How Inflation Stopped the Ottoman Empire
Someone always has to pay for inflation. Make sure it's the other guy.
The infusion of Spanish gold from the Americas induced inflation in the economies of the Mediterranean. Never mind that the European powers in the Mediterranean—principally Venice, Genoa and Spain—had been long engaged in war with the Ottoman Empire. The economies of all of these parties yet remained networked and open. It was by way of that openness that all of these powers perceived inflation, and it was that inflation that stalled the advance of the Ottomans.
This was the 16th century in the run up to the decisive Battle of Lepanto in 1571. “[T]he influx of bullion from the Americas was beginning to hole the Ottoman economy below the waterline, in ways that were barely understood…”
The Spanish real became the most appreciated currency in the Ottoman empires; it was impossible to strike money of matching value. The silver coins paid to the soldiers grew increasingly thin; they were “as light as the leaves of the almond tree and as worthless as drops of dew,” … With these forces came price rises, shortages, and the gradual erosion of the indigenous manufacturing base. Raw materials and bullion were being sucked out of the empire by Christian Europe’s higher prices and lower production costs.
That’s how Roger Crowley puts it in his very engaging tome, Empires of the Sea: The Siege of Malta, the Battle of Lepanto, and the Contest for the Center of the World (2008). Crowley does not concern himself too, too much with inflation, but his account would be consistent with this proposition: Spain realized a financial gain from flooding the economy with American gold, and the Ottomans largely paid for that same gain. In a zero-sum game, Spain prevailed. How could that be?
The basic “quantity theory of money” relates the money supply to the sum of commercial transactions in the economy. But first we need to commit to a medium of exchange, “money.” Historically, societies the world over have committed to a unit mass of gold as a unit of account. Other societies have used beads or seashells. Each unit would amount to a unit claim of value in the economy. Other things equal, increasing the number of units of account—the number of gold Spanish reals, say—increases the number of claims; assigning a larger number of claims to the same volume of transactions amounts to assigning a smaller claim to each unit. That’s inflation; the value of the currency decreases; prices go up.
Other things are not always equal, of course. In the 1890’s, for example, the United States experienced a lot of economic growth. It also operated on a gold standard. Everyone did not necessarily walk around with gold coins in his or her pocket, but everyone was entitled to go to the bank and to exchange dollar bills for gold. Absent a big infusion of gold, those bills amounted to larger and larger claims on value in the growing economy. That is, the currency was appreciating; prices were falling. Given a fixed number of dollars in the economy, and given the economy was growing, the value of those dollars was growing. The economy was experiencing deflation.
Not everyone was pleased with deflation. The people who produced things may not have been too happy to see the prices of their produce and manufactures decline. But, if everyone can anticipate steady decline, is deflation really much of a problem? Least happy, in any case, would have been people straining under debt at fixed rates of interest. If someone could organize a big expansion of the currency, then prices would likely rise. Debtors would have an easier time paying off debts. Lenders, on the other hand, would find themselves getting paid back with less valuable dollars. Inflation would give relief to debt payers, but that relief would come at the expense of lenders.
Deflation became a big issue—perhaps, the central issue—of the 1896 presidential election. Who knew? Williams Jennings Bryan delivered his “Cross of Gold” speech at the Democratic convention. He did not speak of fighting Nazis on the beaches, on the landing grounds, in the fields and in the streets, but he did speak of fighting “the interests” in almost Churchillian language, and that was well more than enough to secure the Democratic nomination. The last passage thus concluded:
If they dare to come out in the open field and defend the gold standard as a good thing, we shall fight them to the uttermost, having behind us the producing masses of the nation and the world. Having behind us the commercial interests and the laboring interests and all the toiling masses, we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.
The “Cross of Gold” speech argued for “bimetallism”: If we could not infuse the system with more gold, then allow the system to accept the abundant silver that was already laying around. At the very least, that would induce a one-time, big shot of inflation. Existing debt burdens would be very much moderated if not relieved in an almost-Biblical quasi debt jubilee.
The infusion of Spanish gold did much to the Ottomans that William Jennings Bryan and the Democrats of 1896 had hoped to do to debt holders in the United States: the advantages of inflation—if any are to be had—have to be paid by someone else in the system; enjoy those advantages, and make one’s enemies pay for it. Spain bore the greatest role in bankrolling the effort to resist the advances of the Ottomans in the Mediterranean, and the Spanish will have experienced inflation like anyone else. But they will have secured a greater share of buying power in the Mediterranean economy by virtue of investing itself with larger stocks of gold. As Crowley observes, the Ottomans did not themselves have access to sources of new gold—gold that they could have used to maintain their own relative share of buying power in the economy. One can imagine Spain and the Ottoman Empire engaged in a financial arms race with each party trying to mint new coins faster than the other in order to maintain or even expand buying power. Instead, Spain ended up with greater buying power at the expense of all other powers, but mostly at the expense of the other largest power in the Mediterranean, the Ottoman Empire.
In the next short essay about inflation, I will likely talk about Britain’s break with a strict gold standard during the First World War as well as about the surprising value of metaphorically hiding cash in a mattress when a strict gold standard does prevail.