Victorian economy v. modern economy

How inflation and debt created our wealthy world

2004.10.17 — Business | Economics | by Barton Castor

The world has changed since the reign of Queen Victoria in the latter half of the 19th century. It has changed in many ways—electronics, powered flight, civil rights, and more. But one of the most important ways in which the world has changed is in economics. The changes between now and then virtually created the middle class and made modern affluence possible.

In Victorian times, the world's economic system was just beginning to become integrated and sophisticated. Corporations and stock exchanges were still new and unproven; even banking was still rare and risky. It actually made sense to literally stuff your money in your mattress. Why?

Deflation & inflation

Nowadays, money becomes less valuable from year to year, thanks to inflation, and prices gradually rise over time. In the late 19th century, Western economies were consistently suffering from deflation.

As populations grew, so did their economies, which drove demand for cash. But with money tied directly to gold and silver, and with gold and silver supplies limited to what people could dig out of the ground, money itself became more and more valuable from year to year. As the value of money rose, prices of goods and services had to fall.

Because money became more and more valuable in the Victorian age, holding debt was debilitating. The money you paid back was worth more than the money you borrowed... plus interest.

Worse, for centuries, there was a bias against charging interest on loans, largely imposed by the Catholic church as the sin of usury; this of course made it difficult for people to borrow money at all (why risk loaning 50 pounds stirling when all you'd get back was 50 pounds stirling?).

Once Western governments had set up a solid system of banking and had found ways around gold-and-silver money, the stage was set for the rise of the middle class and Western wealth as we know it.

You never thought you'd thank your lucky stars for inflation, did you?

Mortgage debt = wealth

When it became possible for an ordinary family to take out a mortgage loan at low interest for 30 years, suddenly a world of possibilities opened up. Ordinary people could borrow large sums of money... providing they gave it immediately to other ordinary people who were building a house for them. That created jobs that also created national wealth in the form of big, valuable buildings that last for a hundred years or more.

The genius of this system is that nobody really has to trust anybody, at least not very much or for very long. Since the builder gets started building a house with a very small amount of money (namely, your down payment), the banker is able to see that the money is being properly spent before giving him any more. And since the house gets built with the bank's money, it's owned by the bank until the "borrower" pays for it... slowly, over 30 years.

Even if the borrower dies immediately after the house is finished, the builder still gets paid and the banker still has a house he can sell to someone else. This makes it very low risk and therefore attractive for the banker—in spite of the huge sums of money and questionable credit-worthiness of the people involved.

Certain flat-earth conservatives would have you believe that we should return to the gold standard, where our government's money is backed by gold sitting in a vault somewhere. But there's not enough gold in the world to back the US economy at anything less than astronomical prices. And what good would it do us to have a trillion dollars worth of gold sitting in Fort Knox?

Let's keep our fiat money. It's made us rich, and it's backed by the thing that really matters: a powerful economy pumping out durable goods.

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