Chart Porn Marathon (The revised and extended version)

Barry Eichengreen and Kevin H. O’Rourke have been updating us on the progress of this depression by comparing it to the big one, The Great Depression. Their original post on April 6, 2009 captivated their audience, and we also ran some commentary on it here.

One thing that struck us was that we might compare the two events to the totally overlooked depression of the 1970s – The Great Stagflation. The reason why this one is missing and, perhaps, lost from official economic history is that it did not resemble the widely accepted official definition of a depression. For instance, as shown in the graph below, year over year Gross Domestic Product enjoyed an unbroken expansion during the entire period.

Chart 1 (Source: Bureau of Economic Analysis)

Compare this performance to the contraction of GDP during the Great Depression

Chart 2 (Source: Bureau of Economic Analysis)

However, when The Great Stagflation is subjected to the critical observation of the varying price of an ounce of gold over the same period, the contraction of the economy easily exceeds both the present contraction of economic activity in intensity, and its more infamous companion of the 1930s in both intensity and duration, as shown below.

Chart 3 (Source: Bureau of Economic Analysis)

Moreover, in this snapshot of the decade we can see evidence of the 1973-1975 recession, which bottoms in 1974, yet shows no evidence of its existence on the chart above. It appears as a dead cat bounce – a momentary recovery before the final leg of the depression unfolds.

Be that as it may, the Great Stagflation presents a bit of a problem: Although gold tells us it occurred, Gross Domestic Product, as measured by dollars, actually ended higher than it began in the 1970s contraction. Peak unemployment, though higher also, was nowhere near the peak of the Great Depression. U.S. trade volume positively exploded, whereas it viciously contracted during the Great Depression.

Here is a comparison between these two depressions, with the current depression thrown in for good measure.

Chart 4 (Source: Bureau of Economic Analysis)

When we use gold to measure the progress of the current depression an altogether striking contrast emerges with the official portrait. Not only are we in a depression, but that depression has been clearly evident since 2000.

Chart 5 (Source: Bureau of Economic Analysis)

Again, between 2004 and 2005 we see evidence of some slight flattening in economic activity, as the housing bubble reaches its crescendo. The bounce, however, is nowhere near that of the 1973-1975 period. The real similarity here is to the steady progressive decline of economic activity during the Great Depression as shown in chart 2 above.

There are two possible explanations for why these three depressions appear so different: Either gold is wrong, and what happened in the 1970s wasn’t a depression. Or, gold is right and the accepted definition of a depression is wrong. In the former case, what is happening now is not a depression. In the latter case, what is happening now is a depression at least approaching the duration of the 1970s and the intensity of the 1930s.

So, how do we break this analytical impasse?

The important thing to remember here is that until 1933 there was only one measure of GDP. As the Great Depression unfolded it was expressed in the single footprint of a dollar pegged to a definite amount of gold. By 1971, the United States defaulted on the Bretton Woods agreement and no longer honored its commitment to settle its international obligations in gold. The dollar was allowed to float against gold, and thus emerged a discrepancy between the two measures of economic activity.

Gold continued to reflect the true value of economic activity only through the inverse action of its dollar price. Whenever economic activity contracts, the dollar price of gold rises. During expansions the dollar price of gold falls. Using the dollar to measure whether we are in a depression or not, therefore, may not only be useless, it can be misleading.

To put it simply, the Great Depression looked like a depression because it was being measured in gold. The Great Stagflation does not look like a depression because we measure it in worthless dollars. When, however, we measure the Great Stagflation and the Great Recession against gold, it is clear each are every bit as true depression events as was the Great Depression – and both are larger, longer, and more intense events.

We will return to this point later. For now we will look at some other interesting data over the same period.

THE COLLAPSE OF WAGES

One of the most visible measures of the condition of working families is the price level of a day’s wages. So, we figured it might make sense to subject those wages to the same sort of analysis we used in the above section: the withering criticism of gold prices over the period. Here is a chart of an average day’s wage since 1964, as presented by the Bureau of Labor Statistics:

Chart 6: Average day's wage in dollars (1964-2010) (Source: bls.gov)

As is befitting a labor force enjoying the prosperity of the freest, most productive, nation on the planet, we have seen our wages rising for the entire period from 1964 to 2010. Even through depressions as intense as that of the Great Stagflation (the first set of green and red bars) and the current Great Recession (the second set of green and red bars) the average day’s wage of American workers has never fallen year over year.

Unfortunately, things are not so rosy when the value of a day’s wage is measured by an ounce of gold:

Chart 7: Average day's wage in gold (1964-2010) (Source: bls.gov)

As measured by gold, the value of a day’s wage reached its zenith in 1970, when those wages measured in dollars were a lowly $28! Although a day’s wage more than doubled to $57 by 1980, their value, measured by gold, fell by 87 percent to just 13 percent of their magnitude when the Great Stagflation began.

From this low point in 1980, wages again double to $118, while the value of those wages jump 4.5 times their 1980 lows. However, this gain only brings them to about 61 percent of the value they had in 1970. This gain also marks the top of the business cycle as the value of a day’s wage again turns lower in our current depression – falling to the present level.

In 1970, a day’s wages could buy nearly three quarters of an ounce of gold; by 2010 those wages could only buy a little more than one eighth of an ounce of the metal. Your wages have quintupled since 1970, yet you actually have become poorer. If you are making the average hourly wage of $19 per hour, you are experiencing a level of poverty that was unimaginable to your grandfather, who made only $3.50 an hour in 1970.

HOME PRICES VERSUS WAGES

Above, we showed how wages performed against the price of gold over the period of 1964 to today. As you saw, wages over the period performed quite poorly in comparison to an ounce of gold – falling from about 72 percent of an ounce of gold to about 44 percent of an ounce of gold between the start of the Great Stagflation and the start of the Great Recession. This was a 39 percent fall in the value, or purchasing power, of a day’s wage as measured by the price of gold.

We naturally wondered how other commodities had performed over the same period. Our hope was to isolate speculation on the price of gold from the picture, so as to draw a clearer image of what the price of gold was telling us about the change in the purchasing power of a day’s wage between the two depressions. We thought it might be interesting to compare the change in the value of wages to the change in the value of a single family home during the same period.

While the price of a single family home rose steadily between 1964 and 2010:

Chart 8: Median price of a single family home in dollars (1964-2010) (Source: census.gov)

Its value, as measured by gold, at the beginning of the Great Recession in 2001 was about where it had been at the beginning of the Great Stagflation in 1970. By, 1980, at the end of the Great Stagflation, the value of a single family home fell to just 17 percent of what it had been in 1970, but by 2001 it had recovered all of that loss.

Chart 9: Median price of a single family home in gold (1964-2010) (Source: census.gov)

Although both the value of a day’s wage, and the value of a single family home swung wildly over the entire business cycle between 1970 and 2001, the value of a single family home recouped virtually all of its losses, while the value of a day’s wage never recovered. By the beginning of the Great Recession, the median price of a single family home required 64 percent more average wage income than it had in 1970 (1409 day’s wages in 2001 versus 861 day’s wages in 1970).

Oh, but this rape of the average wage worker was not over yet by a long shot!

In 2001, in the opening moments of the present depression, Saint Paul Krugman called on the Federal Reserve Bank and Washington to create a bubble in home prices – a now-burst bubble for which the deadbeat African-American sub-prime borrower has been universally blamed – which sent home prices rocketing from 1409 times a day’s wage to 1854 times a day’s wage by 2007!

Thanks, Paul, for all your help.

THE S&P 500, VERSUS HOME PRICES AND WAGES: How the other half fared

After seeing how the value of housing fared against the value of wages in the 30 years between the start of the Great Stagflation and the start of the Great Recession, we could not help but wonder how the investor fared in those same years. So we decided to plot the Standard and Poor 500 (SP500) index against the price of gold to find out. Here is how the SP500 appears when plotted against the annual dollar price of the index. (The prices are all taken from the last trading day closing price of the index for each year.)

Chart 10: (source: yahoo.com)

As you can see, the green bars line up with the first year of each contraction (as measured by gold) – 1970 for the Great Stagflation and 2001 for the Great Recession. The red bars line up with the end point of the contraction of the Great Stagflation (as measured by gold prices) and the present month of the Great Recession. The SP500 index shows several weak periods – in particular the so-called double top of 1999-2007. Yet, in general, the SP500 index continues to rise for most of the period.

We get a rather different picture once the index is filtered through the price of an ounce of gold:

Chart 11: (source: yahoo.com)

Again, as you can see, the green bars line up with the first year of each contraction of Gross Domestic Product (as measured by gold)and, the red bars line up with the end point of the contraction of the Great Stagflation (as measured by gold prices) and the present month of the Great Recession. The yellow bars are thrown in to identify market tops in gold terms.

In this view we can now see several things of interest. First, the SP500 index tops out in value (yellow bars) several years before the economy actually begins to contract. Second, the total value lost by the SP500 during the Great Stagflation is even greater than that lost by the Dow during the Great Depression. Between 1929 and 1932 the DOW lost 89.2 percent of its value; in the Great Stagflation, the SP500 lost 92 percent of its value from its top in 1967. Were we to date the Great Stagflation by the same indicator we date the Great Depression – by the fall of the stock market – we would probably give 1967 (the first yellow bar) as the year it began.

The Great Stagflation exceeded its more infamous companion, the Great Depression, by every measure – not simply in terms of the severity of economic contraction, as measured by gold, but also in the devaluation of financial assets. That this is not commonly understood is solely due to the obscuring impact of dollar prices.

Third, unlike both the value of a single family home, and the value of a day’s wage, the SP500 not only fully recovered its value from before the depression, it went on to nearly double its value by 1999 – when it again topped out.

Chart 12: Comparison of performance of the SP500, home prices and wages between 1970-2000

The value of wages fell to about 60 percent of its former peak between the beginning of the Great Stagflation and the beginning of the Great Recession. The value of a home just about recovered its former peak in the same period. But the SP500 increased in value by 86 percent!

GOLD AND DOLLARS

The value of a day’s wage, a home, or an investment portfolio and the value of an ounce of gold – how much of one can be exchanged for the other – is, of course, subject to fluctuations arising from supply and demand, the business cycle, and the improvement in the productivity of work.

If, for instance, there is a shortage of labor power, we can expect it to trade above its value; if there is a surfeit of labor power it will trade below its value. During periods of economic expansion, we would expect it to trade at the upper end of these fluctuations; and contractions would lead it to trade toward the lower end of those fluctuations. Improvement in the productivity of gold producers might either outstrip or lag that of the producers of a typical basket of goods which compose a working class household budget.

All of these influences mean that labor power will only trade with gold at an exchange ratio reflecting their relative values over some period of time, and through a lot of market noise. It would be impossible to say with any accuracy whether any given wage was actually THE value of that commodity. So money has always been a bit of a problem for economic analysis, since it can often obscure as much as it reveals about what is happening in an economy.

Now, let’s add another wrinkle.

Since 1971, the dollars in which wages and home prices are denominated are worthless, and, therefore, completely incapable of reflecting the value of anything. Since the dollar in which wages are denominated is itself subject to fluctuations in its floating exchange ratio with gold, we are dealing with three independently moving variables – each of whom are subject to the peculiarities of their own processes: a basket of commodities composing the purchasing power of a day’s wage, gold, and the debt manufacturing (i.e., money creation) process. And, all of this is unfolding in the context of a vast global economy.

There is, in short, an area of indeterminacy to this process through which your Nana could drive a Mack truck, pulling her RV, SUV, and tricked out Harley, while Grampy is snoring, mouth wide open, in the passenger seat.

It should be no surprise, then, that economic data presents two entirely different pictures of what is happening in the economy depending on whether we analyze that data through the lens of dollar prices or gold. The question for us is which lens one should we believe?

DEPRESSIONS, INTEREST RATES, AND GOLD

So far, we have presented evidence that the price of gold, rather than simple dollar prices in general, should be the basis for any analysis of what is taking place in the economy.

We have shown that, when measured against the price of gold, there have been three distinct depression events in the U.S. economy, since 1929 – The Great Depression (which is generally accepted), the current Great Recession (which is subject to an ongoing debate), and the Great Stagflation of the 1970s, which is generally not interpreted as a depression event, but as a period of unusually high inflation and unusually high unemployment.

We offer one more piece of evidence which may, or may not, add credence to our assertions – interest rates. Below is a chart of the so-called Fed Funds Rates (FFR), since 1955.

Chart 13: (Source: Federal Reserve Bank)

According to the Wiki:

In the United States, the federal funds rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight. It is the interest rate banks charge each other for loans.

The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.

The federal funds target rate is determined by a meeting of the members of the Federal Open Market Committee which normally occurs eight times a year about seven weeks apart. The committee may also hold additional meetings and implement target rate changes outside of its normal schedule.

The Federal Reserve uses Open market operations to influence the supply of money in the U.S. economy to make the federal funds effective rate follow the federal funds target rate. The target value is known as the neutral federal funds rate. At this rate, growth rate of real GDP is stable in relation to Long Run Aggregate Supply at the expected inflation rate.

Simply put, the Federal Funds Rate is used by the Federal Reserve to maintain a steady upward pressure on the flood of dollars into the economy. By this means, Washington hopes to maintain a constant inflation of prices, or, what is the same thing, to maintain a constant illusion of scarcity for you and your family.

Since the rising price level always outstrips your wages, Washington is able to provoke in you an almost constant feeling of economic insecurity – to which feeling of insecurity you respond, like Pavlov’s Dog, either by increasing your hours of work, throwing more members of your family onto the labor market, continuously searching for a higher wage (or, all three).

The FFR is, in other words, a cattle prod for sheeple – for human cattle, like you.

Baaaaaa!

There are a lot of conventional economic theories floating around about where the FFR must be set by the Federal Reserve to respond to the varying economic conditions. These theories are worthless – period, end of statement. One particular theory proposed by economist, Irving Fisher is the gold standard for the kind of simple-minded mainstream economic thinking prevalent today. According to Sam Williams, who blogs at A Critique of Crisis Theory, Fisher’s simple-minded theory can be summarized this way:

…interest rates should be at their highest when prices are rising at their fastest rate and lowest when prices are falling at the fastest rate.

This is standard mainstream economist reasoning. The rate of interest should include a premium for inflation; so, if inflation is high, interest rates should also be high. When inflation is low, interest rates should also be low. We should be able to test this theory by looking at two periods in particular: The Great Stagflation (from 1970 to 1980) and the Great Moderation (from 1981 to 2000). Interest rates should be high in the 1970s, when inflation raged through the economy; and rates should be low in the 1980s and 1990s, when Alan Greenspan was managing the miracle of Reagan’s low inflation moderate growth legacy.

(Of course, what all these varying views within accepted economics really have in common is the idea that the Federal Reserve has control over interest rates – they don’t. Yes, you read it here first: The Federal Reserve Bank of the United States of America has no control over interest rates whatsoever. All they control is the flood of worthless Federal Reserve Notes inundating the economy.)

One dissenting theory, of fairly long standing, was put forward by Karl Marx – infamous author of the Communist Manifesto. Marx disagreed with the conventional wisdom and this disagreement is summarized in the above rather dense post by Sam Williams in response to our question on the subject of Gibson’s Paradox. According to the Wiki, this paradox – so named because it contradicts conventional economic theory on interest rates –  “is named for British economist Alfred Herbert Gibson who noted the correlation in a 1923 article for Banker’s Magazine.” Mr. Gibson’s study contradicts conventional economic doctrine and agrees with Karl Marx on the issue:

… we would expect at the peak of the industrial cycle when the general price level is at its highest, the rate of interest, including long-term interest rates, would be at its peak. This would be true both in terms of the real money (gold) rate of interest and in terms of the commodity, or real, rate of interest. The currency rate of interest would be the same as the gold rate of interest under the gold standard.

The opposite situation prevails during the downward phase of the industrial cycle. This is because (1) the purchasing power of gold increases as prices fall. And (2) there is a decline in the quantity of real capital in terms of use values. Inventories—commodity capital—are reduced, and a portion of the fixed capital is physically destroyed as well.

Sam Williams, if his interpretation of Marx is correct, concludes that interest rates will always be highest just before the onset of a depression, when prices and wages are at their highest point. Interest rates will fall when prices fall. This change in the rate of interest has nothing to do with the rate of change of prices, but only with the absolute level of prices.

Williams says this change in interest rates will be confined to real (i.e., gold) money, and may be less evident as the dollar’s peg against gold is weakened; it disappears as the peg to gold is altogether eliminated:

Notice that Gibson’s paradox between the predictions of marginalist theory and reality applies only as long as the gold standard is in effect. The “paradox”—in terms of marginalist theory, not our Marx-based theory—is weakened when the gold standard is weakened and pretty much disappears when the gold standard is abandoned.

Williams makes a good observation, but this is not a complete statement. It is true that the relationship is not evident if we confine our examination to dollars. If, however, we include the price of gold in our calculation, we come to a startling confirmation of Marx’s theory. Below is a chart of the price of gold between 1955 and 2010.

Chart 14: (Source: gold.org)

Again, we plot the beginning and end of the Great Stagflation in the first set of green and red bars, and the beginning of the Great Recession until 2010 in the second set. Gold prices peak in 1980, fall until 2001, and then rise to another peak in 2010. According to Sam Williams, interest rates should be highest between the red bar at the end of the Great Stagflation period and the green bar signaling the beginning of the Great Recession. During the Great Stagflation period, and after the beginning of the the Great Recession, we should see low interest rates.

Now if we go back to chart 13 above, we see that the historical data for the Federal Funds Rate shows no such pattern as imagined by Williams. Instead we have a period of rising interest rates until 1981, and a period economists refer to as The Great Moderation – basically lasting until now – when we “enjoyed” both declining inflation and falling interest rates. This was the period of the Reagan Revolution, and Morning in America lasted for nearly two decades! Of course, the damage to your wages had already been wrought by the Great Stagflation of the 1970s – a point generally overlooked by economists – so any improvement was only relative to the devastation suffered by wages at the end of the Great Stagflation.

Economists, as we will continue to emphasize on this blog, are the enemies of Life.

Chart 14 is also the purchasing power of an ounce of gold – how many dollars an ounce of gold can buy. So the purchasing power of an ounce of gold rose continually through the Great Stagflation. The purchasing power of an ounce of gold fell by half in the period leading up to the Great Recession. And, it has been rising every year since 2001.

None of these changes in the purchasing power of gold is reflected in the Federal Funds Rate.

However, economists call interest rates the price of money, and so it occurred to us that there are two costs associated with dollars – the interest rates on debt, and, what Sam Williams calls the “opportunity cost” of not holding gold.

In 1970, a bank could have either loaned you $100 for a year, and collected – say, 10 percent interest, or 3 percent above the FFR – or it could have bought $100 worth of gold, and collected 5 percent on the appreciation of gold. For you, the debt cost ten percent, or $10. For the bank, however, the difference between lending you the money or buying gold would have been five percent – it would make five percent more giving it to you, than it would buying gold.

You have to picture this in terms of gold, not dollars: over the year, the $100 depreciated by five percent against gold – it had less purchasing power. So gold gained 5 percent appreciation just sitting in a safe deposit box.

You, however, added a further 5 percent to the bank’s capital over this sum as interest on your debt. At the end of the year it took $105 to buy the same amount of gold as it did at the beginning of the year, the bank now has $110. The bank only made money because you paid an interest of $10 – raising their capital by $5 more than it depreciated. If your interest rate was 5 percent, the bank would have made no money at all in terms of gold.

Are you still with us? Good – your life depends on it!

To really find out how much the bank makes when it loans out dollars, we have to subtract what it loses when gold rises or falls in price. Or, to put this in terms of gold: To really find out how much the bank could make by buying gold, instead of lending the dollars to you, we have to subtract your interest on the debt from the appreciation or depreciation of the dollar price of gold.

Simply put: When we show you, in chart 13, the FFR target rate for each year, we are providing you with a meaningless number, unless we include the appreciation or depreciation of the dollar price of gold. If the FFR target rate was 5.66% in 1968, but the dollar lost 22.54 percent of its purchasing power in terms of gold that same year, a bank would lose money on any loan which did not at least offset the decline in the purchasing power of the dollar. The cost to the bank of lending out dollars would be the change in the price of gold minus the interest on the loan.

So, here is a chart with the actual Federal Funds Rate for the period 1956 to 2010:

Chart 15: (Source: Federal Reserve Bank)

As you can see, when the appreciation of gold against dollars is factored in, the Federal Funds Rate went decidedly negative around 1970, despite the burst of historically unprecedented inflation and high unemployment. The rate only begins to rise during the so-called Great Moderation of the 1980s and 1990s, before turning decidedly negative again at the beginning of the Great Recession.

The Federal Reserve Bank no more controls interest rates, than a meteorologist controls the weather.

Here is the average FFR interest rate for the periods discussed. including the period before the Great Stagflation. And, as you can see, Marx accurately predicted that the interest rate on real (gold) money would be lowest when the purchasing power of gold was highest – i.e. during a depression – and highest when the purchasing power of gold was lowest – i.e. during an expansion:

Chart 16: (Source: Federal Reserve Bank)

Oh, but wait! There’s more.

You may not remember, but Chairman Ben Bernanke and the Federal Reserve Bank Board of Governors tried to raise the FFR in the middle of this depression. So we wondered how that worked out for them:

Chart 17: (Source: Federal Reserve Bank, gold.org)

It appears that all Chairman Ben got for his effort was a bruised ego – the real interest rates continued to fall.

Marx was right: Economists are simpletons.

WHY THE DEPRESSION OF THE 1970S PRODUCED RAMPANT INFLATION

We showed that Marx’s prediction on interest rates was a key piece of supporting evidence for our contention that his theory of money remains valid, even if concealed beneath the torrent of Federal Reserve Notes flooding the economy. We will now show why the dollar, or, Federal Reserve Note, is not money – not simply because it is completely without an atom of value, but also because it does not behave like money.

When we say it is not money we include all the forms traditionally considered forms of money. Hence, we also assert, it is not credit money, it is not token money, and, it is not fiat money. All of these things bear some definite relationship to a money commodity, e.g., gold, but, this note has no such relation. It is scrip, Monopoly money, dancing electrons – give it whatever description you would like, except money.

There is one distinctive feature of this note that conclusively demonstrates that it is not money: how it behaves when in circulation. To understand how Federal Reserve Notes behave, and why this behavior is different from money, we only have to look at the Great Stagflation and the Great Moderation.

But, first, let’s beat up on economists a little.

Economists generally hold to the view that prices of goods are determined by the amount of money in circulation. This theory of how prices behave is summarized, in its modern form, by the Wiki this way:

In monetary economics, the quantity theory of money is the theory that money supply has a direct, positive relationship with the price level.

A positive relationship between prices and the supply of money means that when the supply of money increases, prices will increase; and when the supply of money decreases, prices will decrease. This relationship will generally hold no matter what object serves as money – in fact, according to the Wiki, the relationship was first noticed in economic thinking when, as a result of the plunder of Mesoamerica, gold and silver began flooding into Europe driving up prices. (The Wiki, apparently in the interest of objectivity, refers to this act of genocide and plunder merely as “the import of gold and silver, used in the coinage of money, from the New World.” How quaint!) The economist sees absolutely no difference between descending into the bowels of the Earth and wrenching a few flakes of gold from the rock, and sitting at a computer in the bowels of the Federal Reserve and typing the number “1,000,000,000” into an account.

So, for economists, the thing that is used as money is not important. Since, for routine uses like buying groceries, worthless Federal Reserve Notes perform just as well as gold coin in the economy, Federal Reserve Notes should behave just like gold would when Notes replace it as money.

In contrast to this view, Marx assumed money had to be a thing of value, e.g., gold, a metal requiring great human effort to produce. For Marx, the consequences of replacing real money with dancing electrons are both jarring and predictable: when gold is being used as money prices should fall during depressions, and rise during economic booms.

As a result of these fluctuations in prices resulting from depressions and expansions, the supply of money would contract or expand accordingly. Gold would be removed from circulation by its owners during depressions and hoarded. It would flow back into circulation when the economy recovered.

So, for the economist, the supply of money determined prices; but, for Marx, prices were determined by other factors, and the supply of gold adjusted to these prices.

He also predicted that, unlike gold, paper tokens of money had no such capacity to respond to fluctuations in the level of economic activity because they are worthless. Once paper money entered circulation, it would tend to stay in circulation, and this would cause a further predictable result: If any country was actually stupid enough to replace gold with worthless Federal Reserve Notes, and call this abortion “money”, they would soon find that when the economy fell into a depression the amount of valueless notes in circulation would remain constant even as the size of the economy contracted. The paper would lose its purchasing power in comparison to gold, or, what is the same thing, gold prices, denominated in the paper, would rise.

It really doesn’t take a genius to figure out how this turns out: this rise in the price of gold would be accompanied by an explosion of the general price level denominated in the paper throughout the economy. Boom! Raging inflation.

And, when the depression was replaced by the expansion phase of the economy, Marx’s theory predicts inflation should suddenly be muted or could even turn into a deflation as economic output expanded faster than the supply of worthless Federal Reserve Notes.

So, when we look at the evidence, who is right?

As you can see from the chart below, during the contraction of the Great Stagflation in the 1970s, the exchange ratio of dollars for gold rose by the staggering proportion of 15-1. When the depression gave way to the expansionary Great Moderation of the 1980s and 1990s, the ratio of worthless Federal Reserve Notes to gold fell from 15-1 to a measly 0.7-1.

Chart 18

As the ratio of dollars to gold expanded with the fall in economic output of the depression of the 1970s, prices exploded into an uncontrollable inflation of nearly 8 percent a year. As the ratio of dollars to gold fell in the 1980s and 1990s, the rate of inflation followed meekly:

Chart 19:

In the 1980s and 1990s, as inflation began to moderate, just as Marx’s theory of money predicted, many began to celebrate – believing economists had discovered the secret of stable low inflation growth. Eventually, however, that celebration turned to worries about the threat of “deflation” – the uncontrollable fall of prices last seen in the early 1930s. There was confusion, even a great clamoring for offsetting monetary policy leading to the replacement of the lizard-faced money manager of the Reagan Revolution, by a clueless scholar operating under the delusion that FDR – not the Moron – was in the White House.

THE GREAT RECESSION: A REPLAY OF THE 1930s OR THE 1970s?

The entire point of this chart porn exercise was to offer a take on where the economy is now. From what we have presented, we think the following things can be stated with some degree of certainty:

1. We are in a depression and have been in a depression since 2001.
2. As would be expected in a depression, the value of both wages and goods have taken a beating when compared to the price of an ounce of gold. The value of wages have fallen to just 30 percent of what they were ten years ago, and just 18 percent of what they were in 1970. The value of a median priced single family home has fallen to just 30 percent of what it was in both 2000 and 1970. This depression has also resulted in the collapse of the value of the Standard and Poor 500 index to about 33 percent of its 1967 market top, and about 19 percent of its 1999 market top.
3. Unlike the depression of the 1970s, this depression has not seen the outbreak of rampant inflation, even though the fall in the values of wages and goods have been nearly as severe as that which occurred at the bottom of the 1970s depression. Nor, have we seen the rampant deflation of prices as occurred during the Great Depression of the 1930s.
4. The reason why we have not seen a rerun of the rampant inflation of the 1970s may be related to the financial crisis of 2008. This crisis may have signaled a breakdown in the mechanism Washington used to mask the ongoing depression – the accumulation of private and public debt.

What can explain the odd performance of prices during this depression? Why have we not seen the rampant inflation of prices as occurred during the Great Stagflation, nor the rampant deflation seen during the Great Depression?

Marx’s theory of money may offer a reason why this is so as well. In the Great Depression the value of a dollar was linked to gold; so when the economy contracted in terms of gold, it also produced deflation – the fall in prices. In the Great Stagflation, however, dollars were no longer linked to a definite quantity of gold; so when the economy contracted in terms of gold, this deflation did not occur – instead, prices, including the price of an ounce of gold, rose.

In the 1970s, new dollars were injected into the economy by the creation of consumer and government debt. As we have shown elsewhere, each time you or government incur debt, the banks immediately create additional dollars in the amount equal to this debt obligation and deposit it in the account of the company from whom you bought the product – whether this is an auto dealer, house seller, etc.

So, when there is a real contraction of the economy, the dollars in circulation do not contract, but are increased by the addition of new debt incurred by both private and public sources. This must result in rampant inflation during depressions unless other factors are at work.

As you can see from the chart below, the inflationary impulse is being severely constrained in this depression by the drop in consumer debt accumulation:

Chart 20: Source: FRB, Treasury Department

The average yearly contraction of GDP in this depression has been nearly the equal of what occurred in the Great Stagflation of the 1970s (9 percent in this depression versus 10 percent in the Great Stagflation). According to the Treasury Department, the average annual increase in government debt has, likewise, tracked what occurred in the 1970s as well (8.7 percent versus 9.4 percent in the 1970s).

The distinguishing feature of this depression, however, has been the severe fall off in the average annual increase of consumer debt during this period, when compared to the rate achieved in the 1970s. According to the Federal Reserve Bank, consumer debt increased at an annual average rate of 9.3 percent during the Great Stagflation, but has only been running at about 3.6 percent in this depression.

One possible explanation for this is that the damage suffered by the wage worker in the previous depression and recovery has severely limited the ability of the class to absorb more debt. In the words of Steve Keen, “all private sectors are now debt-saturated: there is no-one in the private sector left to lend to.”

Support for Keen’s view is visible in the data: as the worker’s share of the social product has declined …

Chart 21: Source FRB

… her ability to service ever increasing amounts of debt has come under intense pressure.

Chart 22: Source FRB

This has resulted in the longest string of back to back monthly declines in total consumer credit since World War II – 19 of the last 22 months:

Chart 23: Source FRB

This last chart is, in our opinion, a flashing red light of an impending economic collapse. With the real economy in what can only be described as a depression as intense as that of the 1970s, the very mechanism which helped mask the depression in the 1970s is now crashing as well. It was this mechanism that softened the blow felt in employment – albeit at the cost of rampant inflation – of a depression that was of far greater magnitude than the Great Depression.

If events continue on the current path, we should expect a collapse in both employment and prices as the underlying forces felt in the Great Depression reassert themselves. As economist Steve Keen recently pointed out, this depression is not over by a long shot.