It’s easy to be overwhelmed by the bewildering array of economic data, statistics, charts, and graphs floating around. Often, we economists can’t see the forest for the trees. It’s hard to figure out what is truly significant and what is background noise. Having made that disclaimer, I offer some data that merit your contemplation.
First are some figures published by Ken Gerbino showing the long-term decline of our currency’s purchasing power. From 1950 through 1965, U.S. gross domestic product increased nearly 160 percent and the M2 money supply rose nearly 180 percent. With the money supply rising slightly faster than GDP, there was a relatively modest increase in prices, that is to say, a relatively small decline in the purchasing power of Federal Reserve Notes.
From 1980 through 2008, GDP increased about 150 percent (a slower growth rate than during the earlier, smaller-government period), but M2 expanded over 450 percent. From this we may conclude that juicing the money supply does not translate into real wealth. If anything, the accommodative (i.e., inflationary) policies of the Federal Reserve have been accompanied by weaker economic growth.
Another table published by Gerbino shows that the U.S. money supply rose from $626 billion in 1970 to $8.2 trillion in 2008, a 1,216 percent increase. During the same time frame, the median income of U.S. households increased a mere 32 percent. I would argue that the 32 percent figure—though true—isn’t completely accurate, because the average household is smaller today. However, the basic point is valid—all that money creation didn’t translate into higher standards of living.
To give you an example of the decline in purchasing power of our feeble fiat Federal Reserve Notes, consider the price of mailing a first-class letter. A stamp cost three cents 50 years ago, so you could mail 33 letters for a dollar. Today, a stamp costs 44 cents, more than 14 times as much, so it would cost you 14.52 Federal Reserve Notes to mail 33 letters. However, if you happen to have a U.S. silver dollar, it is still worth enough to pay for mailing approximately 33 letters today (.77 ounces of silver at $19/oz). Moral: paper currency’s purchasing power melts away; real money retains purchasing power.
Shifting gears, another chart that caught my eye recently depicted the diminishing marginal productivity of debt. I wrote about this very problem two years ago. What we have seen as a long-term national trend is that, as debt continues to mount, it takes more and more dollars of debt to produce a dollar’s worth of wealth.
Due to the financial crackup of the last few years, we have already passed the point of debt saturation—that is, additional dollars of debt produce no net increase of wealth. In fact, data for 2009 tell a distressing story: Each new dollar of debt was accompanied by a net reduction in GDP. In fact, at year-end, each new dollar of debt subtracted 45 cents from GDP (source: U.S. Treasury Z1 Flow of Funds report, 3/11/10). Remember this the next time you hear some economist claiming that Uncle Sam should run even larger deficits to “stimulate” the economy.
Related to the debt saturation issue are two startling charts that I have seen in multiple sources. One plotted the growth of federal spending, the other the growth of federal debt. Both charts show arrows zooming upward at an accelerating rate.
Such chart patterns are familiar to experienced investors. The line on the chart resembles a parabola. From time to time, a certain investment will “go parabolic” (e.g., internet stocks in 1999, gold in 1980). When a chart goes parabolic, it is flashing a danger signal. The piper is about to be paid.
Parabolas represent the blow-off stage of a bubble. Such rapidly accelerating increases, whether in an investment or the amount of a government’s spending or debt, are unsustainable. A devastating bust must follow.
The parabolic charts of government spending and debt point to a wrenching crash ahead. (If I were a prophet and not just an economist, I could tell you when. For more information, see one of 2009’s most important books, “This Time It’s Different,” by Reinhart and Rogoff.) The sovereign debt crisis that is rumbling through Europe today, sooner or later, will hit home.
It won’t be pretty. The sovereign debt crisis might trigger another parabolic blow-off: this one of the Federal Reserve Note, if the Fed follows the recommendations of Keynesian economists like Paul Krugman and implements “quantitative easing” on steroids (that is, hyperinflation). Let’s all hope that I’m reading the economic tea leaves incorrectly.
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