Deflation and Democracy

PRINCETON – The history of finance is partly the history of a struggle for a stable, secure way to measure value. And, like any quest for certainty in our unpredictable world, it was doomed to failure. The latest financial crisis powerfully highlights this vulnerability, as it destroys any sense that we can put an accurate price on assets. Most people are now convinced that this shortcoming is inherent in the financial system. But uncertainties about value also expose deep problems in the political order.

In the past, metallic money provided an inconvenient and unsatisfactory solution to the question of value. It was inconvenient because gold was awkward for everyday transactions, and silver had too little value for major transfers. 

Moreover, metallic money was prone to unpredictable shifts in value with the discovery of new supplies. The arrival of silver from the New World in the sixteenth century triggered sustained inflation. The discovery of gold in California in the mid-nineteenth century, and in Alaska, South Africa, and Australia 50 years later, also produced mild inflation, while the absence of such new discoveries in the 1870’s and 1880’s led to mild deflation.

Consequently, many economists and politicians concluded that paper money could be more easily controlled and more stable. This innovation, which was dependent on high-security paper-making and printing techniques, transformed the twentieth century. But it initially produced a much less stable outcome, because of the strong temptation of political abuse. Instead of moderate inflation, most of the twentieth century was wildly inflationary, as governments over-issued currency.