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The gold flows were not in themselves inflationary

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Unformatted text preview: The gold flows were not in themselves inflationary, for it is the value of gold, not the amount of gold that happens to be located in the United States, that determines the value of the dollar. The sky- rocketing demand for U.S. goods pushed up U.S. prices beginning in 1914. This was primarily what von Mises called a “goods-induced” change in prices, caused by the intense demands of wartime. The same thing had happened when the United States manufactured goods for use in the Napoleonic Wars. That changed when the United States entered the war in April 1917. Gold inflows immediately stopped and were replaced by mod- est gold outflows, perhaps in anticipation of an end to gold redeema- bility (as every European government had done). In September 1917, President Wilson prohibited all gold exports without the permission of the Federal Reserve Board and the Treasury and brought foreign exchange transactions under explicit control. In September 1918, the gold embargo was broadened to prohibit private hoarding of gold, though the war would end only a few months later. The net effect of these two steps was to float the dollar, or at least make its link to gold highly elastic. The Federal Reserve had been created in 1913 to prevent liquidity-shortage crises. The coalition majority that wrote the bill for the new system even claimed it was not creating a central bank. GOLD: THE ONCE AND FUTURE MONEY 54 In any case, the Fed was just starting operations when the Treasury pressured it into accepting a very contemporary central banking role—pushing down interest rates so that the government’s wartime funding could be accomplished more cheaply. With the dollar’s link to gold weakened, it was an invitation for inflation, which is indeed what happened. When the gold embargo was lifted in June 1919, gold immedi- ately flooded out, a sign that the dollar’s value had dropped well below its gold parity. Wartime prices, pushed up by real demand, would probably have begun dropping in late 1919, as government spending contracted, but the Fed’s expansion pushed prices higher into early 1920. Eventually, the outflows of gold could not be ignored, and the Fed, in 1920, began contracting the supply of base money. Combined with a natural retreat of wartime prices, the result was a violent drop in prices and wages of about 35 percent in the brief but intense recession of 1920–1921. The recession was exacerbated by high wartime tax rates, which had not been lowered after the return to peace. The top tax rate of 7 percent in 1913 had gone to 77 percent during the war. Total fed- eral debt had increased from $1 billion to $24 billion, at the time a staggering amount. In his 1919 State of the Union address, President Wilson argued for a lowering of wartime tax rates: The Congress might well consider whether the higher rates of income and profits taxes can in peace times be effectively produc- tive of revenue, and whether they may not, on the contrary, be destructive of business activity and productive of waste and ineffi-...
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The gold flows were not in themselves inflationary for it...

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