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ATLANTIC HIGHLANDS HERALD |
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INFLATION THEN AND NOW Inflation has been in the news lately because it was higher in 2005 (3.4%) than in recent years. The Fed is steadily hiking interest rates to try to “cool off” the economy and stop inflation before it really gets going. This has been tried before – with questionable effect. In the late 1970s we had gas prices comparable to today’s and 14% inflation. The Fed raised interest rates until we had 18% mortgages and the economy was in the tank. (Experts called it “stagflation”.) Inflation didn't cool off until Ronald Reagan deregulated oil, got the Iran-hostages back, and told us inflation was just an expectation of higher prices that was – more or less – in our heads. Historically, not all inflation has been that benign. Young people whose world history education goes no farther back than, say, 1941, may or may not have heard of the great German inflation of 1923. A confluence of economic factors, which I won’t attempt to describe here, caused the German mark – historically stable at approximately 4 marks to the dollar – to inflate horrifically during 1922-‘23 until it reached something close to 6 trillion marks to the dollar in November 1923. The precise figure is irrelevant, as the currency was literally worth less than the paper on which it was printed. (See figure below.) Interested readers should review “The Nightmare German Inflation”, a News and Views Special Report from 1994 (1) which details those events.
Americans tend to view that era as a foreign curiosity that has nothing to do with us. Germany, after all, was universally condemned for having started the World War, which it lost. The country was in economic and political chaos. Millions lost their life savings. Armed bands roamed the streets, and insurrection was in the air. On November 9, 1923, Adolph Hitler led his nascent band of Nazis in an abortive attempt to overthrow the government of Bavaria. The Beer Hall Putsch was crushed, but Hitler used it to become a national figure. The rest (as they say) is history. If you’re under forty, you could think we have always had inflation as low as now. But things were different in the late 1970s. Before Ronald Reagan, inflation was nearing “galloping” speed (14%). Gerald Ford tried Whip Inflation Now (WIN) buttons and jawboning. Jimmy Carter told us we were a bunch of wusses, turned the White House lights off, and tried to slap us into shape. But no one seemed to know how to stop inflation. After Mr. Reagan changed our expectations and lowered taxes, the hobgoblin of inflation seemed to evaporate. The truth – realized retrospectively, but not at the time – is that inflation tends to flare up when people sense weakness in their leaders. (Something to think about now.) The ‘70s were an insecure decade. After Richard Nixon got the bums rush, inflation flared from 6.2% (1973) to 11% (1974), dropped a little to 9.2% (1975), then fell considerably to 5.75% (1976) as Mr. Ford got his sea-legs. But Mr. Carter blew an uncertain trumpet. Inflation increased steadily through his term, reaching 13.6% in 1980 as his weaknesses became obvious. It was still 10.4% in Mr. Reagan’s first year (1981), but diminished markedly through his terms to a low of 1.91% (1986). I know tables of numbers make some readers’ eyes glaze over, but I hope the table below will pique some interest. It lists yearly inflation rates from 1914-2005, as well as the cumulative cost-price index for each year, based upon 1.00 in 1913. As shown, the 2005 CPI is nearly 20. Thus, a 2005 dollar has approximately the purchasing power of a 1913 nickel.
Before anyone looks for a window to jump out of, it’s worth pointing out that things in 1913 didn’t uniformly cost 1/20 of current prices. DVDs didn’t cost 50¢ because they hadn’t been invented yet. A cup of coffee did cost a nickel – my grandma, who lived in New York in 1912, said so – and you can still get one for $1.00 at some places. (Probably not at Starbucks.) The table reflects our history. One glaring fact is that thirteen out of 92 years actually had negative or zero inflation. (I marked them with blue shading.) This is more correctly called “deflation”. The last such year was 1955. Six deflationary years came during the Great Depression. Our worst inflationary periods were 1913-‘20 (100%, due to World War I) and 1970-’80 (112% during the Nixon-Ford-Carter era, as mentioned previously). Along with many, I never realized that the CPI started diminishing from 2.03 in 1920 to a low-point of 1.32 in 1933. (A deflation of 35%!) The CPI did not regain its 1920 level of 2.0 until 1946. The deflation was tough on people who owed money – e.g., mortgages on their homes – since they had to pay their loans with “dearer” dollars. Debtors always benefit from inflation, which is why we generally have more of it than deflation. In the 1923 German hyperinflation, some Prussian landowners paid off their million-mark mortgages with postage stamps. Every economic situation is good for someone. The table enables calculation of inflation over any span of time. One divides the CPI from an ending year by the CPI of a beginning year. Thus, I can find inflation from 1960 to 2005: i.e., (19.984)/3.055 = 6.54, so the inflation was 554%. (If the quotient had been 1.00, the inflation would have been 0.) If you earned $5,000 in 1960, you would need $32,700 today to have (approximately) the same buying power. I know the minimum wage was $1 an hour then because I worked for that wage. To be equivalent, the minimum wage should now be $6.54 an hour. In fact, it is $5.15. (Was $1.00 was the correct minimum wage in 1960? Or should there be a minimum at all? I don’t know. Economists are still arguing about it.) Using the division method, we find that inflation has been:
After you see that inflation was 15% in 1947 and nearly 18% in 1917, you can’t get very excited about 3.4% in 2005. Some wags wonder if the Fed chairman wants to crash the economy so he can look good reviving it. I doubt that, but I do think our politics and economics today are still haunted by the high inflation of the 1970s. The important thing for ordinary people to realize – Mr. Bernanke already does – is how quickly relatively small annual inflation rates can drive the CPI upward. The useful approximation called the “rule of 72” shows this. Divide 72 by any interest rate (expressed as percent) to discover how many years it will take, at that rate, to double the initial index. Thus, 3% inflation a year will double the CPI in 24 years (not 33 years, as the man on the street imagines). The rule works either way – e.g., to double the index in 12 years, the inflation rate must be 6% a year (72/12=6). All this matters because no one rides the income/inflation wave forever. When you stop working, your income usually trails inflation. Even small inflation rates can seriously degrade a fixed retirement income over time. In the past, many people had CPI-adjusted pensions. They didn’t worry about inflation, as their pensions went up too. (Social Security and federal pensions still do.) In the future, fewer people will enjoy inflation protection. As people live longer, their retirements might stretch far enough to see significant inflationary erosion of their incomes. The inflation table enables all kinds of fascinating comparisons, but space limitations let us record only a few. One that I will mention is the cost of college. In 1960 I paid $1300 for my first year at a private school. (My buddies thought I was crazy, since their state teachers college tuition cost only $150/year.) Today, a year at my old school costs $26,000 – twenty times what I paid, and far ahead of inflation which would make it $8600 today. I recall reading that a year at Harvard cost $4000 in ‘64. That would be $25,000 today. I’m sure Harvard costs twice that. Gas cost 30¢ a gallon in 1960. That’s $1.99 a gallon in today’s currency. The 5¢ candy bar from 1955 should cost only 37¢ today, but it’s twice that. The dollar shrank to 50¢ of its 1913 value by 1920, recovered to 75¢ by 1934, dropped to 50¢ again by 1946, was worth a 1913 quarter by 1970, and hit a thin 1913 dime by 1982. As mentioned earlier, it’s worth a 1913 nickel now. Today’s dollar has the buying power of a 1982 half-dollar or a 1974 quarter. My neighbors bought a new color TV in 1958 for $400. The color was very primitive. In inflation-adjusted 2005 dollars, that’s equivalent to $2710 today. But modern color TVs cost only $300, and their quality is miles beyond that 1958 model. Technology doesn’t stand still. In 1927, the last year Ford made the Model T, a basic car cost about $300. That would be $3400 in today’s dollars. A new car costs far more than that now. Luckily, it’s not a Model T any more. ******* (1) “The Nightmare German Inflation”; 1994. ( http://www.usagold.com/GermanNightmare.html)
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