My freshman-year college chemistry professor told the class that there are levels of sophistication that students naturally move to in their study & understanding of chemistry as they progress from memorizing fundamental principles in introductory courses to highly specific, deep expertise in a chosen subfield where they engage in original research, creating new chemical knowledge, & developing critical thinking to solve unsolved problems. At the graduate level & beyond their understanding & mastery moves to another level of sophistication contributing to scientific literature, developing research proposals, & communicating findings through presentations & publications. I always thought that he could have added becoming a chemistry professor like himself to the list..
Taking from the old prof's idea I have come to realize that there are levels of sophistication in economics that Americans naturally rise or fall into - starting with those who have absolutely no understanding of, interest in, or use for economic planning. Such people couldn't care less about handling money. Their lack of sophistication in economics means leading a life of economic illiteracy never having any idea of why their life is so miserable. The other end of the spectrum is a retiree who is a net saver in inflation adjusted terms.
The first group of people described above has not even a basic interest in their own personal financial wellbeing - these people are level 0 sophisticated. For instance such people could have money mistakenly withheld from their monthly Social Security benefit & then neglect to file an income tax return to receive the money withheld. Such people do exist.
Now move a sophistication level higher to the portion of people who profess to have their roots in Reaganomics supply side economic theory but can't wait to get their ever increasing income tax refunds while never realizing that receiving a large refund is a Keynesian principle of demand side economics. April was National Financial Literacy Month & we learned that refunds were received by many people, not just supply siders, way ahead of the April 15th deadline for filing individual income tax returns. The IRS opened the tax filing season on January 26 for tax year 2025 & most early filers expected a refund, as usual, figuring it made no sense letting the government hold their money interest free any longer than the beginning of the year.
But should we expect better economic reasoning from people in a country where over 50% of adults read @ an elementary school level? Source - National Literacy Institute
The rapid inflation of the Covid-19 pandemic years accelerated much faster than wages grew so after some months of losing purchasing power the general public became aware of the affordability issue meaning they had come to realize that things were unaffordable. See graphic below that shows how inflation grew faster than wages. The area between the blue & red lines from April, 2021 through April, 2023 represent the 25 consecutive months that wages lost ground to inflation.
Click on graphic to enlarge
Now the Federal Reserve (Fed) has been tasked by Congress to conduct monetary policy "so as to effectively promote the goals of maximum employment, stable prices, & moderate long term interest rates." Since 2012 the Fed has considered 2% annual inflation measured by the personal consumption expenditure (PCE) index as meeting the stable prices congressional mandate meaning that the Fed is fine knowing that every $50,000 of annual earned income loses $1,000 in purchasing power every year.
People's understanding of the Fed's 2% annual inflation target reveals another level of sophistication in economics. Even from those who are aware of the Fed's 2% target (leaving alone those who are not aware of the target, which reveals another level of sophistication in economics) I have never heard of one complaint to any elected representative regarding this Fed insidious monetary policy that gradually & cumulatively robs us of purchasing power. But when the prices of gasoline, where fifty foot high signs along the highway tell us, or groceries, where the price of everything in the store is marked, go up people get belligerent & an entire affordability movement takes place like in the last NYC mayoral race.
The Fed, under Chairman Paul Volcker, ended the double digit inflation that ravaged the country all through the 1970s & early 1980s after Nixon took the country off the gold standard in August, 1971. After concentrating on an ineffective austerity monetary approach from 1979-1981 Volcker turned his attention to the dollar's relationship to gold which had always been the dollar's anchor of value. It was only after Volcher focused on the value & stability of the dollar linked to gold that he started to get the desired result. Volcker oversaw & guided the quantity of money (base money portion of the money supply consisting of currency in circulation plus bank reserves) by holding the real inflation-adjusted Fed funds rate above the PCE core inflation rate until inflation came down. This was done @ the tremendous cost of double recessions in the early 1980s but the dollar price of gold had been cut by more than half from September, 1980 to June, 1982. From this point until the end of Greenspan's term as Fed chairman in January, 2006 these two men (Volcker & Greenspan) followed a defacto gold standard that kept gold in a relatively narrow range thereby providing a stabilization to the value of the currency. Even then it took over 25 years to break the back of inflation to the point that it was not a major consideration for most of the general public. See graphic below.
Click on graphic to enlarge
The story of the breaking of inflation in the late 20th century is told on the following two graphics. The first graphic shows the Fed funds effective rate raised to almost 20% when the core PCE rate was running @ 10% - both annual rates. The slope of the core PCE rate (red line) moves steadily down over the years as the Fed funds rate is held above inflation & the quality of money follows Volcker's de facto gold standard. The second graphic shows the same information for the blue line read on the left scale expressed as a net difference between the Fed funds rates & the core PCE rates (i.e., the example described above for the first graphic is shown as 10% on the second graphic).
Click on graphics to enlarge
In the 2000s many countries operated under negative nominal interest rates. In the 2010s the United States started operating in earnest under negative real interest rates - i.e., the blue line of the second graphic is below zero from 2008 until the Fed started raising rates in March, 2022.
The following graphic shows that the Fed under Chairman Jerome Powell tried to emulate Volcker's control of the monetary system by raising the Fed funds rate, but, just like Volcker did @ first, Powell did not first focus on the value of the currency linked to the price of gold as the dollar went from $1,605 per troy ounce in March, 2020, when the Covid-19 pandemic caused by the Wuhan coronavirus began, to $5,311 in March, 2026, an increase of 231% in six years. In short Powell did nothing to stabilize the value of the currency before he started raising rates - the same mistake Volcker originally made in 1979 before he realized a pure monetary approach was not working then either. Powell proceeded with a monetary statistical approach using higher interest rates to rid the economy of inflation, like Volcker did, but has found this will not work until a process for stopping the drop in the nation's currency value is put in place.
Click on graphic to enlarge
The high inflation of 2022 started to ease after June when the effective Fed funds rate was just starting to be raised & was still almost 8 percentage points below June's 9.1% YoY inflation rate. So something was different about Powell's inflation problem & Volcker's.
To be sure both bouts of inflation were rooted in the debasement of the dollar - Volcker's by Nixon abandoning the gold standard & Powell's by the massive spending by Trump & Biden. See graphic above entitled "The Link Between Gold & CPI Inflation," that shows the near doubling of the national debt every eight years this century. As Powell's Fed balance sheet expanded we certainly had too many dollars chasing too few goods.
But the year-plus long lockdowns & partial lockdowns ensured that the spending of the Covid stimulus checks were @ least somewhat curtailed resulting in an excess savings of over $2.5 trillion (the amount above what would have been saved if there was no pandemic). In addition to the stimulus checks the elderly also received Social Security automatic annual cost of living increases (5.9% in 2022 & 8.7% for 2023). Price controls enacted in a majority of states further distorted this situation. However, the negative supply shock caused by the lockdowns was short lived as U.S. manufacturers & global supply chains quickly made goods & services available.
Add this all up & you have a graphic (Fed Funds Rate & The Control Of Inflation above) that displays a situation that is different from the Volcker experience. Why would the inflation rate start to come down if real interest rates were still negative, even though less so than before if the above Covid related conditions were not in play?
The Fed has not hit its 2% inflation target in over five years & if Powell's successor Warsh is going to use interest rates the way Volcker did he will never hit the target without raising the real rate above current levels & without linking the currency to gold - i.e., the process will not work any better now than it did for Volcker originally.
It is important to understand that the Fed's modern mandate from Congress is based on the discredited Phillips Curve that found an inverse relationship between unemployment & money wage rates (later expanded by Samuelson & Solow to unemployment & price inflation). Even after the 1970's stagflation misery where inflation & unemployment simultaneously moved higher, the Fed & Congress still think prosperity can be controlled & recessions can be avoided by adjusting interest rates.
At the heart of this still current mistaken method of operation is the idea that growth is bad bringing about inflation & that by raising interest rates inflation can be slowed but all the while hoping that the interest rates are not raised high enough to cause a recession. Shouldn't we have long ago questioned an inflation fighting model that deliberately slows growth & raises unemployment? Reaganomics
Instead of the Fed playing inflation against unemployment by raising & lowering interest rates the Fed should adopt a market-based approach where interest rates are determined by supply & demand market forces that signal where people think the economy is going rather than through their direct intervention & control that is really a form of price control. The Fed's current mode of operation impedes natural price discovery in the market by distorting information that often results in the misallocation of resources leading to suboptimal economic outcomes. This price control point is why I have written that the Fed is the biggest currency manipulator in the world. Naturally, as emphasized earlier herein, the interest rate function comes after the return to the Gold Standard & the sound money it ensures as Volcker & Greenspan demonstrated.
I positioned the last post entitled Dow Jones 50,000 Quiz, that asked readers to strip out inflation from the 4,900 point run up in the DJIA, directly in front of this post as a preview for understanding the impact inflation has on people's standards of living & to point out its importance especially to people about to graduate from high school, vocational school, or college. Those who can see & manage the dynamics involved with the erosion of their money will have a much higher level of sophistication in economics than those who don't. They will have a much happier life.
I think a new graduate should not only note his own personal starting salary but also gauge the standard of living of an older experienced person in his field who makes twice that salary. There he has a good measure in 2026 dollars of what can be realized in that career. For instance a new chemical engineering graduate starting this June @ $85,000 per year should focus on making $170,000 per year in 2026 dollars when he is 62 years old. In order to actually make such a figure his nominal salary forty years hence may very well be over $800,000 per year due to inflation, which has to be stripped out to get the real purchasing power compared to the starting salary & its doubling goal.
Mark down the CPI in June, 2026 & keep track of your salary in 2026 dollars your entire working career focusing on that doubling goal that requires real growth of 1.75% per year over 40 years - say ages 22 to 62. Focusing on the doubling goal may actually result in a tripling goal if you see that doubling your starting salary in real terms will not get you to the desired standard of living - i.e., some career fields have low starting salaries. Along the way you will be able to buy a house, invest in IRAs & 401(k)s, & watch your investments grow as your salary grows. Having a target on work day one is a far superior method of managing the progress of your career than just aimlessly hoping for raises that are masked by inflation that don't readily reveal real purchasing power growth or even worse don't reveal real purchasing power decline. You can adjust the arithmetic for goals of tripling, or more, of your starting salary.
The point is to have an anchor of value to gauge your progress so that you can quickly strip away the inflation portion of any income increases to clearly judge your progress from your starting point & your realistic starting point goal. CPI data are readily available so people who did not begin their careers with this method can easily check on their progress no matter how old they are. See graphic below for the doubling scenario.
Click on graphic to enlarge
Periods like the 25 consecutive months beginning April, 2021 shown on the above graphic entitled "Affordability Display - Inflation Greater Than Wage Growth," leave wages losing ground to inflation. And just last month in April, 2026 YoY inflation escalated to 3.8% while inflation adjusted hourly earnings declined 0.3% from a year earlier. These periods have to be made up in order to reach the doubling goal. Also periods of income growth that do not keep up with the annual 1.75% real rate growth requirement have to be made up because you won't get to doubling @ 0.3% wage growth - the rate for the twelve months ending in March, 2026 when the nominal average wage increase of 3.5% masked the real purchasing power subpar growth. Likewise interest rates have a real & an inflation component that sophisticated investors use one way when borrowing money (looking for negative real rates) & the exact opposite way (looking for positive real rates) when adding to their savings.
After you retire, keep track of your retirement income purchasing power & total asset value & net worth as time rolls on. You'll need the CPI the month you retire, which will never change, & the CPI for the month of your comparison. This is the gauge to use to make sure you are living within your means in retirement so that your money is spent well & does not run out. If your real purchasing power & real net worth increase in retirement you are one of the elite net savers I mentioned @ the beginning of this post. If you have enough data you can determine your own inflation factor & use that instead of the CPI.
At the top of the levels of sophistication in economics is Steve Forbes who defines inflation as "the distortion of prices that occurs when money loses value" & goes on to say "to this day, most economists still don't understand that the critical factor in the 1970s stagflation, as well as in the Great Moderation of the 1980s & '90s, was the value of the dollar."
Every bit @ Mr. Forbes' top level of sophistication in economics is Vladimir Lenin who over 100 years ago said "There is no subtler, no surer means of overturning the existing basis of Society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, & it does it in a manner which not one man in a million is able to diagnose."
When I first read Lenin's remarks as a young man I was inspired to want to spend my time with that infinitesimal portion of people Lenin described who could diagnose & prevent the inflationary ruin of a society that results from currency debasement that this post is all about. Even more importantly, I strived to learn about this destructive force so that when I was fortunate enough to come in contact with these precious few people they would want to spend any time @ all with me.
No comments:
Post a Comment