Violating the Promptings of the Economy

I left my heart in San Francisco
High on a hill it calls to me
To be where little cable cars climb halfway to the stars
The morning fog may chill the air, I don’t care

My love waits there in San Francisco
Above the blue and windy sea
When I come home to you, San Francisco
Your golden sun will shine for me

— Frank Sinatra

Today we’re in San Francisco working, observing, writing and taking pause with our wife and son to ride cable cars up and down Powell Street, traverse through the city’s varying districts – like Chinatown, North Beach, SoMa and Fisherman’s Warf – and eat fresh crab and pasta.  What follows are some ruminations on the City’s beginnings, gold, Jack London, and much, much, more…

The First Day of the California Gold Rush

On January 24, 1848, James W. Marshall stepped out from Sutter’s Mill and peered down the American River, in Coloma, California.  In the distance he saw a glimmer along the river bank twinkling back at him.  What could it be?

“I picked up one or two pieces and examined them attentively,” recounted Marshall.  “I then collected four or five pieces and went to Mr. Scott (who was working at the carpenters bench making the mill wheel) with the pieces in my hand and said, ‘I have found it.’”

‘“What is it?’ inquired Scott.

‘“Gold,’ I answered.”

There’s no way Marshall could have known it at the time, but his discovery marked the first day of the California Gold Rush.  From that day forward, California would never be the same.  In fact, the effects of the Gold Rush completely transformed the State and its cities.  Between 1846 and 1852, for instance, San Francisco’s population boomed from 200 residents to about 36,000.

But not all newcomers found what they were looking for…

Wealth In, Not Out

Following Marshall’s find, treasure seekers rapidly descended on the area to collect their fortunes.  In total, billions upon billions worth of gold was discovered, which brought instant prosperity to some.  But the vast majority never acquired enough gold to substantially improve their wealth.

Those who really made money were the suppliers.  Take Samuel Brannan.  Just as the gold rush began he purchased all the prospecting supplies in San Francisco and opened the first supply store in Coloma.  Thus, having cornered the market, he re-sold the supplies at a substantial profit.

Likewise, Levi Strauss made his fortune not by panning for gold…but by selling denim overalls to those panning for gold.  Others found affluence with shipping, lodging, and saloons.  The gold rush also brought significant investment to transportation infrastructure including the first transcontinental railroad, the Panama railway, and regular steamship service from San Francisco to Panama.

No doubt, the abundance of investment and human capital brought wealth to California.  However, the abundance of gold leaving California and finding its way into the global gold denominated money supply did not bring new wealth and abundance to the world.  How come?

Pondering this apparent paradox, 19th century English economist and logician, William Stanley Jevons, in 1884, astutely asked the question: “Have the Gold Discoveries added to the Wealth of the World?”

Violating the Promptings of the Economy

“If we take wealth to be that which is agreeable and useful to mankind, it may be safely said that the mere gold produced by Australia and California represents a great and almost dead loss of labour,” explained Jevons.

“A century or more ago it was the fashion to consider gold and silver as the only wealth, because it happened to be the measures and vehicles of wealth.  Now it is more correctly seen that gold is one of the last things which can be considered wealth in itself, and that in its most useful employment as money, the very scarcity of gold is its recommendation, rendering the value greater, and the weight or quantity to be carried as money less.

“To over-estimate the indirect effects of these discoveries in creating new colonies, in spreading the English people and language, and in newly animating commerce, is not easy.  But in itself gold-digging has ever seemed to me almost a dead loss of labour as regards the world in general – a wrong against the human race, just such as is that of a Government against its people, in over-issuing and depreciating its own currency.”

In short, this new addition of money, while it required substantial human effort to extract, had the same effect as today’s monetary stimulus.  The money supply rapidly increased but the world’s stock of wealth didn’t budge.  Instead, and as we’ll discover over the coming years, prices adjusted upward to account for the new money.

“One cannot violate the promptings of one’s nature without having that nature recoil upon itself,” wrote San Francisco native Jack London, in White Fang.  Naturally, London wasn’t describing the propensity of central bankers to inflate the money supply.  Nonetheless, he identified an instructive natural axiom.

The Federal Reserve, in violation of the promptings of the economy, has tripled its balance sheet over the last four years…creating nearly three times more money than they created in their prior 95 years of existence.  Most of this money, however, has disappeared into the electronic vaults of the financial system; it has not made it into circulation within the economy.  At some point, perhaps when the economy improves and bank loans increase, this pent-up money will work its way through the economy at an accelerating velocity.

What we mean is, sometime over the next several years prices will by-and-large adjust upward and, in doing so, will distort and recoil the economy in ways that today are hardly imaginable.  Certainly, you can count on us to report on this transformation as we watch it unfold every step of the way.

Sincerely,

MN Gordon
for Economic Prism

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