Wednesday, March 26, 2014

A Brilliant Look at US Monetary History

by Pater Tenebrarum

Bob Prechter on the Quality of Money and Stock Prices

Regardless of whether one is a fan of Elliott Wave Theory, it is undeniable that Bob Prechter frequently presents extremely interesting insights. An article published in the most recent (March 2014) issue of the 'Elliott Wave Theorist' is a very good example. The article is entitled: “Government, the Fed and the Nation's Money: 200 Years of Ineptitude; 100 Years of Theft and Failure; 50 Years of Economic Regression”.

Prechter recounts US monetary history and brings it into context with the stock market. In the beginning, the 'dollar' was not an independent monetary unit at all: it was simply a specific weight of silver (0.7734 oz.). Later Congress made a first major mistake when it decided to fix the exchange rate between silver and gold instead of letting it be dictated by market forces. The result of the artificial parity was initially that gold coins were driven out of circulation, and later the same happened to silver coins (following the discovery of gold in California).

Attempts were made to 'fix' this mistake by introducing a different parity, but such price controls can of course never work. Over time, the character of the nation's money was altered step by step, with the biggest change arriving with the founding of the Federal Reserve. No longer was the dollar simply a certain weight of metal: henceforth, notes issued by the central bank could also be 'backed' by treasury debt. Then came FDR's gold confiscation, coupled with a dollar devaluation by about 70%, with the new gold/dollar exchange rate simply made up by the president on the basis that he 'liked the number'.

Contracts involving payment in gold were retroactively and prospectively abrogated by law, and citizens were forced to use paper money. Private ownership of gold was made illegal. However, the treasury still issued notes backed by silver until 1965. That was the last year when the government issued money that was actually backed by metal. In 1971, the final step toward a pure fiat money was taken when Nixon defaulted on the Bretton Woods gold exchange clause.

Most readers are probably quite familiar with this historical progression from the employment of an essentially market-chosen money to today's state-issued fiat scrip backed by absolutely nothing. Actually, theoretically, these fiat money IOUs are supposed to be backed by the 'entire value of the nation's assets' according to Congress. However, as Bob Prechter points out, it has yet to be tested what this really means. Could the government be obligated to confiscate every asset in the nation to satisfy its creditors?

What is really interesting though is how the step-by-step change in the character of money has redounded on economic affairs and especially the accumulation of wealth. In order to find this out, Bob Prechter simply looks at the history of the stock market valued in gold terms. The idea is that the market's real value is a pretty good mirror of both economic progress and economic regression. He has discovered that there is an astonishing difference in how the market's real value has developed depending on what type of monetary standard was in use.

Economic Progress and Regression

The question Bob Prechter tries to answer is whether the Fed has actually produced any economic benefits. If it had, we should be able to measure these benefits in some way. It is of course inherently difficult to 'measure' such abstract concepts, but both the prices of stocks and the exchange value of gold are market-derived data that can certainly be compared with each other. This offers a way of checking how the nation's wealth has changed over time under different monetary regimes.

The difference is enormous. The net gain of the stock market in terms of gold in the century prior to the founding of the Fed was 1,489%. In the century since the Fed's founding, the gain amounted to a mere 315% (in spite of the fact that the market has recently reached new nominal record highs). From 1813 to the peak in 1929, the stock market gained an astonishing 10,161% in gold terms, and has actually lost 35.8% of its value since then.

It becomes even more extreme if one considers the 173 years from 1792 to 1965, given that 1965 was the year when the last vestiges of a metallic money standard were abandoned with the treasury's decision to no longer issue silver-backed notes. The market's gain in gold terms over this time period was 30,556% (from 0.9 ounces to 27.59 ounces). Since then it has declined by 57%.

Assuming the market had continued to rise by the same average amount as reflected in the old trend, it would have gained more than 150,000% since 1792 in real terms. In reality, its  net gain only amounts to a little over 13,000% – a difference of more than 90%.

Of course such extrapolations are not really valid, since we cannot go back in time and reset conditions for an objective empirical test. Still, the historical data as such are what they are, and they clearly show a stark difference in how the market's real (i.e., gold-denominated) value has changed over time under different monetary dispensations.


The conclusion is that the alleged 'benefits' of the modern 'flexible monetary standard' simply don't exist – at least it seems obvious that wealth accumulation has been slowed down dramatically by abandoning sound money. One can of course not deny that certain groups in society indeed benefit to the detriment of everybody else from the current monetary dispensation, but even they have probably lost more net-net than they could have potentially gained if sound money had continued to be used. The return to a sound, market-chosen money should be the primary objective of economic policy. It is really high time to admit that the central planning of money has failed in every respect.

PS: if you ever considered whether to give a trial subscription to the EW Theorist a whirl, now seems to be an extremely good time for doing so. The March issue is really a treat we highly recommend (it also includes charts showing the developments discussed above). Moreover, of you do so by using the link provided on the right hand side, you automatically contribute to 'Acting Man' as well (we are an EWI affiliate), thereby killing two birds with one stone. What could be better?

eccles-buildingThe Mariner Eccles building, where the US version of 'GOSPLAN' resides. The Fed's century-long interference with the economy has led to impoverishment on a grand scale.

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