In the previous article (The Real Economy) I showed that the purchasing power of the Dow Jones, when it is compared against commodities instead of against "imaginary" dollars, has decreased by about 50% since they year 2000. In this article, I will play with the assumption that the US dollar is still backed up by gold. I am using data from 1901 to the present, because the US adopted the gold standard in 1900. A clarification is needed here, I do not think that gold is particularly useful in any way as money, but since the US used it as money from 1900 to 1971, I think it is appropriate to use it as a constant value.
I created this constant value using the following formula:
1 Dollar / Average Yearly Gold Price = Price of 1 Dollar in Gold
Other studies compare the depreciation of the Dollar to other currencies, or to a basket of commodities. This constant allows us to compare US Dollars to US Dollars and to figure out the real depreciation of the Dollar as compared to itself over time.
From 1901 to 1932, the average price of gold remained pretty constant, at around 20.70 dollars per ounce. This gives us a price of Dollar in gold of around 0.048 ounces of gold per dollar. In 1934, with the New Deal, we have the first jump in the price of gold to 34.7, or, in other words, the first important drop in the price of the Dollar to 0.028. This level remains constant until 1968, when it jumps to 38.69. From then on, it is basically a continuous fall of the price of the dollar compared to beginning of the century (or gold backed) dollars. Nowadays, the price of the dollar is 0.0014 ounces of gold.
Again, if the US Dollar were still be backed by gold, 1-dollar bill would be worth 0.0014 ounces, which is an inflation rate of 3400% or around 32% annually from 1901 to 2007. If you feel uncomfortable with the word inflation, let us just say that gold backed US dollars, have lost an average of 32% of its purchasing power during the past 106 years.
Traditional Republicans and other traditional "small government" conservatives should be happy with this way of looking at the value of the US dollar because the falls in the purchasing power of the dollar match "big government" Democratic programs, like the New Deal and the War on Poverty.
However, most of the current members of the Republican Party (all of the ones who supported the Nixon administration and the current administration) should give up any pretense of fighting "big government". Coincidentally, Vice President Cheney had his first forays in politics during the Nixon administration.
In "imaginary dollars" (dollars that you will not use to purchase anything, or have no backing other than government IOUs) this is how the story of the US looks as told by the Nominal GDP:
As you can see, this is beautiful picture of constant progress where it is impossible to see why people made such big fuzz about this or that war, or why Clinton’s "The economy, stupid" resonated with American voters.
In the following detail, you could conclude that the Vietnam War was good for American economy. It is also hard to see what was so bad about the economy during the Carter years, what Reaganomics was all about, and why the Reagan’s "Morning in America" theme resonated so strongly with American voters.
However, if we use more realistic Dollars (for instance, gold standard Dollars) the story looks completely different.
At this point, a short historical note is needed. The big drop in GDP after 1971 corresponds to the decision by the Nixon administration to nix the Bretton Woods system, and giving up the Gold Standard for good. On that basis, it could be argued that the chart does not reflect the economic reality; however, I shall argue that it is the exact reflection of the economic reality of inflation generated by the Vietnam War, the destruction of the industrial base of the US economy, and in general, the climate of despair and social tension that dominated the Nixon-Ford era. I will further argue that had Nixon not freed the price of gold, his destiny would have been much worse.
As you can see, this chart paints a picture that is more "in tune" with how people actually felt about the economy. Nixon’s ousting and Ford’s presidency show clearly as an acceleration of the GDP in gold standard dollars, and Carter’s economics show as clear economic deterioration (compare to the "nominal GDP" chart and you will see that in the other chart the economy never stop growing). Finally, Reagan’s presidency and his economic measures show clearly as a point of inflection in the chart and the beginning of a period of growth.
The following chart shows why Clinton’s "The economy, stupid" resonated with American voters. As it clear only if we measure GDP in gold standard’s dollars, America’s GDP had been growing steadily from 1980 to 1992, and stalled in the 1992-1993 period.
In contrast, the imaginary chart of GDP looks like this:
So far, I have demonstrated that by looking at the price of 1 dollar in gold we can have a much better picture of the economic reality than by other means of statistical comparison. The reason you get this better picture is that you are comparing "apples to apples" in a way. For instance, you can use this method to see the changes on the prices of commodities. In the following example, I am using Iron Fines. Using the price data in Dollars the chart looks like this:
This chart is misleading in many ways, and it is hard to see the business cycles reflected on the supply and demand of iron. Finally, we have this big spike in the price of iron starting in 2003. Some economist would rationalize that the spike in the price is due to the increased consumption by China. However, China did not start consuming iron in 2003 at a higher rate that would justify the spike.
This second chart, on the other hand, show the adjusted price of iron fines in real Dollars.
As you can see, the chart paints a more realistic view of the increase in the price of iron on a smoother trend. The same spike on the price of iron is present starting in 2004, but it is part of a trend, and therefore more predictable than by looking at the previous chart. What is more, in the first chart, the spike in iron looks out of the ordinary, while in the second chart it looks like one more spike that fits the standard deviation. In other words, it may not be good, but it is not extraordinary. Moreover, on this chart is easy to detect the recessions’ bottoms in 1980, 1987, 1994, and 2003, while showing that, as told by the price of iron, the global economy is in a growing pattern (not a flat pattern as in the previous chart).
Going back to the real economy, where are we now? The Dow Jones chart in real Dollars does not look as exciting now. You see, debt and printing money without anything to back it may act as a drug for administrations with failed policies. They will look at reality with the twisted mirror of the imaginary dollar rather than facing the truth and taking steps to fix the causes of the problem. In other words:
This is the Dow Jones on Drugs (yearly high)
And this is your brain (oops, sorry the Dow Jones)
I know, you liked the argument until it proved that the past seven years have been really bad for the economy. You may still hold to your more optimistic idea, though. After all, you may say, the Dow Jones is just an average of 30 companies, and does not reflect the whole economic picture. And I must agree.
However, when looking at the GDP chart for the past seven years the picture is not as rosy either.
As the chart showed the failed economic policies of Carter, and the changes created by Reagan, it also shows that the current administration has destroyed American wealth at the same rate that the Nixon administration did.
By the way, did I mention that Cheney’s first forays in politics were during the Nixon administration?
The previous chart brings me to the last chart I am going to show here. If you wonder where all of that GDP is going, the answer is simple: to oil-producing countries.
We are witnessing the distribution of wealth from America to these oil-producing countries at a rate we had never seen before. Not even during the Carter days was the transfer of wealth so pronounced.
If history brings any lessons, I would say that Bush and Cheney will suffer similar historical destinies to Nixon or Carter. Although it does not seem foreseeable at this point (with less than one year to general elections) that Bush and Cheney would be Nixoned out of office, I do think that this administration will leave office in shame.
The middle class is hurting, the working class is hurting, and the only barrier between that hurt and the expression of anger in the streets is a sense of patriotic duty. In other words, Bush is not dealing with angry people around the White House because the American people are "taking one for the team". I am not sure the Democratic Party or the Republican Party are fully aware of the reality in the American homes. I think that they take this patriotic silence for complacency, and they are wrong.
At this point, it is going to be very hard for the Republican Party to find an "outside" candidate, somebody who is not perceived by the public as entangled in these failed international and economic policies. From the Democratic side, I would not be surprised if the next few months show dramatic changes on the playing field, with currently ignored candidates coming to the forefront, and even some figures who are not running yet, entering and wining the race.
Franklin @ November 7, 2007