Monetary Froth, or How Inflation Deceives Us

Inflation in the US deceives us. Here’s an example.

The two charts below show the S&P 500 monthly closing prices since 1950. The first chart isĀ in raw dollars; the 2nd chart is adjusted for inflation and shows the value of the S&P500 in 2012 dollars.

(I used the BLS’s inflation calculator to do the adjustment. Both charts are logarithmic and use base 10.)


The top chart appears to depict an economy which has been steadily growing, albeit with a few bumps and hiccups along the way. The bottom chart demonstrates that the economy’s growth is not really as steady as we’ve been led to believe and in fact is mostly illusion.

From the high around 1968, (bottom chart, blue arrow), to the low around 1983, the SP500 declined in real terms to levels not seen since 1955. We didn’t recover 1968-level valuations until the early 90s, and didn’t start gaining over those levels till 96. Then we returned to the mid-90s level valuations in 2002 and again in 2008.

The growth periods were from the end of the war till 68, and from 94 to 2000. Everything else is smoke and mirrors.

You can see the economy attempted to recover the 1968 high in the 72-73 time period, but Nixon decoupled the dollar from gold, thus unleashing the hounds of inflation for the next 20 years. The internet boom seemed to result in real growth in the late 90s, but we crashed back to those 68 levels in 2002 and below them in 2008.

Starting in 2001, the Fed lowered interest rates 14 consecutive quarters, driving money out of the bond markets and into equities. When the Fed-induced housing bubble burst in 2008, the Fed then dumped trillions of dollarsĀ into the coffers of the Too Big To Fail banks. When that failed to get the economy going, they repeated the folly of the 2002 recession and lowered interest rates back to essentially zero, again detroying the Bond Market and driving money back into equities.

The only actual economic growth this country has experienced since the end of WWII are the years from the end of the war till 1968, plus a little bit of growth in the late 90s. Everything else has been monetary froth.

4 thoughts on “Monetary Froth, or How Inflation Deceives Us”

  1. Do you really believe the increase in our standard of living since 1968 is really only due to a little bit of progress in the 1990s? I doubt it. Here are the problems with your analysis:

    1. What do you mean by “economic growth?” Really think hard about this one, and give it a thorough answer. I’m not being sarcastic; it’s actually not a very obvious question. How you answer it determines your later analysis, and this post suggests you haven’t thought very hard about it.

    2. Equity values are proxies for expected future growth; they are not growth themselves. If a company’s stock value is high, it means lots of future profit is expected. If it’s low, it means not much future profit is expected. A real decline in the S&P doesn’t indicate real wealth has been destroyed; it means the future production of wealth looks a lot bleaker than it once did.

    3. There are lots of economic proxies that *have* grown steadily since WW2. For example, the number of man-hours required for a worker at median income to work in order to purchase a dozen eggs has grown a lot since then. If the economy is growing, people are getting richer, meaning they can buy more stuff…like eggs. Lots and lots of eggs.

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