I wrote a story
about poor Clarence who retired in 1979, and even poorer Larry who retired
last year. I created these characters to challenge the notion of calculating
a real interest rate by subtracting inflation. The idea is
that the decline of a currency can be measured by the rate of price
increases. This price-centric view leads to the concept of purchasing
power—the amount of stuff that a dollar can buy. It’s the flip side of
prices. When prices rise, purchasing power falls.
Recall in the story, Clarence retired in 1979. At the time, inflation was
running at 14% but he could only get 11% interest. Real interest was -3%, and
Clarence had a problem. He was losing his purchasing power.
Suppose Clarence bought gold. The purchasing power of gold held steady for
the rest of his life (see this chart of oil priced in
gold). Gold does solve this problem. However, gold has no yield. Clarence
is only jumping out of the frying pan and into the fire. Sure, he escapes dollar
debasement, but then he gets zero interest.
Let’s look at how zero interest impacts Larry. He makes $25/month on his
million dollars. Obviously he can’t live on that. So he gives up his nest
egg, for eggs. For a year, he feasts on omelets. Since inflation was slightly
negative, the same swap in 2015 nets him the same plus a few additional
quiches.
Through the lens of purchasing power, we don’t focus on the liquidation of
Larry’s wealth. We ignore—or take it for granted—that he’s trading his life
savings for bread. We only ask how many loaves he got.
Shopping Trolley / Grocery Cart Cut Out
If you had a farm, would you consider trading it away, to feed your family
for a year? I hope not. A farm should grow food forever. Its true worth is
its crop yield, not the pile of bacon from a one-time deal.
How perverse is that? It’s nothing more than what zero interest is forcing
Larry to do.
A dollar still buys about as much as it did last year. Larry’s purchasing
power didn’t change much. However, debasement continues to wreak its
destruction. Steady purchasing power does not mean
that the dollar is holding its value.
It means that prices are wholly inadequate for measuring monetary decay.
Our monetary disaster becomes clear when we look at the collapse in yield
purchasing power. This new concept does not tell you how many
groceries you can get by liquidating your capital. It tells how much you can
buy with the return on it.
In 1979, Clarence’s $100,000 savings earned enough to support his middle
class lifestyle. In 2014, Larry’s million dollars didn’t earn enough to pay
his phone bill. To live in the middle class, Larry would need over a hundred
million bucks. That’s a pitiful income to make on such a massive pile of
cash. It reveals a hyperinflation in the price of capital, which has gone up
1100X in 35 years.
It also shows that the productivity of capital is collapsing. Back in
Clarence’s day, businesses earned a high return on capital. It was high
enough for Clarence to get 11% interest in a short-term CD. Unfortunately,
the dollar rot is in the advanced stage now. There is scant interest to be
earned. Return on capital is low, and so borrowers can’t pay much.
Retirees suffer first, because they can’t earn wages. Normally they would
depend on interest, but now they’re forced to live like the Prodigal Son.
They consume their wealth, leave nothing for the next generation, and hope
they don’t live too long. Zero interest rates has reversed the tradition of
centuries of capital accumulation.
Purchasing power may look fine, but yield purchasing power shows the true
picture of monetary collapse.
This article is from Keith Weiner’s weekly column, called The Gold
Standard, at the Swiss National Bank and Swiss Franc Blog SNBCHF.com.
