Thursday, January 10, 2013

100 Years of Gross Mismanagement

The following needs no further comment (H/T: Oikonomika Blog; click to enlarge):

Or, one could depict the same disastrous management of the dollar since 1913 by using this picture graphic (again, click to enlarge in a separate window):

For more of my ruminations on the depredations by which the Fed wrecks The People's Money, please go to this page, and follow the links.


  1. Thank you for posting this Mr. Haley. I find it most interesting to note that in the century since the Federal Reserve Board was established, the purchasing power of the U. S. dollar has fallen such that what cost $.03 in 1913 not costs $1.00. And I am thoroughly convinced that the correlation is not coincidental.

    Pax et bonum,
    Keith Töpfer

  2. This is a misleading graphic on several fronts.

    1) The people have literally a wealth of other superior investment classes and opportunities compared to cash. Equities, bonds, real estate, even measly bank accounts have all generally outpaced inflation. That $.03 in 1913 invested in the Dow Jones would now be worth more than $5.40. More important to the middle class is that wages quadrupled after inflation from 1913 until 2006.
    1.1) Despite the decline of this graph, the money supply has increased tremendously over the last hundred years. Wealth has gone up (the average person has much more purchasing power today) and money supply has also increased. Roughly since 1980, inflation has caused the value of a dollar to halve, but the number of dollars in circulation has more than doubled while dollars in savings accounts, money market funds, etc have increased more than 10 fold.

    2) As hinted at in the example above, cumulative interest over 100 years really starts to add up. It sounds shocking to say that inflation has killed more than 90 or 95% of the value of the dollar in the last hundred years, but over 100 years it just isn't that big of a deal. Three percent annual inflation compounds to a 95% decline over 100 years.

    3) The mix of goods and services available in 1913 is radically inferior compared to today. Try buying computing power, insulin, or jet travel with a 1913 dollar.

    4) Most important, the Fed is not an investment manager for the dollar. The goal is not to maximize the dollar's value relative to itself over time. If it were, then deflation would be a good thing. See the years' where your dollar chart increases? You imply that those were good years for the Fed. They were around 1919 and 1929-34, i.e. two terrible periods--the recession after WWI and the teeth of the Great Depression. Not good. Conversely, you imply that the steepest periods of inflation were bad, but 1917-21 and 1939-49 were wartime booms. Not by chance did GDP and debt explode, public debt that was paid for in part by inflation. So...
    4.1) Inflation is not bad per se. Inflation is bad for debt holders but good for debt owners, e.g. Truman post-WWII. When GDP is undercut by high debt, then inflation can have a stimulatory effect.
    4.2) However, very roughly speaking what does tend to wreck havoc is volatility and unpredictable inflation. So all those big changes of slope in your curve can cause fear as inflation hits different sectors of the economy at different times unevenly. But look at the data from 1977, the slope of the curve is pretty constant. Who do we have to thank for that besides history for sparing us another global war?

    Why that would be Paul Volcker at the Fed. That doesn't mean that Greenspan was right about the housing bubble, but you couldn't pay me in dollars to pull an Andrew Jackson by eliminating our central bank and returning to the much more volatile business cycles of the 19th century. You think it's bad now? Try the Panic of 1893. JP Morgan had to bail out the Treasury Department and unemployment hit 18.5%.


    The Curmudgeon does some nice legal analysis so far as I can tell, but I'm not so sure about his macroeconomics.

  3. Plantagenets, thank you for your comments, but I cannot let your plethora of economic half-truths go unanswered.

    You appear to think that a person who invested $.03 in the Dow Jones in 1913 would be ahead by having that sum grow and compound to $5.40 today. Even if I accept your figures as accurate, you would have to agree that such a person has hardly escaped the ravages of inflation. In 1913, $0.10 would buy you a good steak; and you would spend about $16-18 for a good one today, so all your 100 years of investing have brought you is the ability to keep abreast of prices as they inflate. No growth of capital, no provision for your old age or heirs – just treading water for the past 100 years.

    The increase of the money supply in response to increased production and productivity is a natural and necessary form of monetary growth, but increasing it by purchasing worthless assets (over $2 trillion worth in the last 2.5 years, and now growing at $60 billion or so every month) is irresponsible and foolish – as would be the latest fad proposal of increasing it by minting a trillion-dollar platinum coin (which, to give credit where it is due, you at least do not mention).

    The 3% inflation rate over one hundred years that you cite was not, as you say, a constant, but an average. And in that average are hidden the multitude of inflations and deflations to which you refer, with real suffering attendant upon each, depending whether you were a creditor or a debtor at the time. Mathematically the graph shows exactly what has to happen, given that average rate; it is a truism to say so. But no one in 1913, it is safe to say, expected or foresaw the ups and downs that would follow from centralized (mis)management of the money supply. After all, the Fed was sold to Congress and the people as a means of stopping those previously ruinous panics from happening.

    It does no credit to Paul Volker to point out that there have been no big swings in the curve as it approaches zero after having declined by 97%. Indeed Volker’s much-touted years of 1977-1981 are one of the steeper parts of the curve. And once the curve hits a value of .03, how steep a further decline could one expect as the value goes to .01, in comparison with the drop from 1.00 to .03?

    Central banks have ever and always been created and maintained for one and only one purpose: to fund government overspending. And the consequences of such funding have also been ever and always the same – ending always in runaway inflation. If you do not believe that the current accelerating foolishness will not end in the same fashion as it always has before, then be careful about whom you charge with a faulty appreciation of macroeconomics. ;>)

  4. Ha, ha, Mr. Curmudgeon. I love your words but not your numbers. Unfortunately for your case, this is an argument about proportion and thus number!

    1 ) In 1913, the Dow Jones Industrial Average was under $100. Inflation adjusted adjusted using the headline Consumer Price Index, that would $1782 in December of 1913 in 2013 dollars. Today the DJIA is about $13.5k in 2013 dollars, so after inflation, the DJIA has outpaced inflation by 13,500/1782 or about 7.5 times. So 100 years of investing has brought you a 750% gain in real capital, a 750% gain in provision for old age and heirs. Note that this index of inflation isn't relative to a single good (steak) but the entire basket of goods and services the average consumer purchases.

    This is great news! This is real wealth creation! This is why we have laptops, big houses, MRI's, cars, appliances, etc. that our grandparents never could have afforded on a wide scale. People in 1913 were much poorer than we are even if steak was cheap. This isn't some accounting gimmick; this is real wealth creation thanks to a century of population growth, invention, investment, and labor.

    2) Of course, I totally agree that inflation wasn't constant over the last 100 years. If we want to get technical about it, we'd say that the first derivative of the curve is its slope and its second derivative measures the rate of change in slope. My point is that that second derivative has been much less volatile in the second half of the graph than during the war years. That means much more price stability. Note that the second derivative is time independent; it can fluctuate just as much in 1920 as it can in 2013. But it hasn't. Not because the value of the dollar has asymptotically approached zero but because inflation has been much more stable recently.
    In other words, we can calculate the steepness of the curve at .8 just as easily as at .03. It's not as though in 2000, economists would say, "well, the dollar is just .03 relative to 1913, so there can't be much inflation this year. We just don't have anymore money or purchasing power left for volatility in inflation." There could have been wild inflation in 2000 in the US. There just wasn't.
    Imagine a graph similar to the one you posted above but indexed to the Spanish currency in the 15 century. After the hyperinflation of the 16th century, the curve would have hit .01 well before the 20 the century, but you wouldn't argue in 2013 that there couldn't have been any meaningful steep declines in the 20the century because the curve had already hit .01.

    3) There may be all kinds of foolishness today, but deflation, which kills economic growth and investment has been largely eliminated by central banking and inflation has been smoothed too. I confess that I don't know what the intentions were behind the creation of the Fed, but those are the results.

    That said, I don't love inflation or think that the Fed is always right, e.g. the contraction of money in 1933 that intensified the Great Depression. But I think that the Fed provides the only mechanism for directly smoothing the boom and bust cycle thus fostering greater growth in the long run. Do you have a better alternative to the Fed after looking at this graph?

  5. Plantagenets, you are moving the goalposts. You say this is all about proportion -- well, you were the one who gave me the original proportion of $.03 to $5.40 -- a 180-fold increase over 100 years.

    Next you argue that the Dow grew from $78 (the actual "number below $100" it was at the end of 1913) to ~$13,500 today. That is a 173-fold increase, so close enough. And I pointed out that, using the exact same ratio, a $.10 steak in 1913 would cost about $18 today.

    Those two comparisons illustrated the relative purchasing power of the dollar in 1913 versus the dollar today: it takes about 180 of today's dollars to buy what $1 would have bought in 1913. And purchasing power is how you compare the effects of inflation on a nation's currency.

    But then you move the goalposts, and bring forward 1913 dollars to 2013 by converting them using the CPI -- so now, $78 in 1913, "adjusted for inflation," is the counterpart of $1782 today. Finally you compare that inflation-adjusted amount with the actual 2013 DJI, and claim that shows that the DJI "outpaced inflation by ... 7.5 times."

    But that is not what you showed. You showed that, had there been zero inflation between 1913 and 2013, $1782 invested in the DJI back then would have compounded to $13,500 by today -- a 750% increase in 100 years, or an average return of 7.5% a year.

    That return would hardly be sufficient to overcome a 180-fold loss in the purchasing power of the dollar over the same period. While your initial investment grew from $1,782 to $13,500, that $13,500 is the purchasing equivalent of $78 -- not $1,782 -- in 1913. So you actually lost $1,704 of your 1913 capital, all due to the Fed-managed inflation.

    I do not dispute that we have far greater riches and wealth today than people did in 1913. But we also have far many more producers and consumers, and far greater productivity. The question is not what people are able to buy today with their 2013 dollars. It is what they would be able to buy today had they invested everything they had in 1913 into the stock market, and trusted the Fed.

  6. "You showed that, had there been zero inflation between 1913 and 2013, $1782 invested in the DJI back then would have compounded to $13,500 by today."

    Yes. $1782 in 2012 dollars in 1913 invested in the DJI would become $13,500 in 2012 dollars in 2012. That's a 7.5X increase in purchasing power relative to 2012 dollars.

    However, had there been zero inflation between 1913 and 2013, cash purchasing power would have remained the same by definition. $1782 cash locked in a time capsule in 1913 would be still be $1782 in cash in 2013; it would have identical purchasing power in this hypothetical zero inflation world.

    You are going from $78 to $1782 to $13,500 and calling both transitions inflation. In fact, the move is from $78 in 1913 dollars in 1913 to $1782 in 2012 dollars in 1913 to $13,500 in 2012 dollars in 2012. The first move is an inflation adjustment; the second move is a real investment gain.

    Also, I define inflation in terms of the CPI, which is a measure of the price level/purchasing power of a market basket of weighted goods and services. You are defining inflation in terms of steak prices/steak purchasing power, a single good. It terms out to my surprise that the value of steak has risen exceptionally much over the last century relative to other goods and services.

    But consider some other goods. A gallon of gas cost 12 cents in 1913. Today it's about $3.50 a gallon, a 29X increase. A gallon of milk has gone from $.32 to about $4, a 12.5X increase. If you add up the inflationary increases for many more goods and services then weight their average, you get the CPI. That's one reason why the CPI is the standard measure of purchasing power over time.

    Double check: the CPI market bundle has gone from $9.8 in 1913 to ~$230 today.

    So that's a 23.5X increase in inflation over the last 100 years, not ~173X like for the stock market and steak. So that $78 in the DJI in 1913 in 1913 dollars goes to $1832 in 2012 in 1913 dollars purely by inflation. Multiply that by 7.5X and we get... $13,742 in 2012 in 2012 dollars--not a terrible estimate. So on average the DJI outpaced inflation by a little more than 2% a year. (Compound interest multiplies exponentially, so 1.02^100=7.5; 7.5% annual interest yields 1.075^100=1,383. Total US capital markets have probably increased at a higher multiple because there was no NASDAQ in 1913.)


    "I do not dispute that we have far greater riches and wealth today than people did in 1913. But we also have far many more producers and consumers, and far greater productivity."

    Per capital purchasing power has increased significantly since 1913. In 1913, the average American made about $5,000 in 2005 dollars. In 2013, the average American made about $40,000 in 2005 dollars. Double check: nominal GDP has gone from $39b to over $15trillion. $39b * 23.5 for inflation = $916.5b. The population has increased 312m/97m = ~3.2. If purchasing power were the same per capital, then 2012 nominal GDP should be 916.5b * 3.2 = 2.947t. That is short by about 12 trillion dollars or a multiple of 5 that corresponds to an increase in per capital purchasing power. (Yes, the CPI indicates a 8X increase; I'm guessing that quality differences the CPI accounts for between 1913 goods and 2013 goods come into play here, i.e. even with zero inflation a $25k 1913 car isn't as good as a $25k 2013 car.)

    Ultimately, all this makes sense because the 2013 American worker is significantly more productive than his 1913 forefather thanks to access to bigger markets, better technology, better health, etc.

  7. "However, had there been zero inflation between 1913 and 2013, cash purchasing power would have remained the same by definition. $1782 cash locked in a time capsule in 1913 would be still be $1782 in cash in 2013; it would have identical purchasing power in this hypothetical zero inflation world."

    Plantagenets, I respectfully beg to differ. Purchasing power is not the same as "dollars adjusted for inflation." You yourself were the one who pointed out that the people of 1913, no matter what their "purchasing power," could never have purchased what we can purchase today.

    Th CPI measures (albeit very imperfectly, because the government monkeys around with it constantly) what a given amount of money purchases at any given point in time, relative to a base index that is arbitrarily chosen for purposes of comparison. But (again, citing your own statement) the basket of goods that $1 could purchase in 1913 is not the same basket of goods available for purchase today (other than steak and similar non-subsidized items). Milk and gasoline, for example, could never be compared to their 1913 counterparts because of the intervening government subsidies, tax credits and the like that determine today's prices for those commodities.

    Thus when you adjust the dollar amount of the 1913 DJI for inflation, you are not comparing the asset value of the stocks comprising the DJI in 1913 (which, by the way, were fewer in number than the ones making up the index in 2013) with the asset values of the stocks making up the DJI in 2013 -- you are only adjusting the composite dollar index of those stocks at two different points in time. But since the underlying stocks (and the assets they represent, and represented) were greatly different in 2013 than they were in 1913, I do not see how the approach you are using could yield a meaningful comparison.

    Either you focus on a single parameter -- the decline in the purchasing power of the dollar since 1913, as represented by the two graphs above, or else you try to take into account multiple parameters, such as the basket of stocks making up the DJI in 1913 versus the basket of stocks making up the DJI in 2013 (I believe that GE remains the only company whose stock is used in reckoning both indices). And rather than use a variable like the CPI, one probably should try to normalize time differences by using a factor that is not as variable, such as the GDP Deflator.

    But now we stray too far afield from the original point of the graphs above: the US dollar has declined in its purchasing power (relative to a base index where 1913 = 1.00) to 0.03, in exactly 100 years. And during that whole period, the money supply, which has a significant effect upon purchasing power, was in the hands of the Federal Reserve.

  8. You seem to think that the decline in the purchasing power of the US dollar relative to 1913 has been so bad that average savers have not been able to make any profits or gains in purchasing power in US capital markets.

    I think you're wrong by tens of trillions of dollars. Here's why: The Simpson-Bowles Commission, Republicans in Congress, and most economists all agree that the CPI overstates inflation. Politicians because it doesn't include consumer substitutions like the chained CPI. And economists because it fails to account for goods improvements like we've discusses. So, there's actually been less inflation than the CPI states.

    With that in mind look at this graph:

    You'll see that from 1950-2009 the broader S and P 500 still beat the artificially high CPI by an average of 7% each year. We can play around with trying to find a perfect yardstick to compare purchasing power over time, but the spread is so great that it won't change the bottom line. The American Century was a great time for investors. The purchasing power of the dollar may have gotten killed, but assets inflated too and then they grew greatly. Your original chart tells me merely that guys who stuffed their cash under the mattress got killed, but my chart shows that investors have done beautifully under the Fed's watch.

  9. Pax, Plantagenets -- I think we have the apples now sorted out from the oranges. As you now observe, my original graphs were a pure money picture -- what would have happened if a person in 1913 had stuffed $1 into a mattress for 100 years. His $1, while still legal tender, could buy only 3% of what it could purchase in 1913.

    Then you came along and pointed out that there were many other factors to consider along with the pure monetary one, and we got off onto looking what would have happened if that same 1913 $1 had been invested in the stock market.

    But neither scenario is realistic -- no one I know of would leave money in a mattress for that long, and very, very few investors would have stayed fully invested in just the DJI stocks for 100 years, making the same switches into and out of companies just when Dow changed their index from time to time.

    Your principal point is that investment can beat inflation over time -- which, of course, is one of the motives for people to invest. My point in response is that the return on any investment is dragged down unnecessarily by the inflation that occurs under the Fed's watch, and that, to quote the title of a recent film by the 89-year-old Alain Resnais (and also the title of an old rock song), "You ain't seen nothing yet."

  10. Yes, yes, Peace be with the Curmudgeon.

    I'm sorry if I'm being harsh or quarrelsome. Disclosure: I used to work in finance and to see a smart guy like you question the existence of the Fed rattles me just as if you saw serious thinkers questioning the existence of the DOJ or the Federal Courts.

    I believe that the stock market is a massive pillar of American capitalism, so I want to ensure its dominant gains over inflation are clear. To follow your excellent point about investment if capital markets had flatlined relative to inflation for a century, then we might as well funnel all savings through Social Security and the welfare state, a frightening prospect to us both no doubt.

    There are over a trillion dollars in US index mutual funds that try to ape as closely as possible the same switches into and out of companies that indexes like the DJI and SP500 make. You're right that no one holds them for 100 years, but they are a useful signal of relative wealth over time.

    And yes, you are right that inflation drags down equities and slows economies. Some business cycle inflation is unavoidable even desirable to stimulate investment (the Mundell-Tobin effect), but investors and consumers probably would have been much better off had the Fed put up a bigger fight earlier in the 70's.

    But let's not overlook the other half of the equation. Deflation and bank failures are the kiss of death for economic growth. Since the creation of the Fed, we have been saved from bank panics like those of 1837 (the year after Jackson killed our original central bank), 1839, 1857, 1873, 1893 and 1907 except for 1933 when the Fed wrongly failed to intervene to the agreement of Keynes, Friedman, and Hayek alike.

    I saw a book review of the new Volcker biography in my mail yesterday and learned that Volcker hated inflation because he believed it undermined people's trust in the government's power to print money. Maybe, because I've been on "the inside" a little that doesn't bother me as much, but I see more clearly where you might be coming from.

    To paraphrase Renais's _Hiroshima, Mon Amour_, I just don't want to forget where we've been.

    Signing off,
    The Plantagenets