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Mark's Market Blog

7-15-09: That 70's Show: Stagflation

By Mark Lawrence

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In a recent airing of the Phil Donahue show, there was a discussion of the Wall Street bailouts. At one point a member of the audience stood up and, to thunderous applause and approval, said, "Why are the tax payers paying for this bailout? The government should pay!" Sometimes writing this blog feels like trying to empty the Bay of Fundy with a fork.

We're currently running a $1.8T deficit in 2009, and the current projection by the Congressional Budget Office (CBO) is that in the next 10 years we will double our national debt from $11T to $22T. What does this mean? Briefly, the government wants a bunch of money to buy stuff. Big stuff. Important stuff. For more money than they can get from taxes. So, they're going to print a bunch of treasury bonds that total up $11T and sell them in Washington's version of a bake sale. Who buys these bonds? A few go to investors, some go to China, but most of them need a home. This is where the Fed steps in - the Fed buys them. And where does the Fed get the money? The Fed prints it up. Problem solved. In the chart below we see that printing money has been a popular form of finance for our government over the last 30 years, but never before on the scale we're seeing today.

Federal Budget Deficit, 1980 to 2019

What happens when the Fed prints all this money? The simplest answer is that there's more money in circulation. Simplistically, the total amount of money available is proportional to the National Debt. Simplistically, doubling the National Debt means doubling the supply of money. If the economy doesn't change much, then simplistically this means prices will also double. This is what happened when LBJ formed his Great Society and fought the war in Viet Nam, all without raising taxes: inflation. In the chart below we see that this country managed to fight two world wars and a great depression, finance the rebuilding of Europe and put men on the moon, all with relatively stable prices until 1970. Before 1970 inflation in this country averaged about 2.5% per year. Since 1970 inflation has averaged about 6% per year. (Yes, I know the government's CPI figures tell a very different story.) What changed in 1970?

Consumer Prices and Inflation 1915 to 2009

In 1914 the average income in the US in 1914 dollars was about $630 per year, about $15,000 in today's dollars. Today average income is about $46,000. Of course we see immediately it's important to keep track of what a dollar is: we're all very aware of the effects of inflation. The government has an official number for each year's inflation, the Consumer Price Index, but then since most of us think the government causes inflation we doubt their reliability at reporting it. To paraphrase Kissinger, "If a group's stated goal is to take your money, it is not difficult to believe that they are also willing to lie to you." In the chart below you can see that income stagnated and even declined during the Great Depression. After WWII income rose nicely in this country until about 1970, and has more or less stagnated since. Again, what happened in 1970?

National Average Income in 2004 dollars, 1914 to 2006

Before 1970, US Dollars were redeemable in gold. The government fixed and sometimes changed the price of gold, but if you didn't trust the dollar you could demand gold instead. This put a strong constraint on the government's ability to print money at will: if they got out of control, there would have been a run on Fort Knox. In 1971 Nixon took us off the gold standard, relieving the government of having to maintain even the illusion of fiscal responsibility. Since then inflation has tripled and income growth in this country has all but died. In the twenty years from 1950 to 1970 income nearly doubled from about $22,000 to about $42,000 in 2009 dollars. In the twenty nine years since 1970, income has grown from about $42,000 to about $46,000. Notice that I haven't proven that taking us off the gold standard and allowing Washington to print money as they please caused this stagnation in incomes: it could also be that foreign competition kept wages in check. However, absent any limits on the Fed, the Fed's history since the 70's is that under pressure they fold up like a cheap Kleenex and print money to suit their masters, the politicians. This leads to growth-crushing inflation. Today it's generally agreed that but for cheap imports from China there would have been massive inflation for the last ten years; in fact there was massive asset inflation, just not consumer goods inflation.

There is no single commodity which you can follow to measure inflation. Imagine you had a modern 52" diagonal LCD color TV that you could sell in 1914. They had never heard of TV, it would be difficult to advertise what you were selling. Few homes had electricity, there were few people who could plug it in. The electricity was extremely unreliable, so it would be nice of you to include a good surge protector. There was no broadcast TV, so by itself the TV would simply be a weird wall decoration. You could perhaps also sell them a DVD player and a bunch of movies, but you would probably make more money starting up a theatre and selling tickets. Bring back an iPhone to 1914, it doesn't do anything without the cellular network and they would hate our music (Heck, I live here and I mostly hate our music.) And how would you be paid? Their uninflated dollars would be unimpressive today - a top of the line Model T automobile was about $600. If you brought a bunch of their work cloths forwards to today, you could not give them away due to the terrible fit and finish by modern computer-cut cloth standards. It's very difficult to compare products over a long time period. Some people say the perfect money is gold, but the price of gold depends on a lot of things besides inflation, like wars and the threat of financial collapse, not to mention people or countries manipulating the market. I don't know how to choose a unit of value that doesn't change in time, so I'll just use gold, the same way many other people have for 3,000 years.

We've all been told for twenty years now that stocks are always the best long-term investment. We've been told that by the people who sell stocks, but we've been told. Is it true? Below is a chart I've put together of the Dow from 1950 to today in the dollars of the day. Also shown is the price of gold in the dollars of the day, and the value of the Dow divided by the price of gold, which is the Dow priced in ounces of gold instead of dollars. We see from the green line, the Dow priced in ounces of gold, that the story of stock value in the last 10 years has been asset inflation, not real growth in productivity, profits and value. In fact, priced in gold, it's clear that there have only been two true bull markets in the last 60 years: 1950-1965, and 1985-2000. The next bull market isn't scheduled to start until 2020.

The Dow, Gold, and the Dow priced in Ounces of Gold, 1950 to 2009

We see above that from about 1972 until about 1985 gold was a better investment than stocks. Stocks were much better through the '90s, but we see that their advantage has eroded enormously since 2005. Given Obama's apparent love for deficits and massive government programs, it's not hard to draw a parallel between this administration and the Johnson administration of the late 60s, or better yet the Roosevelt administration during WWII. It's not hard to project a decade of inflation and stock and wage stagnation just like the 70s.

Please allow me to clarify something: I'm no fan of the gold standard. I don't like our currency based on such a capricious commodity. South Africa, Russia, China, Peru and Indonesia produce about half the world's gold and don't at all necessarily wish our economy well. However, in the absence of a balanced budget amendment or some similar restraint on politicians, the gold standard is better, imho, than the fiscal irresponsibility we have had for 30 of the last 38 years. As my son Richard aptly put it, "Handcuffs are bad. Criminals running loose are worse." Our criminals politicians have been running loose.

Who will fix this deficit / inflation problem? In the chart below we see that getting the national debt under control was clearly a priority of both parties from WWII until Reagan pronounced that "deficits don't matter." Since then, only Clinton has shown any taste for the discipline to get the budget under control. Why is inflation so popular? There have been huge productivity gains in the US in the last 30 years due to computers and the Internet. Most of these gains have not been paid to the workers or even the business owners. They've been claimed by the government, using deficits and inflation as a hidden tax to grow agencies and programs, making ever more people dependent on handouts and make-work jobs. These days it seems Washington thinks we're back to fighting the Great Depression and WWII. I agree, except this time I think it's Washington who is making the world unsafe for Democracy. The projections in the chart below from 2009 to 2019 are by the Congressional Budget Office; I'm already on record that I think their projections are low by several trillion dollars, by 20% to 30% of GDP.

The National Debt 1940 to 2019; projection by CBO


If you're planning on financing your retirement by investing in the stock market, hoping it will recover in a few months then resume its seemingly inexorable climb to ever new heights, I suggest you make alternative plans. Just in case.

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