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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LESSONS LEARNED #13: “If you were to live under the socialist maxim ‘from each according to his ability to each according to his need’ you would find yourself surrounded by needy people with no ability.” -Old Pithy

Posted by PITHOCRATES - May 13th, 2010

KEY TO CIVILIZATION growth is the food supply.  Food surpluses in particular.  Before dependable food surpluses, life was short, harsh and miserable.  Especially for women.  When they weren’t working in the fields they were giving birth and raising children.  High infant mortality rates, though, inhibited population growth.  Most of the children women gave birth to didn’t survive to adulthood.  So there was a constant state of child rearing.  But few children survived to help with the business of family life.

Malnutrition and famine were common.  Feudalism provided a precarious balance between life and death.  For centuries the common people (i.e., peasants) eked out survival on their landlord’s manor.  The lord owned the land.  The peasants worked it.  Most of the bounty went to their lord.  But they kept what they grew on a small strip of land for themselves.  Just enough for subsistence.

But England changed all that.  By 1750, her agricultural output was second to none.  Private property.  Free market economy.  Capitalism.  Increased productivity.  Specialization.  These all combined to provide incentive.  Incentive produced food surpluses.  Food surpluses produced profits.  Reinvested profits improved farm yields.  This produced more profit.  And the cycle continued.  In less than a century feudalism would disappear from England.  There, you either worked land you owned or were paid wages to work land owned by others.  People began to live longer and healthier lives. 

The British Empire ruled the civilized world in the 19th century.  Representative government.  Abolition of slavery.  Free trade.  The Industrial Revolution.  These things, and others, gave them wealth, power and moral authority.  A lot of good came from this island kingdom.  Including the United States.  They weren’t perfect.  There was a learning curve.  But the modern capitalistic economy which they gave us liberated the masses.  It let us do what we wanted to do, not just what we had to do.  In particular, women, who could do more than just raise families and work in the fields.  One day, she could even become prime minister of Great Britain.

FOOD SURPLUSES BEGET industrialization.  Food surpluses beget everything, really.  Food surpluses release human capital to do everything else we do besides farming.  England was at the van of this modernization.  Others followed.  In time. 

Russia abolished serfdom (i.e., feudalism) in 1861.  Industrially backwards at the time, this liberty awakened a dormant human capital.  They followed the English model.  In time, with the advent of steamship and rail transportation, Russian grain competed with other European producers.

Joseph Stalin, looking to jump ahead in the industrialization process, implemented collective farming in the late 1920s.  He turned away from the English model.  The government became land owners.  It was feudalism on a grand scale.  Large collective farms would produce vast food surpluses that could feed industrial cities.  And there would still be surpluses left over to export to raise capital to build these industrial cities.  At least, that was the plan.

With less incentive came less productivity.  What land the former serfs had come to own was lost to the state.  The state took so much of the harvest that there was little food left for those who labored to grow it.  And the price the state paid for their crops was less than it was before collectivization.  The ‘free’ serfs were earning less and working more.  They didn’t like it.  And chose not to participate.  Collectivization became forced collectivization. 

Deportations, terror, murder and famine followed.  Perhaps more than 5 million starved to death during the famine of 1931 and 1932.  Others were to follow.

Forced collective farming produced famines elsewhere.  In China, during Mao Zedong’s Great Leap Forward, forced collectivization produced even greater famine deaths.  Historians estimate that 20-30 million, maybe more, starved to death in the famine of 1959–62.  Though hard numbers aren’t available, North Korea suffered a devastating famine in the late 1990s that claimed millions.  But in the West, in the 20th century, famine was unheard of.  When the United States suffered during the great Dust Bowl of the 1930s, there was no corresponding famine despite the loss of productive farmland.

WITH INDIVIDUAL LIBERTY comes incentive.  With incentive comes productivity.  A small island nation of free land owners could produce grain to feed themselves with surplus left over for export.  Nations with great fertile tracts farmed by forced collectivization led to famine.  Slaves have little incentive other than to subsist.  The collective good means little to them when they are starving.  They continue to sacrifice.  And continue to suffer.  Even if they do produce a few more bushels of grain.  So if the suffering is the same, what is the incentive to work harder?

As individual liberty declines, those in power tend to exploit those they rule.  In the name of the state.  Or the common good.  This is easy to see when it results in famine or revolution.  Not easy to hide those things.  But it is a little more difficult to see when the results are more benign.  Longer unemployment benefits, for example.  I mean, those are pretty nice.  Hard to see the downside in them.  As it is in other benefits these rulers give us.  So we are seduced as they whisper these sweet nothings in our ears.  And soon we willingly cede our liberty.  A little at a time.

WITH THE RISE of individual liberty, there was a corresponding decline in the ruling elite thanks to representative government.  Great Britain gave this gift to us and the United States took it to incredible heights.  The oppressed everywhere immigrated to the United States to feed a growing industrial demand.  Being new, we did not know all the affects of industrialization.  When the bad things came to light, we addressed them.  Great Britain, for example, was one of the first to protect women and children from the worse of industrial society.  Still, working conditions could be harsh.  As could life in the industrial cities.  Poverty.  Filth.  Disease.  And it was the wretched state of life in these slums that gave birth to a new school of thought on industrialization. 

In 1844 Friedrich Engels wrote The Condition of the English Working-Class to expose life in these slums.  He would collaborate 4 years later with Karl Marx on a treatise called The Communist Manifesto.  And from this Marxism, Communism, socialism, collectivism, etc., would follow.  As economic systems go, these would all prove to be failures.  But the essence of them lives on.  State planning.

You see, it was capitalism that gave us the industrial slums.  And that was good propaganda for a ruling elite looking to rule again.  So they whispered sweet nothings into our ears.  They talked about a Social Utopia.  From each according to his ability to each according to his need.  Fair taxation (i.e., only the ‘rich’ pay taxes).  Social safety nets (paid for by taxes of the rich).  Shorter workdays.  Longer paid vacations.  More government benefits.  A burgeoning welfare state.  Free stuff for everyone.  Again, paid for by taxing the rich who have exploited the working class.

What evolved was the elimination of the middle class.  You had the evil rich (and the middle class were, for all intents and purposes, rich because they didn’t need government help) whose wealth the government taxed away.  And the poor.  The poor who the government would now take care of.  If elected.  And they were.  They seduced a great many people with their utopian vision.  Even in the West. 

Great Britain and the United States would fall to this seductress, too, thanks to the Great Depression.  It was capitalism that gave us the Great Depression, after all.  The greed of the money people.  And so these great nations declined from greatness.  They became welfare states, too.  They had short respites during the 1980s.  Margaret Thatcher helped rejuvenate Great Britain.  Ronald Reagan, the United States.  But the ruling elite whispered more sweet nothings in our ears and the decline continues.

In 2010, our appetite for state benefits appears to be insatiable.  And we may have run out of wealth to tax away to pay for it.  California is on the brink of bankruptcy.  New Jersey elected a governor who proposed draconian spending cuts to stave off bankruptcy.  Other ‘blue’ states (i.e., states who vote Democrat) are also in trouble.  Underfunded pension obligations.  Demands of teacher unions.  Of government worker unions.  Everyone is there with their hand out.  None of them are willing to sacrifice for the common good.  No, they expect others to do the sacrificing.

THE OBAMA ADMINISTRATION has increased federal spending to such record levels that Communist China is concerned about our fiscal/monetary policies.  As they should be; they hold a lot of our debt.  The federal government has ‘bailed out’ private industry and taken de facto control.  They have created a healthcare entitlement that will cost more than a trillion dollars.  More spending is coming.  And it is all for the greater good.  They are vilifying those who are not poor, taxing away what wealth they can from them and giving it to the poor.  When about half the electorate doesn’t pay any income taxes, there is little opposition to raising taxes on those who do.  For if the ‘rich’ complain, the government vilifies them.

Where will it all end?  It is difficult to say.  How will it end?  Badly.  We can look at Europe who we seem to be emulating.  They’re further down The Road to Serfdom than we are.  With the excessive government spending, there will have to be greater government revenue (i.e., taxes).  Previous methods of taxation may prove insufficient.  Hello value added tax (VAT).  It’s all the rage in Europe.  It’s a multiple tax.  At every stage of production, government is there.  Taxing.  From the raw materials to the final assembly, government is there at every stage.  Taxing.  VATs will increase government revenue.  But they will also make every day life more expensive.  VATs increase the sales price of everything you buy.  And you pay it again at checkout.  It’s everywhere.  Everything will cost more.  From manicures to lattes to toilet paper to tampons.  And this is a tax everyone pays.  Even the poor.  It is a regressive tax.  The rich will pay more, but the poor will feel it more.  This hidden tax will take a larger portion of what little the poor has.

But how bad can it really get?  In 2010, I guess the answer would be to look at Greece to see what happens when a country can no longer sustain her welfare state.  And the people aren’t all that keen on losing the government benefits they’ve grown accustomed to.  It isn’t pretty.  But when you start down that road (from each according to his ability to each according to his need), the taking and giving always get bigger.  It never gets smaller.  And when you reach a critical point, government just can’t sustain it any longer.  And it crashes.  Like in Greece.

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