No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seventeen: A Short History of Macroeconomics 431 During the conflict, industries that produce war materials are relatively favored and need to readjust upon cessation of hostilities. The U.S. saw a massive inflation of “greenbacks” during the Civil War, and it took many subsequent years of deflation to restore monetary order. Likewise, most nations inflated their currency during World War I, despite previously being on a gold standard. Upon the conclusion of the war, not only was some level of resource reallocation necessary to reflect peacetime production realities, but in addition, all prices reflected the new inflated monetary reality. Great Britain decided—very foolishly—to make its currency, the pound sterling as “good as gold,” by resuming the gold standard at its pre-war parity, as if the inflation had never even happened! This would mean that the entire economy would need a deflation roughly equal in magnitude to the inflation that had preceded it. Unfortunately the British labor market was incapable of the kind of wage rate flexibility that was needed; and if the price of labor is not allowed to adjust due to union pressures (or any other rigidity), the only other choice is to reduce the quantity of labor. In this matter John Maynard Keynes and Ludwig Von Mises would be in agreement. Keynes warned of returning to the pre-war parity in The Economic Consequences of the Peace , and Mises would similarly say that attempts to reverse inflation by subsequent deflations is akin to, after having run someone over by a car, you now try to help the patient by putting the car in reverse and backing over her again! Great Britain therefore started down the path to what would become the Great Depression much earlier than the U.S. U.K. unemployment was generally greater than 10% from 1921-1929 and accelerated once the global Great Depression began, ultimately peaking at over 22% in 1932. Why so much earlier? Perhaps the main reason was their overvaluation of the pound sterling, which led to gold flight to the U.S. and the rest Consumer Price Index, United States, 1775-2012 . 6