over time. Who would make the decisions on the
Some of the support for a commodity basket approach comes from
commodity producers themselves, which, in the past, were most of the
population, as they were farmers. Normally they wouldn't complain too
much when prices rose, but when they fell -- in the 1870s-1890s period
for example -- they would agitate for some scheme or another to produce
higher prices. This typically amounted to one or another argument for a
currency devaluation. The farmers often held significant debts, so a
devaluation would in effect lighten their debt loads. Maybe you can see
why Jevons had a ready audience for his commodity basket ideas, when he
was writing in 1875,
Between 1870 and 1890 the number of farms in the United States rose by
nearly 80 percent, to 4.5 million, and increased by another 25 percent
by the end of the century. Farm property value grew by 75 percent, to
$16.5 billion, and by 1900 had increased by another 25 percent. The
advancing checkerboard of tilled fields in the nation's heartland
represented a vast indebtedness. Nationwide about 29% of farmers were
encumbered by mortgages. One contemporary observer estimated 2.3
million farm mortgages nationwide in 1890 worth over $2.2 billion. But
farmers in the plains were much more likely to be in debt. Kansas
croplands were mortgaged to 45 percent of their true value, those in
South Dakota to 46 percent, in Minnesota to 44, in Montana 41, and in
Colorado 34 percent. Debt covered a comparable proportion of all
farmlands in those states. Under favorable conditions the millions of
dollars of annual charges on farm mortgages could be borne, but a
declining economy brought foreclosures and tax sales.
Railroads opened new areas to agriculture, linking these to rapidly
changing national and international markets. Mechanization, the
development of improved crops, and the introduction of new techniques
increased productivity and fueled a rapid expansion of farming
operations. The output of staples skyrocketed. Yields of wheat, corn,
and cotton doubled between 1870 and 1890 though the nation's population
rose by only two-thirds. Grain and fiber flooded the domestic market.
Moreover, competition in world markets was fierce: Egypt and India
emerged as rival sources of cotton; other areas poured out a growing
stream of cereals. Farmers in the United States read the disappointing
results in falling prices. Over 1870-73, corn and wheat averaged $0.463
and $1.174 per bushel and cotton $0.152 per pound; twenty years later
they brought but $0.412 and $0.707 a bushel and $0.078 a pound. In 1889
corn fell to ten cents in Kansas, about half the estimated cost of
production. Some farmers in need of cash to meet debts tried to
increase income by increasing output of crops whose overproduction had
already demoralized prices and cut farm receipts.
Railroad construction was an important spur to economic growth.
Expansion peaked between 1879 and 1883, when eight thousand miles a
year, on average, were built including the Southern Pacific, Northern
Pacific and Santa Fe. An even higher peak was reached in the late
1880s, and the roads provided important markets for lumber, coal, iron,
steel, and rolling stock.
We can see here the problem with simply
assuming that a change in the price of wheat (or a basket heavily
weighted in agricultural commodities) is a pure reflection of a change
in the value of money, rather than simply a reflection of the supply
and demand for wheat. Between 1866 and the mid-1890s, production of
wheat tripled while land in production roughly doubled (due in large
part to the fact that increasing railroad expansion opened up new areas
to commercial agriculture for trade).
By the way, in 1887, a total of 12,894 miles of new railroad track was
laid in the United States. This was without petroleum, without
electricity, and without all the mechanized tools we have today. The
U.S. population in 1890 was 63 million people. Don't you just love the
whiners who say that we can't build trains today due to declining oil
production? What a bunch of bozos.
Then we come to the issue of international exchange. When all countries
use gold as their monetary standard, then their foreign exchange rates
are fixed. When each country uses its own homegrown commodity basket
standard, exchange rates would fluctuate, causing all the usual
problems in international trade.
A commodity basket isn't really deliverable. How would you do it? A
barrel of oil, a bushel of wheat, and a pound of copper? Thus, you
couldn't really have a "redeemability" feature when using a commodity
Lastly, I will mention that commodity prices tend to lag changes in
currency value, sometimes by as much as a year. This was noted by Roy
Jastram in his 1977 book The Golden
t. Jastram says this effect could be seen going back four
hundred years. Obviously, you can't manage a currency system based on
an indicator which has a one year lag time. A CPI-type indicator is
worse, as the lag here can be up to thirty years!
For these and other reasons, a commodity basket is inferior to gold as
a standard of value. But more importantly, gold has never failed. I
have never seen anyone say: "we thought gold was a stable measure of
value, but we were wrong
Nobody said: "We used gold as our monetary standard, and it was a mistake
." While probably
anyone would admit that gold varies in value by some small amount, it
has never reached the extent that it caused a major crisis. Actually,
it is hard to even identify a time in which gold varied in value at
all. Thus, these "small variations" remain as something of a hypothesis.
Why fix what ain't broken?