Keynesians, Gold Standard, Consumer Price Index, Money Stock, Nixon Shock, 1973 Oil Crisis, Gasoline Prices, Hidden Tax and Wealth Transfer

Posted by PITHOCRATES - April 24th, 2012

History 101

With the Increase in the Money Supply came the Permanent Increase in Consumer Prices that Continues to this Date

Keynesians hate the gold standard.  Because it puts a limit on how much money a government can print.  Keynesians believe in the power of government to eliminate recessions.  And their cure for recession?  Inflation.  The government prints money to spend in the private economy.  To make up for the decline in consumer spending.  But it turned out this didn’t work.  As the Seventies showed.  They printed a lot of money.  But it didn’t end the recession.  It just raised consumer prices.  Because there is a direct correlation between the amount of money in circulation and consumer prices.  As you can see in the following graph. 

 Source: M2, CPI

 The consumer price index (CPI) data comes from the U.S. Department of Labor.  The data is at 5 year intervals.  The CPI is a ‘basket’ of prices for a selection of representative goods and services divided by another ‘basket’ of prices from a fixed date.  The resulting number is a price index.  If you plot these for a period of time you can see inflation (a rising graph) or deflation (a falling graph).  M2 is the money stock (seasonally unadjusted).  M2 includes currency, traveler’s checks, demand deposits, other checkable deposits, retail MMMFs, savings and small time deposits.

The Breton Woods system established fixed exchange rates for international trade.  It also pegged the U.S. dollar to gold.  The U.S. government promised to exchange U.S. dollars for gold at a rate of $35/ounce.  Making the U.S. dollar as good as gold.  This set the rules for international trade.  Made it fair.  And prevented anyone from cheating by devaluing their currency to make their exports cheaper to gain an economical advantage in international trade.  The system worked well.  Until the Sixties.  Because of the Vietnam War.  And LBJ’s Great Society.  These increased government spending so much that the U.S. government turned to printing money to pay for these.  Which depreciated the dollar.  Making it not as good as gold anymore.  So our trading partners began dumping their devalued dollars.  Exchanging them for gold at $35/ounce.  Which was a problem for the Nixon administration.  For that gold was far more valuable than the U.S. dollar.  They could print more dollars.  But once that gold was gone it was gone.  So Nixon acted to keep that gold in the U.S.

On August 15, 1971 Nixon decoupled the dollar from gold.  Known as the Nixon Shock.  Reneging on the solemn promise to exchange U.S. dollars for gold.  And ramped up the printing presses.  Which you can see in the graph.  After August 15 the money supply began growing.  And continues to this date.  With the increase in the money supply came the permanent increase in consumer prices that, also, continues to this date.  In lockstep with the growth of the money supply.

Prior to the Nixon Shock Gasoline Prices were Falling at a Greater Rate than the Rate Consumer Prices were Rising 

Since August of 1971 the U.S. has maintained a policy of permanent inflation.  Which caused a policy of permanently increasing consumer prices.  Those high prices we complain about, then, are not the fault of greedy businesses.  They’re the fault of government.  And their easy monetary policy.  In fact, if it was not for government’s irresponsible monetary policy the high price we hate most would not be as high as it is today.  In fact, because of the efficiency of the industry bringing us this one product its price has not followed the general upward trend in consumer prices.  And what is this product?  Gasoline.  Which, apart from two spikes in the last 60 years or so has either been falling or holding steady in comparison to consumer prices.

 Source: CPI, Gas $/Gal

 These prices are from DaveManual.com.  And reflect generally the price at the pump over this time period.  Using at first leaded gasoline.  Then unleaded gasoline.  Using inflation adjusted average prices.  Then chained 2005 dollars.  These prices are not exactly apples-to-apples.  But the trending information they provide illustrates two major points.  The two spikes in gas prices were due to demand greatly outpacing supply.  And that even with these two spikes gasoline prices would be far lower today if it wasn’t for the government’s policy of permanent inflation.

Note that prior to the Nixon Shock gasoline prices were falling at a greater rate than the rate consumer prices were rising.  These trends stopped in the Seventies for two reasons.  The Nixon Shock.  And the 1973 oil crisis.  When OPEC punished the U.S. for their support of Israel in the Yom Kippur war by cutting our oil supply.  These two events caused gasoline prices to spike.  But then something interesting happened with these high prices.  It brought a lot of oil producers into the market to cash in on those high prices.  This surge in production coupled with a falling demand due to the U.S. recession in the Seventies caused an oil glut in the Eighties.  Bringing prices back down.  Where they flat-lined for a decade or so while all other consumer prices continued their march upward.  Until two of the most populous countries in the world modernized their economies.  India and China.  Causing a spike in demand.  And a spike in prices.  For it was like adding another United States or two to the world gasoline market.

Inflation is a Hidden Tax that Transfers Wealth from the Private Sector to the Public Sector

Keynesians love to talk about how great the economy was during the Fifties when the high marginal tax rate was 91-92%.  “See?” they say.  “The economy was robust and growing during the Fifties even with these high marginal tax rates.  So high marginal tax rates are good for the economy.”  But they will never comment on how instrumental the gold standard was in keeping government spending within responsible limits.  How that responsible monetary policy kept inflation and consumer prices under control.  No.  They don’t see that part of the Fifties.  Only the high marginal tax rates.  Because they don’t want to return to the gold standard.  Or have any restrictions on their irresponsible ways.

Keynesians believe in the power of government to manage the economy.  And they really like to tax and spend.  A lot.  But taxing too much has consequences.  People don’t like paying taxes.  And don’t tend to vote for people who tax them a lot.  Which is why Keynesians love inflation.  Because it’s a hidden tax.  The higher the inflation rate the higher the tax.  Because government also borrows money.  They sell bonds.  That we buy as a retirement investment.  But if there’s been a good amount of inflation between the selling and redemption of those bonds it makes it a lot easier to redeem those bonds.  Because thanks to inflation those bonds are worth far less than they were when the government issued them.  Even Keynes noted that inflation was a way to transfer a lot of wealth from the private sector to the public sector.  Without many people understanding that it was even happening.

If you ever wondered why it takes two incomes to do what your father did with one income this is why.  Inflation.  This never ending transfer of wealth from the private sector to the public sector.  Leaving us less to retire on.  Making it harder to save for our children’s college education.  Not to mention the higher cost of living that shrinks our real wages.  While they tax our higher nominal wages at ever higher income tax rates (income tax bracket creep is another inflation phenomenon).  Everywhere we turn the government takes more and more of our wealth.  All thanks to LBJ increasing the government spending (for his Vietnam War and his Great Society).  And Richard Nixon decoupling the U.S. dollar from gold.  Instead of doing the responsible thing.  And cutting spending.  But much like high taxes you don’t win any friends at the voting booth by cutting spending.  So thanks to them we’ve had permanent and significant rising inflation and consumer prices ever since.  And as a result a flat to a falling standard of living.  Where soon our children may not have a better life than their parents.  Thank you LBJ and Richard Nixon.  And thank you Keynesian economics.

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