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The 16th-Century Inflation Caused By Spanish Silver Drove A Real Increase In Wealth. Just Not In Spain.

I begin to feel like a broken record, but Matt Yglesias has a cool post up about “Game of Thrones” and (what else) monetary policy: As you watch members of House Lannister and House Tyrell scheme for control over King’s Landing here’s something to keep in mind. The Westeroi conventional wisdom that that the Lannisters […]

I begin to feel like a broken record, but Matt Yglesias has a cool post up about “Game of Thrones” and (what else) monetary policy:

As you watch members of House Lannister and House Tyrell scheme for control over King’s Landing here’s something to keep in mind. The Westeroi conventional wisdom that that the Lannisters are the richest house in the Seven Kingdoms is dead wrong. House Tyrell is number one in all the ways that count. . . .

Gold is useful primarily because it’s a convenient medium of exchange (who wants to carry all that wheat around) and a durable store of value (keeping a whole bunch of horses alive and healthy is itself a resource intensive process). So people with claims over valuable real resources will often end up accumulating gold. But though the Lannisters have more gold than anyone else, that’s not how they got their gold. They just own gold mines.

Now don’t get me wrong, you’d rather own gold mines than not own them. But the ability to pull shiny metal out of the ground is trivial compared to the power of a well-fed army. Imagine a scenario in which the Westerlands are out of food, and the Reach is out of gold. The Tyrells and their bannermen will need to curtail their consumption of luxury goods until they can manage to sell food for gold, but the austerity will be survivable if a bit unpleasant. The Lannisters, by contrast, are going to find that if they try to trade a whole big pile of gold for a whole big pile of food that the price of food will skyrocket. The illusion of Lannister wealthy is based on the idea that we can take the marginal price of an ounce of gold, then multiply that by the total quantity of the Lannister gold supply, and then conclude that the Lannisters are hyper-wealthy. In reality, any effort to mobilize all that metallic wealth will lead to inflation rather than the ability to mobilize vast quantities of real resources.

You can see this historically from the Spanish conquest of the New World and the ensuing influx of newly mined “treasure.” This appeared to give the Habsburg dynasty a decisive wealth edge vis-à-vis its European rivals, but the Habsburgs’ struggles with France led to the inflationary “price revolution” and ultimately the victory of a French state built on the control of real resources—productive agricultural land and a large population. My guess is that by the time the Song of Fire and Ice is concluded we’ll see something similar. Real resources—not shiny gold—are the true test of wealth and the real source of power.

Indeed! I suspect most goldbugs would agree – that’s why they argue that you can’t create real resources by debasing the currency.

Yglesias’s rejoinder to that would be that the optimal level of inflation is the one that corresponds to complete mobilization of real resources. If you have lots of people sitting around unemployed, that’s prima facie evidence that people are hoarding money rather investing it in productive activity (or purchasing goods and services that cause others to invest in the productive capacity necessary to deliver those goods and services). Make holding money less-attractive, and you make that investment (or consumption) relatively more-attractive, and the economy moves in the direction complete mobilization.

And this feeds back into the economy’s productive capacity in two ways. First, idle human resources decay in value. Apart from the human tragedy, that’s the reason why long-term unemployment is a serious national economic problem. So if you mobilize those resources, you are preserving – or enhancing – national wealth by maintaining or increasing the productive capacity of the workforce. Second, when the economy is operating at or near full-employment, the incentives to develop productivity-enhancing innovations are maximized – because this is the only reliable way to increase profits. By contrast, when labor markets are slack, it’s more possible to squeeze profits out of labor concessions, and more possible to scale up production simply by hiring more people to operate the same processes at larger scale. And those productivity-enhancing innovations are what primarily drive national wealth in a modern economy.

So Yglesias believes that the amount of money – whether made of metal or paper – circulating in an economy does affect the mobilization of real resources. And he believes that the mobilization of real resources does affect the productivity of the economy, and thereby contributes to increases in real wealth. So why did a massive infusion of silver from the mines of Bolivia leave Spain economically hollowed out, with other powers – France, England, the Netherlands – having leaped ahead in terms of productive capacity?

That’s a complicated question, but part of the answer is surely that Bolivian silver enabled Spain to purchase more goods – consumer and capital goods – abroad. It therefore created powerful incentives in, for example, the Netherlands to invest in productivity improvements. Spain felt wealthier, because they actually were wealthier – they had a larger share than previously of claims on the globe’s productive capacity, because they had a bigger share of the world’s mediums of exchange (gold and silver). But because, at the margins, their society was less-well-positioned to increase its productive capacity, capital flowed to better-positioned societies, and those societies saw a durable increase in wealth.

Moreover, the distributional consequences of the silver infusion made the situation worse. After all, the increase in wealth didn’t accrue to Spanish society as a whole – because Spanish artisans and peasants weren’t much involved in generating the wealth. Rather, it accrued to the top of Spanish society: the court and those who depended on the court for power and profit. Because they suffered from inflation but didn’t participate directly in the influx of wealth, the infusion of silver made ordinary Spanish people poorer, and therefore even less-able to invest in improving their productive capacity.

How is that relevant to us today? Well, this was kind of my point in my Dark Matter post. If America isn’t actually a net-debtor because we’ve invested successfully in profit-making enterprises abroad while foreign investors in America have overwhelmingly preferred low-yielding government bonds, that should reassure us that we’re not going to have a currency crisis any time soon. But it shouldn’t reassure us at all about what we’re doing to our nation’s productive capacity in the long term. Indeed, it should make us more worried if selling bonds (not much different from printing money or digging up silver) and investing the proceeds abroad is an economically viable strategy for a good long while. Because that means we might keep doing it long after its social costs become manifest.