The history of economic theory through the 18th to the 20th century is punctuated by several important works which would prove important in influencing intellectual discussion with great consequence for better or worse through time.
Gold was very important to the backbone of economies, gold backed currency was central to classical economic policy as it was a ‘sound money’.
The gold rush of 1849 marked the first global interest in prospecting for gold, whilst several rushes had already taken place all over America, this interest led to rushes in Australia, South Africa and Wales among others. A gold rush is whereby workers migrate to areas that had seen a large discovery of gold. Overall only few saw huge riches but because the world’s money supply was based on gold, this was an economic stimulus that had far reaching effects both nationally; with immigration leading to the permanent inhabitation of new regions. And globally with the stimulation of global trade and investment.
1844 saw Britain’s Sir Robert Peel pass the Bank Charter Act. This nationalised the nation’s money supply by ensuring that only the Bank of England could issue new banknotes, and only when they were backed by gold or in cases of debt whereby the government retained and used the right to suspend this clause of the act several times in financial crises. This allowed for the managed expansion of paper currency whilst ensuring there would be far less worry of inflation due to the far more regulated nature of the printing of banknotes.
In the 1880’s the world was hit by a global economic depression. This has been attributed to exhaustion of the goldmines in California and Australia and the hoarding of gold by India and China by Alfred Marshal.
Quantity theory of money states that money supply has a direct, proportional relationship with price level. Therefore in this context a tighter money supply means there will be fewer transactions and therefore cause unemployment thus the economic crisis as this occurs on a global scale.
Monetary policy: Interest Rates.
Interest rates are set through the issue of government bonds (gilts).
The more gilts that are issued, the higher the rate of interest.
However the ability to issue bonds depends on legitimacy of government and confidence in economic policy. In times of economic crisis where there is a deficit of money a government will acquire bonds to stimulate their economies. Due to the trust based nature of bonds, those countries will offer them at far higher interest rates than normal, making a substantial profit due to the desperate nature of the country in question.
Fiscal policy: This is the use of government expenditure and taxation to influence the economy.
The Classical approach is to regulate only the bond market and subsequently interest rates. This is due to the preference for a ‘balanced budget’ approach which is the idea that there must be balance between government spending and taxation.
However Keynesians think it more important to use fiscal policy to regulate aggregate demand. Aggregate demand is the total demand for all final goods and services in the economy at a given time and price level.
A management or increase of aggregate demand is achieved through government spending i.e. the issuing of bonds and specific taxation with the function of controlling the spending habits of different groups, for example in encouraging the poor to spend more i.e. taxing goods over income. Whereas the rich taxed on an income basis as they invest rather than spend.
To manage aggregate demand (Y) three factors must be taken into account:
Household Spending (C)
Private Investment (I)
Government Spending (G)
Thus Y= C+I+G
However there are several problems with such methods as identified by Galbraith and Hayek:
· Inflation and ‘stagflation’ (the latter being where inflation is high whilst economic growth slows and unemployment remains high).
· There is an increased role of the state as mentioned, this is argued to result in a decline of freedom as the government completely controls monetary policy.
· Further to the aforementioned point, central government planning undermines democracy in the fact that it relies on a technocratic elite of economists and statisticians not subject to the General Will. Thus their policies can simply be technically correct but devoid of real benefits which simply pander to public ignorance.
· A destruction of profitability in private instituations such as medicine.
· An orientation towards arms spending and militarism. (Large job creation but little public benefit).
· A complete collapse of rational expectations i.e. frozen wages and stagflation.
· Protectionism which stifles innovation, investment whilst increasing the bureaucracy and compounding social issues such as racism.
· Cheap credit asset inflation leading to bank failures which consequently lead to a credit shortage and thus universal bankruptcy with the possibility of a currency collapse and social collapse known as a ‘credit crunch.’ Such as in Ireland and Greece.
The more active states practised neo-mercantilism in the 1800’s, a form of protectionism that encourages exports and discourages imports. It also controls the movement of capital and centralises currency decisions to a central government with the aim of more effective monetary and fiscal policies by increasing the level of foreign reserves held by the government. (Foreign reserves are foreign currency deposits and bonds held by monetary authorities such as central banks)
This would lead to state spending and social democracy with the extension of voting rights.
Socialsim, social democrats and trade unions would appear with the first socialist party governments appearing in 1880s Germany.
Nation building, imperialism whilst partly political in nature are founded on a neo-mercantilist basis. A particular example of this is the Protectionism movement in England with Imperial protection and tax tariffs to promote the integration of the British Empire which can be seen from President Lincoln onwards in the USA and in the EU now.
The 1920s:
The 20th Century was turbulent time for the world economy.
The USA enjoyed the ‘roaring 20s.’ Deficit spending for the war led to the money supply expanding. There was a multiplier effect which led to speculation and rising prices. Ordinary citizens invested in the stock market as a way to get rich quick and the banks were more than happy to give out loans to any and all.
A typical citizen would go to their bank and ask for a loan of e.g. $500, they would invest this in shares and then sell these shares to produce a profit and then pay back the banks.
However the stock market crashed. This was largely due to overproduction. High quality consumer items such as cars and radios, which had once enjoyed huge demand were now in the homes of millions of citizens. There was no longer a domestic market that could support companies who had continued to over produce. Exportation was not the solution as the import tariffs imposed on foreign goods were likewise imposed on American exports meaning products could not sell competitively in foreign markets. Thus shares in companies declined in value. Consequently people could no longer afford to pay back their loans and millions simply disappeared.
This was the period of the great depression which had a knock on effect on other foreign economies. Germany suffered massive hyperinflation in 1923.
The neo-classical view of the great depression is that it constitutes a temporary market correction.
The view also states that the answer to unemployment is to reduce the cost of wages and money itself (through manipulation of interest rates).
The reduction of wages is only effective in an environment devoid of both trade unions and unemployment benefit. This ensures labour mobility; workers will migrate to where there are the most opportunities, mostly concerned with employment but also education as workers will likely move with their families to permanently settle. Thus all labour is re-emplyed in areas of best interest to the nation. I.e. jobs are filled where needed.
Parallel to this the initiative to ‘cut government waste’ through reduction of government spending and raising taxes. Reduction of spending is to create downward pressure on interest rates through the bond market. Raising taxes can be done in a multitude of ways such as the raising of tuition fees which is a ‘stealth tax.’
In response to the global economic crisis Winston Churchill went back on the gold standard as he argued the collapse in world trade was due to cheap money.
Keynes argued it was in fact the opposite, that deflation was the reality and would not simply cure itself. Keynes argued that to devalue currency and issue more money would bring unemployed resources into effect and thus companies and consumers would have more money (through tax breaks) and that government spending would result in job creation thus more employment.
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