“Our incomes are like our shoes; if too small, they gall and pinch us; but if too large, they may cause us to stumble and trip” -- Charles Caleb Colton, English Writer, 1780-1832.

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There’s a lot of talk about gold these days, and it’s not about jewelry. As Mom used to say, much can be learned from history. So to better understand today’s markets (present and future) I dusted off some old textbooks to refresh my understanding of the former gold standard and the relationship with inflation and deflation.

During the 1800s the United States operated with gold and silver standard. The true Gold Standard Act came about in 1890. This ended in 1933 when President Franklin D. Roosevelt outlawed private gold ownership (except for the purposes of jewelry).

In 1946 The Breton Woods System created fixed exchange rates for governments to sell their gold to the United States treasury at the price of $35/ounce.

Fast forward to 1971 when President Richard Nixon ended trading of gold at a fixed price. The gold standard hasn’t been used in any major economy since. Think of a dollar having a fixed value, as if it were in a straight-jacket tied to a value exchangeable for gold. Since that is no longer the case, our currency value floats with over all exchange rates throughout the world — think global economy.

The past decade, inflation increased between 1 percent to 3 percent annually, not a problem if you’re working and wages and salary increases have kept up. What if you’re retired on fixed income? Suppose you have $1 million in bonds paying 10 percent; you receive less each year because of inflation. If the inflation rate is 3 percent, every $1,000 generated the first year is worth just $970 the second year, $941 the second and soon inflation has a major impact on your standard of living.

The 1970s and early 1980s were a time of double digit inflation. The standard of living eroded faster because inflation took a bigger bite out of the dollar and purchasing power. That $1,000 in 1978 was worth just $687.83 three years later after inflation rates of 11.22 percent (1979), 13.58 percent (1980) and 10.35 percent (1981) demoralized the nation — and led the Federal Reserve Board to take an inflation-fighting stance.

What’s the opposite of inflation? Deflation, and at first glance it may seem to be a good thing. However, as prices fall, the downward spiral can lead the economy into a recession — or, worse, a depression.

First, consumers notice the trend and begin to wait until prices dip further before buying. Demand for goods and services drops — leading to lower prices. As businesses lose profits, people lose jobs and a depression may easily develop. Credit contracts and the money supply recede. The low costs may be appealing, but if gasoline costs only $.50 a gallon, you still need $.50 to buy it. If you’re not working or your pay has been slashed, you may not have it.

The Great Depression of 1929 is the classic American example of deflation, but there was another earlier, devastating depression at the end of 19 century.

At this time most families lived on farms and were dependant on railroad companies for commodity deliveries. The railroads collapsed, leaving farmers high and dry. Farm foreclosures rose and bank failures followed. At the time, money was backed by the national gold reserve.

A debate began as to whether a gold or silver standard was the wisest monetary policy. A South Dakota newspaperman L. Frank Baum was thus inspired to write his children’s book, “The Wonderful Wizard of Oz.” *

Next time you watch the movie, made four decades later in Technicolor, cast yourself as Dorothy; the Scarecrow is a farmer with straw for a brain, the Tin Man is an industrial worker who’s lost his soul and the Cowardly Lion is presidential candidate William Jennings Bryan, bumbling with little real courage.

In Baum’s book, the yellow brick road represents gold and Dorothy’s silver slippers — a more poignant ruby red in the film — represent silver. Dorothy is skipping along with her friends who look to the Wizard in Emerald City to save the day — as some expect Washington to solve the country’s economic woes — to only find that he’s a sham. Ultimately Dorothy and her gang have the power within themselves to cure their ills. As Baum knew — he published the book in 1900, three years after the recovery began — Washington had no solution. The economy worked through rising prices, a flood of immigrants who provided cheap labor, and a huge supply of new consumers to finally revive itself.

*Deflation History, Minnesota Public Radio, 1998.

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Darcie Guerin is a financial adviser and branch manager at Raymond James & Associates Inc. at 606 Bald Eagle Drive, suite 401, Marco Island. Contact her at Darcie.Guerin@raymondjames.com, 389-1041 or toll-free (866) 343-0882.