I Will Gladly Pay you Tuesday for a Hamburger Today

There has rightfully been much discussion lately regarding inflation.  Some want more, some don’t want any and some think it’s just right.  Now we aren’t talking about Goldilocks and the Three Bears so we should try to understand if there is an absolute truth regarding inflation.  Let’s start by taking a look at monthly aggregate inflation but in terms of the value of a 1914 dollar over time.


The chart is telling us for every 100 cans of Coke a dollar would buy us in 1914 today it only buys us 3.6 cans.  Another way to look at it is that one dollar today buys us only as many goods as 3.6 cents bought us in 1914.  The implication of this is that if you earned a dollar in 1914 and held onto that dollar until today you’ve lost almost 97% of the purchasing power of that dollar.  If instead you had purchased some hard commodity with that dollar in 1914 and hung on to it all these years you could now sell that commodity for around $2770.  Now sure I’ve had worse trades but not on what I expected to be risk free savings.

So what does this matter?  Well think if you had lent money to someone in 1914 say on a 30 year loan similar to a mortgage.  The purchasing power of the dollar you lent them in 1914 was much greater than the purchasing power of the principle returned to you 30 years later.  Now of course there is interest on that loan and so what you lose in inflation you should make up on financing costs.  This is exactly the problem today.  The market is being distorted by a central bank manipulating interest rates so that rates are not in line with inflationary risks.  The result is that natural lenders, meaning those who must allocate finite resources efficiently, are choosing not to lend to the US because the risk of lending far exceeds the reward of lending i.e. expected inflation is much greater than current interest rates.  And so we have created a spiralling effect that will be very difficult to stop.  Specifically, we don’t have a sufficient amount of natural lenders which forces us into having the Fed print money and use that money to purchase debt from the Treasury (monetization of debt).  This creates low interest rates by artificially creating bond demand and thus higher prices for bonds (as bond prices rise, interest rates decline).  The spiral effect occurs because as we print more money the risk of future inflation increases yet the interest or reward for lending decreases further depleting natural lenders in the market.  This results in a need for more and more money printing further exasperating the problem and the spiral effect worsens, which is exactly where we are today.  The elephant in the room is how do we ever stop printing with very few natural lenders left in the market without having economically crushing increases to interest rates?

An interesting observation to note from the chart is that periods of war correlate to the sharpest periods of inflation.  Since WWII we’ve been in almost a perpetual state of war.  But looking at the time periods of WWI, WWII and Vietnam, three of the most expensive wars in real dollars, we see the highest rate of devaluation of the dollar.  No moral commentary here just an observation but it does tend to substantiate Ron Paul’s claim that warfare leads to inflation.  In reality it is not war per se, it is the artificial increase in economic activity that war represents. That is, fiscal and monetary expansion occurs during war and that printed money leads to government spending which goes into the economy to purchase supplies for the war.  This represents a significant increase in private earnings, both corporate and individual, as supply manufacturers require increased employee levels to accommodate increased production levels.  The problem is that as incomes increase the purchasing power of each dollar of income is declining.  Once the war ends the excess economic activity and thus employment declines to natural (non wartime) levels, yet the real income remains at the devalued level as money supply is inelastic to the downside.  This means less real income and so it’s a hit to families’ standards of living.  At the same time, the country has higher debt levels to manage which means more income must be diverted to debt and debt service via taxes or further printing must occur and thus further devaluation.  This is the boom bust cycle of money printing.  It can certainly lead to short term stimulation but has long term and permanent negative implications (i.e. reduced purchasing power).

So that all seems pretty precarious but if we’ve been doing this for one hundred years and everyone has managed to live pretty well throughout that hundred years why is this such a corrupt practice?  After all isn’t quality of life the real measure of a policy’s success?  Well let’s think about what happened to the early mammoth hunters once they discovered more ‘efficient’ methods.  Tribes’ quality of life increased for a short period of time while their bellies were always full.  However, at some point they depleted the balance of their natural economy.  Specifically they killed off the mammoth and they starved.  Similarly, in 1914 we implemented a new method of economic stimulation.  In 1971 we discovered that if we simply print money and monetize debt we can have unlimited spending which allow us to continuously run trade and budget deficits as far into the future as we can plan.  We can rest assured, however, that we are no different from the early mammoth hunters.  We have distorted the natural balance of our economy and although we might have lived high on the hog for a while there is a certain end to the high life.  It comes in the form of a depletion of purchasing power.  This is no secret to those who study the subject and is clearly depicted in the chart above.  Our 1914 dollar is now worth only 3.6 cents of purchasing power.  It isn’t long before that hits zero.  This is being hidden, in part, because other fiat currencies are being devalued in the same way and so as there is a facade of relative strength but what we will find is that relative strength is only superficial.  When it does finally break it will shatter like glass, not bend like steel.  I’m not sure how I or anyone can make it more clear than the chart presented above.  We are heading to zero purchasing power and we are close.  So if you’re game I will certainly pay you on Tuesday for a hamburger today.