Jesse's Café Américain: US dollar Purchasing Power

How many ounces of gold can $1000 buy?

The answer over time is instructive. Here is some knowledge about money.

It is remarkable how few economists really understand this, and what it means, what it implies.

Here is Paul Krugman's opinion on the currency war and the US dollar in a recent piece called Godwin and the Greenback.    I think it speaks for itself, approaching the language of economic jingoism.

And he is certainly not the worst economic voice out there, which is what makes this so disconcerting.   At least he is not an austerian, those who would crucify the public for the sins of the one percent.

Thanks to my friend Nick at Sharelynx.com for this.

Nick impishly added in a note that the US defaulted on its gold obligation in 1933 and 1971, a 38 year gap. And it has been 42 years, so we might be due again.

I am not a great believer in cycles. But I am a confirmed believer in what Thomas Mann called the stupidity of cleverness as being among the worst forms of foolishness. It is the capability of knowledge, but without wisdom and sound judgement.

We seem to have a surfeit of clever ones eager to play fast and loose with the nation's currency these days as a means of pushing off genuine reform, and delaying the reckoning between the people and the banks, and the powerful few that control them.

Postscript (Oct25): In discussing this chart further with Nick, I think the data is accurate back to about 1790 or so. As you may recall, the US used various forms of currency prior to declaring its independence. As someone might wish to extrapolate what a currency might have been, relating it to other currencies, so this is what I think has been used prior to 1792.

I would have preferred not to have used it since it adds *nothing* to the analysis, but it is not my call. However I do not agree that this valuation is good prior to 1792 because I do not understand the method that was used to derive it. That does not mean it is wrong. It means that I have less confidence in it that the rest of the chart because it is based on a derivation that I have not examined.

A bubble is a significant increase in valuation supported by a set of artificial, inexplicable, and otherwise unsustainable conditions. The 'increase in valuation' can be nominal as in a price that goes 'higher' without a corresponding increase in value, or a decline in the value underlying the asset while the price remains nominally the same. (note 1)

True bubbles almost always involve some element of secrecy, a cover up, and some dispensation from common knowledge and experience. There are almost always dissenters, voices of warning, that are ignored and even ostracized. "It's different this time..." without there being an identifiable difference, only the self referential rationale.

Stocks are not a bubble because they are going higher and the market is infallible. Housing cannot be a bubble because the housing market is so geographically diverse. You get the point. Not all things that increase in price are a bubble, but this does not mean that bubbles cannot be identified. They can, but when they serve some greater end, the voices of dissent are overwhelmed. Almost all bubbles involve control frauds and the corruption of the media, the analysts, and the regulators, to some degree, through benefits and intimidation.

When the artificial conditions are removed the valuation of the bubble 'reverts to the mean, ' a more normal valuation based on the fundamentals, unadjusted and undistorted supply and demand. An asset bubble often involves a fraudulent design taking advantage of and even perpetuating a corresponding foolishness. In other words, the fraud is father to the folly.

The duration of a bubble does not make it valid or 'the new normal.' Like most chronic conditions it just means that the adjustment will be all the more difficult.

The US dollar as the world's reserve currency, and the unusual period of US prosperity, is an historical artifact of the post World War II era that will not continue indefinitely. When the reversion to the mean occurs, it is likely that the dollar will have to be reissued as 'the new dollar' similar to the rouble in the post-Soviet adjustment. I can think of few better examples of what the US faces than the collapse of the former Soviet Union. For the UK, it looks like Argentina, or Iceland writ large, but with the sharp edge of a police state.

This is my fundamental currency thesis that I have been following since 1997, and it appears to be valid so far. I do not see the resolution in hyperinflation per se, but I do think the new dollar will have a value of about 10% of the current dollar. I think a hyperinflation requires a loss of confidence against some external standard. So the object is to weaken any that might appear.

At some point they will merely knock a zero off the current dollar and demand their surrender for new dollars. That should play havoc with those holding large bundles of 'cash.' For example, if you have $100,000 in savings, and it will afterwards be worth 10,000 in new dollars.

Eliminating 90% of its foreign debt obligations will certainly help to repair the US Balance Sheet. It is possible that this is accomplished in inflation, rather than a more formal evaluation, and over a long period of time, say twenty years or so.

If this seems impossible to you, then you are not aware perhaps that the same thing was accomplished from 1933 to 2000, or 67 years, and should avoid looking at the last chart. The Fed was merely squandering the nation's wealth, without the advantages of modern financial engineering and deregulation. The next leg down will probably be about three times more efficient, under the leadership of Zimbabwe Ben.

Chart from the latest ScotiaCapital FX Presentation

"Facts do not cease to exist because they are ignored." Aldous Huxley

Wouldn't it be convenient for the oligarchs if their think tanks could somehow concoct a story, some plausible sounding theory, to persuade a portion of the world's population to hold dollars, expecting them to GAIN in value, even in the face of significant defaults and credit failures and a deteriorating return in GDP growth per marginal dollar debt? Or even better, getting them to remain fully invested in a series of artificially contrived dollar denominated financial assets that could be selectively 'pulled down' while keeping the overall scheme intact and running. Bernays would be proud.

But the trick is to convince the non-sleepwalking portion of the public to ignore the signs of a failing economy and an approaching currency collapse. This is the sort of black is white brainwashing exercise that occupied quite a few of the whiz kids for the latter part of the twentieth century.

It might take a lot of work, and some high level financial engineering, raw determination to play the long game, public relations professionals engaging invoking slogans and prejudices, and a suite of new financial instruments that would have to be protected even when it was suspected they were fraudulent, but it would be a useful tool for the Übermenschen to have in their toolbox. Nothing works better than to convince a free people to willingly enslave themselves.

Advice for far too many economic forecasters and precious metals analysts.

You know who you are.

Stay thirsty, my friends.

Note 1: The latter case is the most difficult phenomenon to understand, but is behind much of the financial crisis which we are experiencing today. Inflation can occur even if money supply is flat and declining, because it is the level of demand for the money that could be dropping even while supply is constant. A example of this would be Europe in the aftermath of the Black Death, in which case the 'wealth' remained constant but the number of people demanding it were reduced dramatically and precipitously. If the value, the productivity of a country is all that stands behind a fiat currency, if that productive capability is in decline, to be replaced by 'service,' then in fact an inflation can occur even while the nominal money supply is flat or decreasing. One has to consider what is 'backing' the money from an external perspective.

It might be easier to understand if you imagine that a country is on a gold standard, with a constant money supply, but covertly gives away all of its gold. That country will experience a significant inflation which will come upon it seemingly overnight once the confidence, the backing, in the currency is dissipated.

This argues strongly against the monetarists who are pure relativists. Their relativism lead inevitably to central planning and a command economy, ideally a one world government. The need for great and greater control is necessary of the continuation of their fraud. This is why Wall Street banks always seem to be entranced with fascism, or more properly, statism, and why the robber barons chose to build slums rather than vibrant cities. And why the Chinese government fears to stimulate domestic prosperity under market discipline. Its a matter of control. Their end is not an increase in general prosperity, but rather the maintenance and increase of the power of the few over the many, relatively speaking as a close ended system. Your weakness increases my strength.

I will leave the discussion of value for another time, but let it suffice to say that it involves the determination of efficient markets. An efficient market is one that is free of fraud, all information being available to all participants at the same time, with full transparency. Any limitation or even worse, monopolization of information detracts from market efficiency. Transactions are relatively frictionless, and there are strict limits on the use of size and leverage to distort the determination of value. Obviously there are no perfectly efficient markets in this world, but it is useful to have a measure to understand how imperfect that are, and whether a rule or a change makes them better or worse.