Purchasing Power: The Only True Measure of Earnings And Wealth
(December 21, 2009)
Let's start our discussion of purchasing power with a recent comment by frequent contributor Harun I.
In Why a 35% Decline in Housing Values Would Be Good for the Nation (December 15, 2009) I wrote: "Borrowing trillions to pay out-of-control price spirals will lead to national insolvency. There is no other end-state."
Harun submitted the sentence modified thusly:
"Borrowing trillions which leads to out-of-control price spirals will lead to national insolvency. There is no other end-state."
Harun also offered this explanation:
Any positive growth rate in the currency will result in a collapse of the currency. The rate may be stated at some seemingly benign level (2.5%) but that means the money supply doubles every 28 years, and does so until the amounts are staggering. This embedded feature of current economic dogma is never discussed openly by its practitioners and is not understood by the public whom they serve.
As longtime readers know, Harun has often shared an analysis based on purchasing power rather than nominal valuations or concepts such as inflation/deflation, which so often end up further muddying rather than clarifying the measuring of our earning power and wealth.
For instance: take the value of the U.S. dollar (USD) in 1914, 1919 and now. According to the Bureau of Labor Statistics handy inflation calculator, a 1914 dollar equals $21.63 in 2009 dollars, while a mere five years later, the 1919 dollar equals only $12.50 in today's USD.
This raises a number of questions. Are we as a nation wealthier in terms of purchasing power and earnings than we were in 1914? In other words, even though today's dollar is only worth a nickel in 1914 money, can a citizen buy more FEW resources (food, energy and water) with an hour's labor today, despite the massive decline in the dollar's nominal loss of value?
Put another way: if a laborer earned 10 cents an hour in 1914 and paid no income taxes, and bread was a nickel a loaf, his/her purchasing power was 1 hour = 2 loaves of bread.
If bread is now $3 a loaf and a laborer earns $12/hour and pays $3 in income and Social Security taxes, leaving $9, then 1 hour = 3 loaves of bread.
Regardless of the nominal value of the currency, the laborer has greater purchasing power today.
Between 1914 and 1919, the dollar lost a staggering 42% at least measured nominally. (Recall that World War I lasted from August 1914 to November 1918.) Did wages rise 42% in those five years? If so, the rise in wages offset the decline in purchasing power of the dollar. If wages did not rise 42% (and while I cannot find any spreadsheet for those years, my sense is wages did not rise that much), then wage earners lost considerable purchasing power in those few years.
This could be phrased in a number of ways: if money supply growth exceeds GDP growth, then the currency loses purchasing power.
This is partly why discussions of "inflation" and "deflation" are so often fruitless. Clearly, "inflation" ate up 95% of the nominal value of the 1914 U.S. dollar. But if the purchasing power of an hour's wage rose, then what can we conclude?
If income/wages fall faster than deflation, purchasing power also declines.
The rapid decline in the dollar's value in the five years between 1914 and 1919 reveal how the real question is not how much did the nominal value change, but how did the purchasing power of wages change.
Correspondent Micah Zuorski submitted a brilliant concept: an Excel spreadsheet for calculating purchasing power.
Here are Micah's comments, and the instructions you will find upon opening the spreadsheet:
I just finished reading Survival+ a couple of days ago, and I've been thinking about what you wrote about considering the value of assets in terms of how many loaves of bread you could buy with them. I thought about how hard it could be to visualize the development of purchasing power over time, and so I built the attached spreadsheet that I believe will make it easy for someone to see their own value in terms of FEW resources over time.
Thank you, Harun and Micah. I am confident from our email correspondence that
Micah considers this spreadsheet a work in progress. Feel free to play around with it
as a way of escaping unfruitful concepts and exploring the measure of purchasing power.
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