– August 4, 2020
dollar construction

Economists are strange creatures. They use odd words for everyday events; they say things that sound counterintuitive to most people; and they specialize in complicated trade-offs when what the wider public wants usually is simple answers. 

We might also say that their consensus positions are only selectively picked up by the public – a trait they probably share with many other scientific fields: psychology and nutritional sciences come to mind.  

While some economic topics are contentious and genuinely not yet settled – the world is a complicated place – there is also stunning agreement among professionals in the field. Rent control, for instance, or tariffs of various kinds – two topics where economists overwhelmingly (90-95% or more) agree: those policies harm the people they intend to help. Don’t do them. The public is much less eager to side with the experts here. 

Another such topic for us monetary geeks is the burden of a falling purchasing power – or what we otherwise call inflation. One claim that usually makes the rounds among goldbugs and crypto fanatics is that money printing by central banks has eroded the purchasing power of money. The dollar, the argument goes, has “lost its value,” to the tune of some large number over some long-time period, say by 97% or 99.5% over a century.   

Such numbers are usually correct, at least if you read official statistics like the Fed’s Consumer Price Index for Urban Consumers: $1 in 1913 would buy you roughly what would require $26.15 in 2020 – a cumulative loss of a little over 96%. Of course, CPI comparisons over that length of time stretch their meaning, as economic historians have always pointed out: no amount of money in 1913 could have bought an iPhone, comfortable transatlantic flights, indoor air conditioning or penicillin.  

The implication of the 96% statements is one of a huge loss – that governments have skimmed hard-working regular people of their just dues. Cash holdings surreptitiously declining in value must have harmed someone. Intrigued by the statement, I wondered where I could find the victim of this alleged swindle: where is the person who held dollar bills over a century and, stoically, faced this loss?

Right off the bat, there’s a problem. As notes became serious collectibles beginning in the 1960s, whoever was lucky enough to hold on to their 1913 notes today would be holding some quite valuable items. On eBay, notes from the 1910s and 1920s routinely sell for hundreds of dollars. For instance, for a mere $249 this $5 note from 1914 can be yours, as can this $1 note from the 1928 series for $80 – corresponding to real returns of 1% and 5% per year respectively. 

Next, any cash earning even the minimum return available from bank accounts or safe 3-month Treasury bills would obliterate that great loss. Joe Weisenthal, a Bloomberg journalist formerly writing for BusinessInsider wrote: 

“Yes, if someone had a bunch of cash in 1959 and literally put it in a shoebox, they’d have lost a lot of money over the last several decades. But for almost anyone in the real economy who’s collecting anything on their cash, the myth of inflation destroying the dollar is just that: a myth.”

There doesn’t seem to be an actual person who suffered a supposed 97% loss. Besides, as we hold cash for our immediate consumption needs, we are much more concerned about the (short-term) predictability of our cash balances – next month or six months hence. 

Economists are much more likely to stress that general price levels rising impacts households in more than one way: your wages will usually rise in tandem with inflation, offsetting this loss; debts are payable in less valuable dollars of which you now earn more; slight positive inflation often makes labor markets work better, for reasons of psychology or habit.  

Mistaking nominal changes for real changes is so pervasive that it even has its own term: money illusion

To judge whether inflation is a burden, predictability is a much bigger problem: a variable rate makes (long-term) planning difficult; a stable 2% decline in the purchasing power of a monetary unit does not. While one virtue of the Classical Gold Standard was that the price level was anchored in the long run (money held its value over decades), what you could purchase with your money was wholly unpredictable in the short run. From one year to the next, it could fluctuate in purchasing power by magnitudes of 5-10%. Holding rent money in a currency that can rise or drop 10% overnight is a financial risk that few people are willing to take.  

Much of the issue of inflation’s burden instead turns on whether it was expected or not. When inflation is expected, as is the case when central banks have anchored their targets (and actually hit them), economists usually don’t see much loss done to anyone. The reduction in money’s purchasing power is, after all, expected and incorporated into (long-term) contracts in the economy. A bank willing to lend at an annual real rate of 3% will charge around 5%, knowing that about 2% of its principal will be devalued during the year. A borrower, similarly, can carry the higher 5% rate in full knowledge that some of the real debt burden will be reduced by inflation. 

If we have inflation of a magnitude other than what was expected, the story changes. Say the inflation rate in our example is zero instead of 2%. Now, suddenly, the borrower is paying a real rate of 5% rather than the 3% predicted and the bank receives an unforeseen windfall; lower-than-expected inflation redistributes real resources from debtors to creditors. 

Similarly, an inflation unexpectedly overshooting the target amounts to forgiving some loans – the borrower whose wage adjusts upwards next time she renegotiates her wage can more easily repay the loan in less valuable dollars. 

In one sense, many observers who worried about the ills of inflation in recent years have pointed to vulnerable groups like savers or seniors on fixed income: headlines like “Savers are getting destroyed by super low interest rates” generates more clicks than enlightenment. Sure, all else equal, a lower deposit rate at your bank means that your cash savings earn you less than you otherwise would. But central banks lower their policy rates in response to lower than target inflation rates; what you now “lose” in foregone earnings has been “gained” in lower price increases of the things you buy. Moreover, if you – like many pensioners and savers do – own assets like properties or stocks, lower interest rates likely contributed to a greatly increased valuation of those assets.  

Inflation is not a one-trick pony, with an easily predictable outcome. Rather, it does several things at the same time. Looking at claims like the eradication of a dollar’s purchasing power is misleading: it is not the case that inflation has ripped off savers by eradicating 97% of their savings’ worth. Nobody suffered that loss. Indeed, holders of cash voluntarily held it, judging that the gain from money held exceeded the (predictably) minor loss in purchasing power.

Joakim Book

Joakim Book

Joakim Book is a writer, researcher and editor on all things money, finance and financial history. He holds a masters degree from the University of Oxford and has been a visiting scholar at the American Institute for Economic Research in 2018 and 2019. His work has been featured in the Financial Times, FT Alphaville, Neue Zürcher Zeitung, Svenska Dagbladet, Zero Hedge, The Property Chronicle and many other outlets. He is a regular contributor and co-founder of the Swedish liberty site Cospaia.se, and a frequent writer at CapXNotesOnLiberty, and HumanProgress.org.

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