Prices Provide Misleading Measure of Dollar Devaluation

Dollar Devaluation

Keith Weiner

There’s not a human being alive who doesn’t know the dollar is falling. Everyone over 25 has stories of what prices were like, way back when (and younger people have heard them). I remember when gasoline was 60 cents a gallon, and my mom remembers when it was 20 cents.

Federal Reserve Chair Janet Yellen acknowledges the official objective to pursue dollar devaluation of 2 percent per year. This intention is behind the Fed’s ill-conceived loose money policy.

It’s important to measure each devaluation. This is not just to keep a scorecard on the Fed, but because a change in the dollar skews historical comparisons and distorts business decisions, like giving increases to workers and pensioners.

For example, if the estate of J.P. Morgan was worth $68M at his death in 1913, how does that compare to the estate of Steve Jobs in 2011, which Forbes estimated to be $7B? The gold dollar in Morgan’s day has no more similarity with today’s Federal Reserve note, than a bottle of Château Laffite Rothschild has to a keg of Keystone beer.

Measuring a decline in the dollar seems simple. Just use the consumer price index to restate any historical figure in today’s dollars. By this method, Morgan’s estate was worth $1.6B in today’s dollars. Morgan was rich, but it seems that Jobs was over four times richer.

More importantly, suppose we’re calculating the return on invested capital. Last week, I discussed a bad $100,000 investment in a lemonade stand. It sells only $1,000 worth per year. But if a cup of juice goes up to $100, this business may appear to generate a good return. That’s just an artifact of dollar devaluation.

We need constant-value money to compare current profits to historically invested capital, and calculate the real rate of return. We have to sort good investments from bad, increasing the good and liquidating the bad.

The dollar is not constant, so we struggle with how to compensate. Using consumer prices to adjust it is fatally flawed. Every farmer, miner, manufacturer, and distributor constantly works to improve its efficiency. Real costs are falling. Prices follow costs (though it’s a complex relationship).

The dollar is falling and real prices are falling too. By using prices to measure the dollar, we can only see the difference between the two rates of descent. In some areas, like electronics, prices fall faster than the dollar. For example, the iPhone today is more powerful than supercomputers that used to cost millions.

By contrast, the price of milk is falling slower than the dollar. In 1965, a gallon sold for about $0.37 (wholesale). By 2012, it was about $2.42. The conventional view measures only the difference—$2.05 or 554 percent.

However, it misses most of the real dollar devaluation. I calculated that the real cost of producing milk fell at least 87 percent since 1965. If the dollar had kept its value, then grocers should be paying about a nickel and milk would retail for ten cents.

Using the price of milk, the dollar appears to inflate 554 percent. That’s bad enough, but it misses the massive reduction in costs. In reality, the loss is about ten times worse—over 5,000 percent.

We use the dollar to measure prices. Then we turn around, and attempt to use prices to measure the dollar. It’s circular.

There is a better way to measure the dollar: gold. In 1965, a dollar was worth 889mg gold. Today it’s 25mg. The dollar has lost 97 percent of its value between 1965 and today.

The price of milk was 0.01oz gold in 1965. Now it’s 0.002oz. Milk actually fell by 80 percent (despite increased taxes and regulations).

If you’re curious, J.P. Morgan was worth 3.4M ounces of gold. Steve Jobs was worth 4.3M. Jobs was in fact richer, but only by 26 percent. Using consumer prices overestimated the gap.

There hasn’t been a real recovery from the crisis of 2008. The reason is not simply that the Fed has made a particular mistake. The cause of the crisis is the dollar itself. There will not be a recovery until we return to the use of gold as money.

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