Saturday, February 25, 2012

No, the dollar did NOT really lose 95% of its value since 1913

There is a chart making the rounds lately,  that claims the dollar lost 96.2% of it value since 1900.  One of Ron Paul's fav talking points. Though technically true in a very narrow sense, if you look at average incomes during the same period, it is clear why this is deceptive.  Additionally, the way the line chart is presented is highly deceptive. It makes it seem that there has been higher inflation in the last 40 years.  But if you look at the actual numbers in the chart, that is clearly not the case. See the last 2 paragraphs for more detail.

Let us take at the period from 1913-2006, where we have complete data. So what do they mean, when they say the dollar lost 95.1% of its value in those 93 years? Essentially, an average good/service that cost $1 in 2006,  used to be priced at 4.9 cents in 1913. In other words, the average price level of goods/services increased by 1930% since 1913.  True, but guess what, average earned income increased by 6560% during the same time period. Average earned income rose from  $740/yr in 1913 to $49,300/yr in 2006.  Adjusting for inflation, $740/yr in 1913 is $15,000/yr in 2006 dollars.  Average incomes, not only kept pace, but beat price inflation by 230%.

So does it make any sense all to say the dollar lost value?  In reality, the REAL purchasing power of the average American, has increased by 230% in the past century.  Sure, prices were cheap in 1913, but $740/yr doesn't buy you a whole lot, not anymore than 15,000/yr today.  Even this statistic doesn't fully capture the quality of life gains of the last century.  A household making $15,000/yr today is well below the poverty line, but yet, they are highly likely to have a refrigerator, indoor plumbing, electricity, tv, cell phone and maybe even heating and cooling.  They are highly likely to have government help in making ends meet - food stamps, subsidized housing, Medicaid etc:.  And yeah, thanks to advances in medicine, they don't have to worry about half their children dying before the age of  5.  Their analogue in 1913, making $740/yr had none of these "luxuries".  And that was the average income...  Can you imagine what the poverty line looked like then?

Anyone who says the dollar lost value, is really trying to sell the false point of view, that somehow things were better off in 1913.  Seriously?? Maybe we should send them back in time to live in the slums of New York.  Yeah, we had actual slums back then. Update 3/2/2012:  Yes, technically, in the parlance of mainstream economics, the dollar dropped in value.  But, anytime Ron Paul says the dollar lost 95% of it value, but conveniently ignores the fact that average incomes and average savings beat price inflation, he is deceiving the American public.  The fact the incomes and savings beat inflation, it makes the "fall" in the dollar completely irrelevant.  What I am saying is we need a change in terminology. 

Inflation Adjust Average Income 1913-2006 (2006 dollars) h/t

 Further more, according to the ridiculous logic in the article, the dollar "gained" in value during the great depression.  This must have been a very prosperous time. Maybe we should start another depression so the dollar can "gain" in value. The dollar "gaining" in value is deflation, and that is rarely a good thing, especially for debtors.  Deflation doesn't usually happen in prosperous economic times. The question should not be whether the dollar "gains" or "loses" in value.  The question should be, will incomes beat inflation?  That is the real metric of progress.

During the pre-depression years (1913-1929) average incomes barely kept up with inflation.  During the market liberalization era (1979-2006),  things were slightly better, but not by much. Average incomes beat inflation by just 22%.  Most of the real income gains of the last century came during the high tax, "big" government New Deal era (1933-1973), when average REAL income increased from $9,980/yr to $40,500/yr. In other words, average incomes beat inflation by 300%.  Had real average income grown at the same rate during 1979-2006,  it would be $97,200/yr in 2006!!  The contrast is even more stark, if you look at average real income of just the bottom 90%. For them, average incomes beat inflation by 400% during 1933-1973, as opposed to 1.6% during 1979-2006![1]

In addition, the line chart showing the price level, is  highly deceptive. It makes it seem like there has been higher inflation for the last 40 years. But, inflation is not a linear dataset[2]. Note that the 2nd highest inflationary period in the chart was 1910-1920, when the dollar "lost" half its value (and yes that was during the gold standard).  In other words inflation was 100% in the 1910s, while it was 33% in the 1990s and 28% in the 2000s  But yet the chart makes it look like the 1990s and 2000s have a steeper slope than the 1910s. If the chart were accurately depicted they would use percentages.  This is how Fox news style propaganda works, take factual data and present it in a deceptive way, to sell a false point of view.

Perhaps the point of view they are selling, is that inflation has been higher due to the termination of gold convertibility in 1971. And it does seem many of the post's commenters perceive it that way.  That is clearly, not the case, inflation was pretty normal for most of the 80, 90s and 00s. Yes, the 1970s was the decade with highest inflation rate at 104% (just beat the 1910s by 4% points). But, the primary reason for high inflation in the 1970's and early 1980s were the twin oil shocks of 1973 and 1979.  If you compare inflation vs crude oil prices from 1973-1984, they track pretty close together.  Crude oil prices nearly tripled within a few months starting in late 1973, and that is not going to affect the prices for other goods?  You know, oil is used for transportation of other goods. What a coincidence that inflation peaked right after the oil shocks, twice.  What a coincidence inflation subsided, right after crude oil prices fell of a cliff in 1982-83.  Nothing whatsoever to do with termination of gold convertibility.

Update 3/1/2012:

Many Ron Paul supporters make the argument that the real value of a dollar saved in 1913, would only be worth 5 cents if spent today.  Yes, that would be a valid point, if we assume, that we live in a parallel universe where everybody holds mostly cash savings.  Let us look at data from the real world, that looks at non-home wealth distribution (mostly financial) from 1983-2007. See page 46 in the pdf.  You see three distinct classes. First, the bottom 40% household with an average net financial wealth of $-10,500(yes negative). Then, the 3rd quintile (40-60 percentile) who have little net financial wealth on average (just $26,500). And finally, there is the 4th and top quintile who have most of US net financial wealth.

Paul's argument is completely irrelevant for those bottom 40%, who have no savings. They live paycheck to paycheck. A little inflation, will actually help reduce their debt burden. Thus real income gains are what matters for these folks, and to enable that we should rollback market liberalization .[3]  For the top 3 quintiles, their non-home investments beat inflation on average by 122%, 83% and 66% in 24 years. Even the 3rd quintile who had no REAL income gains in the same period, gained 66% in their financial investments.

I will grant you, this was in 2007 before the financial crisis. By 2012, at most the cumulative returns were cut by half. They still beat inflation. The point is real people, who have actual savings are clearly NOT holding 100% cash.  If they were the average REAL return would have been negative 52%.  In reality, liquid assets only comprise 6.6% of all assets in 2007. Obviously this category include money market accounts. Hell, even money market accounts and online savings accounts had returns that beat inflation 5 years ago, before the Fed funds rate was cut. Same was true of time deposits. And usually in normal times the FFR is set higher than inflation.


1. All average income figures in chart and rest of blog in 2006 dollars. Source: Emmanuel Saez  UC Berkeley   Table A4 based on IRS data
2. Inflation isn't linear.  If you have 9% inflation/yr over 10 years, the price level doesn't increase by 90%.  It increased by  1.0910 = 2.37 or 137% .  From 1910-1920 the price index rose from 1.1 to 2.2,  while in 1990-2000  14.7 to 19.6.  Which decade shows greater price inflation?  The line chart deceptively makes it seem like it was the 90s.  But, really prices doubled (100% increase) in the 1910s, while it only rose 33% in the 1990s.
3. The main reason the bottom 40% are in this quandary, is due to market liberalization, as more and more share went to top 1%, less went to them. That wasn't always the case, from 1933-1973 the average income of the bottom 90% beat inflation by 400%.