Here’s Why the Purchasing Power of Your Dollars Will Continue to Drop
Comparing the dollar’s purchasing power between 1971 and today
In August of 1971, just before Nixon canceled the Gold Standard and the dollar was left without the backing of gold, an employee earning the federal minimum wage was able to buy — in return for one hour of work – about 5.2 Big Macs. By 2019, an hour’s work could barely purchase two Big Macs. That’s a 61.5% drop in purchasing power as it relates to food. In 1971, just 3 years of median household income was sufficient to allow a family to purchase a median home. By 2019, this family would need more than 5.5 years of work to finance such a purchase (a 55.5% drop as it relates to lodging).
If an average family in 1971 wanted to send a child to college, the tuition for a single year was a little less than half of the family’s monthly wages. In 2019, two months’ wages could barely finance that single year of studies (a 75% drop in purchasing power as it relates to education). And back then, if that average family lived in California and was trying to finance studies in the UC system, like at UCLA, they’d need only five days’ wages, less than 5.1% of the cost in 2020 (a 94.9% drop). The classic Ford car would cost an average family about 3.3 monthly paychecks in 1971; a similar model in 2019 would require 6 (a 45% drop in purchasing power as it relates to transportation). If the family also wanted to save for their future, in 1971 their average monthly income would have bought them about 5.79 units of the S&P 500 index, as opposed to barely 1.5 units in August 2021 or a 74% drop as it relates to investments.
The Nixon Shock — eliminating the Gold Standard…
Our monetary base is, in broad terms, the total of money initially created by the Federal Reserve, from which banks via the mechanism of fractional reserve banking and via debt create even more money. As long as the monetary base was tied to gold, whether by force of law (the obligation to hold a gold backup reserve of 25% after World War II and 40% before World War II) or by force of treasury commitment to convert paper bills into gold (to ordinary individuals during the classic Gold Standard period, or to central banks only after World War II), the limitation of having to hold at least 25% in real physical gold when printing money kept our government in check.
But when this limited the government’s ability to fund wars and entitlement programs, our government severed the dollar from its gold backing in 2 steps. First, in 1968, Congress passed the “The Gold Reserve Requirement Elimination Act,” and then, in 1971, President Nixon declared the end of the convertibility obligation from dollars to gold set in the Bretton Woods agreement after World War II (hence “The Nixon Shock”).
This caused the dollar to become a “fiat currency.” Fiat is Latin for “decree” — “so it will be” — meaning, in this case, that the money draws its value not from a socially agreed-upon asset like gold or silver but from the state rules. This caused the monetary base to lose its effective meaning, making it possible to increase the money supply without limitations, which is exactly what happened.
… and draining the purchasing power of the dollar
Just before the Nixon Shock, our monetary base, (the total amount of actual currency created by the Fed and put into circulation; read more here) stood at around $75 billion. By June 2021, it had grown 80-fold to around $6 trillion. This, combined with other Federal Reserve printing activities (e.g., its direct purchasing of debt), brought the Fed balance sheet (the total money printed by the Fed) to a record $8.4 trillion as of the beginning of October this year — more than a hundredfold growth from its volume in 1971. At the same time, the Fed’s interest rate has fallen from a peak of 21% in 1981 to just above zero in 2009, where it has remained more or less ever since.
With the aid of the Fed’s accommodative interest rate policy, banks have transformed the basis of this money to more than $85 trillion in debt (the total debt of all sectors of the US economy). This represents an increase of more than $83 trillion in the money supply since 1971. About $56 trillion of these new dollars have been added in the current century alone — and more than $30 trillion since the financial crisis of 2009. That’s more than four times the growth in GDP during these periods.
This flood of new dollars has decreased their value. The purchasing power of a single dollar in 1971 equals the purchasing power of $6.74 in the second half of 2021, according to the CPI measures. But the impacts of the dramatic growth in the quantity of money, the decline in its value, and the massive rise in the prices of goods and services haven’t been distributed evenly across all players and sectors within the economy.
The debasement of the dollar and the rise of China
Richard Nixon not only introduced the fiat dollar to the world but also started US relations with China. When China opened its economy to the US, China’s depressed and cheap labor markets became available to US businesses, and a cascade of the new dollars began to flow eastward. The Chinese people welcomed the printed dollars and were prepared to work for them at a wage that was one-tenth of what similar employees would earn in the US. Therefore, 1975 was the last year in which the US had a positive trade balance. Since then, the negative trade balance — most of it with China — has grown measured in dollars as well as in its percentage of US GDP.
In 2018, at the height of President Trump’s verbal war with China, the trade deficit with China stood at over $418 billion, and since 1995, it has totaled over $10 trillion. Before 1971, in the age of limited and sound money, this would have been impossible due to something called the “Price-specie flow mechanism.” In the world of money backed with gold, countries with continued import surplus eventually deplete their gold reserves, which flow to the exporting countries. This loss decreases the amount of money in the importing countries and increases the amount in exporting countries.
Since gold in those days was the base of money supply, these changes in the money supply influenced the entire price system when it came to wages, products, and money (interest rate) for everyone. The decrease in gold (money supply) in the countries with continued import surplus puts downward pressure on the local labor market and prices and upward pressure on the interest paid for international loans, making imports less competitive and more expensive. And the opposite occurs in exporting countries, where the flood of incoming gold (money supply) caused wages and product prices to increase, making exports more expensive and less attractive.
Infinite money printing harms purchasing power and the trade balance
In simple terms, under a hard form of currency like a gold-backed monetary standard, the US wouldn’t have been able to create a continuous, deeply negative trade balance for the last 43 years, simply because its gold would have run out. It almost ran out in 1971, and Nixon’s solution kept the charade going.
Today, the fiat dollar is limited only by the amount of “ink in the Fed’s printers” and by the credit volume that the banks are prepared to provide. Since neither of these was in short supply, alongside the flood of the created money and imports, most of the US industrial base began to move to China, where it was possible to manufacture at a much lower cost. At the end of the 1970s, around 23% of all employers in the US economy operated in the manufacturing sector. This number has decreased to about 8.4% today. The disappearance of the US industrial base had a huge impact primarily on “rust belt” industrial states, and it is a historic tragedy where an empire has transferred its industrial base to another country, turning it in time, and financing its growth, to become its largest strategic foe.
Ongoing competition from the Chinese labor market has also seriously harmed wages for individuals and communities working in jobs that could be exported to China. But there were exceptions. The migration of jobs did not impact individuals whose jobs did not face this competition. In fact, the opposite is true. Among these individuals — physicians, lawyers, finance professionals, upper corporate management — the printing of money has been expressed through dramatic salary inflation.
The above process created a situation in which the median household income has only increased by around 29% between 1973 and 2018, while GDP has risen more than 3-fold and income increased by 80% among the top 5% of earners.
Who has benefited from the Fed’s money-printing?
The Fed-induced money waterfall, especially since the late 1990s, has therefore been flowing in two directions: One went toward China, financing endless imports and taking with it the US industrial base, crushing in its wake the low-income/middle-class worker. The other portion has been flowing toward New York and Silicon Valley, creating an unprecedented rise in asset prices, increasing the price of securities, stocks, and real estate to levels never seen before and disconnected from any fundamentals. While the average income has barely doubled nominally since 1995, the average home price in Denver has gone up — according to the Case Shiller Housing Index — four-fold, in Los Angeles by 4.66 times, in San Jose by 4.3 times, and in San Francisco about five-fold. In Miami and the urban centers of Texas, home prices have gone up by “only” 3.4 times.
And so, while the buying power and the wealth-building of the millennials and the middle class have deteriorated over the last few decades, the ones fortunate enough to own stocks or property have grown wealthy beyond imagination. This development can be clearly seen in Forbes Magazine’s list of the 400 wealthiest Americans. In 1990, the individual at the top of the list was worth $5.6 billion. In 2020, the wealth of the individual in the first place, Jeff Bezos with his Amazon stocks, had grown more than 30-fold to $179 billion. A fortune of $2.6 billion, which would have put you in seventh place in 1990, would now barely let you reach 327th place. And without $2 billion in wealth, you wouldn’t even make the exclusive list.
Wealth and income inequality is taken to the extreme
With this stock market (of which 88.2% is held by the upper tenth percentile) and the “Everything” asset bubble, it should come as no surprise that the 50 wealthiest Americans together hold more wealth than the 160 million Americans in the bottom 50% of income earners. Nowhere is the gap more tangible between those who make a living from wages and those whose earnings come from securities as the ratio between CEO salaries of the S&P 500 companies and the wages of their employees. In 1963, before the era of the fiat dollar, this ratio stood at 21 to 1. By 2020, with the explosion of the stock market, it had soared to 351 to 1. This means that for every dollar earned by the average S&P 500 public company employee, the CEO earns $351, most of which comes from stock compensation.
The soaring US prices for goods and services include not only the prices of properties but also the prices of products and services that cannot be imported from China: housing, college and kindergarten, and, of course, healthcare costs. All of these have risen dramatically in price, sometimes doubling (healthcare) or even quadrupling (education) above the median household income since the end of 1999.
The dollar’s purchasing power will keep suffering from the Nixon Shock
A store of wealth that holds purchasing power relies on scarcity. This is what makes gold unique. Only three Olympic-sized swimming pools of this precious metal have been mined since the time of the pharaohs, and even with technological advances in mining, barely 1.5% more is added to the world supply per year. But with a fiat dollar, on the other hand, it’s possible to create an infinite supply. This is all done according to the whim of the Federal Reserve, which creates money from thin air and artificially sets the interest rates, fueling the debt-money-creation machine via loans and the banks. This is the one-way path that President Nixon set America on.
In 2021, America is celebrating a jubilee, the 50th anniversary of the Nixon Shock, and the birth of the fiat dollar. During the past half-century, the US economy saw debt soaring to dwarf GDP growth, income inequality rising to levels not seen since early 1929, and an ongoing decline in purchasing power for at least 75% of Americans. Still, with the course of the US economy, the policies of both political parties and the “corner” that the Fed has painted itself into, it is reasonable to say, as the song goes, “We Ain’t Seen Nothin’ Yet.”
Author of A Brief History of Money