THE PROBLEM OF MONEY AND TIME

The law of supply and demand is one of the great natural forces of the universe, as ineluctable as gravity. Unhappily for the world, the law—like Rodney Dangerfield and unlike gravity—gets no respect. Nobody would jump out a tenth-story window without intending to die. But a great many people, from historians to elected officials, ignore the law of supply and demand or simply declare it null and void to suit their purposes. Regardless, the law works its way inexorably.

In the case of the necklace and the mansion, the supply of mid-Manhattan land is fixed. There is just so much of it, and that is that. The Dutch made the greatest real estate deal in history when they bought the whole island for trinkets and blankets valued at sixty Dutch gulden. (An excellent example, by the way, of the difficulty of translating the value of money over time: What are sixty Dutch gulden of 1626 worth in today’s dollars? Tradition has said twenty-four for many generations.) Because the demand for Manhattan real estate has been rising ever since that time, the price has been rising steadily as well.

The supply of quality pearls, on the other hand, has increased manyfold since cultured pearls were developed at the close of the nineteenth century and widely promoted after the First World War. At the same time, the demand for them has decreased since the end of the Gilded Age, when grandes dames favored wearing pearls by the yard. Because of increasing supply and diminishing demand, the price of pearls peaked in 1929 and has been in decline ever since.

The law of supply and demand is so fundamental to understanding why things cost what they do that it even explains the most significant economic event since the invention of agriculture: the Industrial Revolution. Before the coming of the steam engine, it was difficult for the economy to put energy to work. There was plenty of energy, with wood and coal in abundance, but it couldn’t be used for anything much beyond producing heat. Real work—even in the strict physical sense of transferred motion—could be done only by wind, falling water, animals, and human beings. But wind and falling water are erratic and often are not found where they are needed. Animals and people require expensive fuel and maintenance.

Then James Watt’s rotary steam engine converted the heat energy of coal and wood into a higher form that could do work. Suddenly there was a way to add massive amounts of energy to the economic system very cheaply. The price of work-doing energy collapsed with the vastly increased supply, and demand soared as the price fell. Entrepreneurs unleashed a flood of inventions to make use of the newly available resource.

Because energy is one of the fundamental inputs of any economic system, the price of nearly all commodities, especially manufactured ones, declined significantly with the decline in the cost of energy. The economic universe was turned upside down in only two generations.

The consequences of the Industrial Revolution continue to work themselves out in the marketplace to this day. Among these consequences are some that the historian must deal with in trying to translate the value of money over time.

The first of these is rapidly rising real wealth. Before the rotary steam engine, economies necessarily grew slowly, only about 1 percent a year. Without powered mechanical equipment, physical capital—such as new fields and pastures for agriculture, new factories and mills for industry, and new roads and canals for transportation—could be created only very slowly. Virtually all products for consumption were handmade as well. Once the Industrial Revolution had begun, however, economies affected by it grew much more rapidly, averaging about 4 percent a year.

This accelerated growth has had profound consequences for simple arithmetical reasons. Growing at 1 percent a year, an economy will double its production in seventy-two years. At a 4 percent growth rate, however, an economy will be sixteen times as productive in seventy-two years. Such is the magic of compounding. (See “The Rule of 72” on page 62.)

Inflation, therefore, is by no means the only reason you need so much money to be rich nowadays. Equally important, real wealth and income —not just the illusion of them produced by inflation—have been rising very steeply for all levels of society since the Industrial Revolution. Many things that were once thought the distinguishing privileges of the rich, such as ample living space, fine clothes, private transportation, education, and professional entertainment, are now regarded as the ordinary perquisites of middle-class life.

A second complication is that while some commodities have risen in price along with inflation since the Industrial Revolution, they have become much cheaper in some other economically significant term, such as time.

In 1870 a round-trip, second-class passage from New York to London could be purchased for about $150. This price would have been in the reach of many middle-class families. But in 1870 the passage took about ten days in each direction, and paid vacations were unknown. Therefore, while many Americans in 1870 could afford the money cost of a trip to England, very few could afford what it cost in time. Today the Atlantic can be crossed in a few hours and paid vacations are the norm. Thanks to jet travel and more enlightened labor policies, Europe now swarms with American tourists (and vice versa).

One very important consequence of both the Industrial Revolution and the Information Revolution has been the steady increase in the value of human labor. Between 1900 and 1970 the average annual wage of American workers, net of inflation, rose by a factor of three. Again, there is more than one reason. The first is that as machines have taken over more and more of the physical work and routine calculations, humans have been able to concentrate on other, more wealth-creating tasks. (Of course, that is a long-term trend. In the short term, there are often severe dislocations as machines compete with and replace human beings in the old jobs.)

The second is that as physical capital has been built up, the productivity of workers has increased. More goods and services are produced for every hour of human labor utilized, and the workers have gotten a share of this. Needless to say, the owners of the physical capital did not volunteer this sharing. The rise of the union movement was another factor in the increase in real wages.

Because of this rising price, those commodities requiring large inputs of human labor in order to be produced have risen greatly in price as well. This goes a long way in explaining such phenomena as changes in architectural style in the twentieth century that are usually attributed to other causes. In the first decade of the 190Os New York City built its magnificent public library for about $10,000,000. To reproduce this building today with its seeming acres of carved marble, its intricate wood and brasswork, its majestic ceilings, would cost in the billions. No city on earth could afford it. The New York Public Library, the greatest Beaux-Arts style building in the country, perhaps the world, is today as irreplaceable as its contents.

So where does all this leave the historian and the reader of history? As we have seen, there is no Rosetta stone, no all-purpose index or formula that can convert the economic universe of, say, 1917 into modern terms at a stroke. Both the past and the present are far too complex for that. In 1917 servants, Fifth Avenue mansions, and live entertainment were, at least compared with today, cheap. Pearl necklaces, European vacations, and private transportation were expensive. Phone calls to London, heart transplants, and the determination of the value of pi to a hundred million decimal places were, in an economic sense, infinitely expensive. For each of these examples, there are a million others that the people living in 1917 had to take into account in deciding what to buy and what to sell.

Because the money of a past era cannot be meaningfully translated into a modern economic idiom by simple statistical manipulation, historians, to do their job, must learn to understand the economic language of the past. A novelist creates the emotional universe that allows the reader to make sense of the characters and their actions. Historians need to re-create the economic universe of the eras about which they write for exactly the same reason. That is not nearly so difficult a job as it may seem, for both the novelist and the historian can rely on the reader’s grasp of human nature.

Once readers gain a sense of the prevailing wage scale and the prices of basic commodities, they will begin to grasp the economic essence of the era under discussion. Human beings, after all, are very intuitive about human situations, whether the situation be economic or emotional.

And just as it is human nature to laugh and to love and to wonder, it is equally human nature to seek the patterns in things, to pursue one’s self-interest, to buy cheap, and to sell dear. The law of supply and demand is inescapable because it is rooted in the very bedrock of what it means to be human.

John Steele Gordon writes the “Business of America” column in this magazine.

In a free market, if the price of a commodity, such as sugar, drops substantially, the price of everything made with that commodity—candy, bakery products, soft drinks—will drop as well, and the effects of the new price will ripple through the economy. If the price of something used in every commodity plunges, however, a tidal wave of change may result and a new economic universe be created.

The collapse in the prices of transportation in the first half of the nineteenth century produced just such a fundamental transformation. Cheap transportation created an integrated, worldwide economy out of a myriad of local ones. Writing in the 1880s, the American economist Arthur T. Hadley noted that “two generations ago, the expense of cartage was such that wheat had to be consumed within two hundred miles of where it was grown. Today, the wheat of Dakota, the wheat of Russia, and the wheat of India come into direct competition. The supply at Odessa is an element in determining the price in Chicago.”

Before the Erie Canal was completed in 1825, it took three weeks to get a ton of wheat in Buffalo—worth only $40—to New York City, at a cost of fully $120. Once the canal opened, a ton of wheat could be shipped between the two points in eight days at a cost of $6—in other words, in one-third the time and at one-twentieth the cost. Little wonder that the canal contributed so powerfully to New York City’s explosive growth as a port.

But canals were expensive to build and maintain. They were suited only to flat and well-watered country. And they could not operate in winter. It was the railroad that brought cheap transportation to the whole world. As the railroad industry matured, the price of transportation dropped still more. Hadley noted that between 1850 and 1880 railroad rates “were reduced on an average to about one half their former figures, in spite of the advance in price of labor and of many articles of consumption.” Hadley, of course, was referring to the trunk routes, where competition among the railroads was fierce. Where a railroad had a monopoly, it charged what the traffic would bear, a fact that profoundly affected the politics of late-nineteenth-century America.