Wednesday, March 12, 2014

Today's Fun Fact

I've written very often about how inflation is mistaken for real economic growth, especially in the stock market.  I believe the entire point of the Quantitative Easing programs have been to inflate the price of housing back to the bubble levels of the last decade and keep the DJIA high.  This is for a very simple reason.

When a bank writes a mortgage, they write it for a specific number of dollars to be repaid.  It doesn't matter if those dollars are worth less than when the loan was written.  In fact, over a 30 year mortgage, it's guaranteed that the money paid at the end of that mortgage is worth about half of what it was - in terms of real buying power - as when the owner started paying.  Likewise, the numbers most people seem to look at to gauge their worth are house prices and the "stock market"; most news sources report the DJIA, S&P 500 and NASDAQ as a daily horse race.  If people feel their house is increasing in price, that they're not underwater, and they feel their 401k is worth more every year, they feel less inclined to take to the streets with pitchforks, torches and sisal neckties - or scoped deer rifles. 

For the banks, the "persistent benign inflation" the Federal Reserve aims for, 2%, is only really noticeable over long periods.  If they could hold a constant 2% rate, prices would take 35 years to double.  Of course, they don't keep tight total control over inflation because they can't.  Shadowstats shows the Consumer Price Index, if calculated according to the "classic" method, has shown inflation running around 9% for a couple of years, now.  Inflation of 9% doubles prices in only 8 years.  (Cheap and easy way to figure this doubling period: divide 72 by the rate - 72/9 = 8.  It's an approximation, but so is the data going in). 

If you're like me, and many of us, you might wonder what these prices really mean, since they're changing all the time.  If we pretend we have a gold standard that's worth something constant, and dollars go up and down with respect to that, we can calculate the Dow/Gold ratio.  With Today's 4 PM numbers, one "share" of the DJIA would cost 11.9 ounces of gold.  So what?  Some historical numbers might be helpful.  In January of 2000 this ratio hit its peak, and a share of the DJIA cost 43 ounces of gold.  So while today's close of 16320 is much bigger number than the 10000 prices of early 2000, and looking at that would lead you to think the value has gone up considerably, Today's Fun Fact is that the value of the DJIA has actually gone down by more than 50% since Y2K.  Just because I bet someone's wondering, the DJIA in 1929, before the big crash, was 389 or 19 ounces of gold.  (Gold wouldn't reach the $35/oz. level until later).
Chart from Fred's Intelligent Bear site.  There are some interesting charts to bear (ha!) in mind in a piece I did over two years ago, "Could the US Return to a Gold Standard?"


  1. Can't find my source data right at the moment but another interesting chart is gold/oil.


  2. IIRC, it's a rather constant value. Just like the price of bread in terms of grams of gold has been relatively constant over the last 2500 years. An ounce of gold buys around 350 loaves of bread and has since King Nebuchadnezzar's reign. In 1851 a one ounce gold piece bought a Colt Single Action Army. Today, a one ounce gold piece buys a pretty nice gun. Not a Les Baer custom 1911, but a nice grade 1911.

    But that's sort of the definition of a standard, isn't it?