Crossings

When you show real and nominal output on the same graph, the inflation-adjusted line always crosses the nominal line at the base year. And if, as a rule, there is always inflation, then before the base year, the inflation-adjusted line is always higher. And after the base year, it is always lower. The year we pick for the base determines where the lines cross, where the adjusted numbers are higher, and where the adjusted numbers are lower.

For example, Graph #1 compares US GDP and inflation-adjusted GDP. You can see that the two lines cross between 2000 and 2010. And you know that they cross in 2005, because the base year for figuring inflation-adjusted GDP is 2005, by standard practice. If you don't know the standard practice, you can look at the label on the left-hand border of the graph. It gives the units as Billions of Chained 2005 Dollars (for the blue line) and Billions of Dollars (for the red). In 2005, the two were equal.

Graph #1: GDP and Inflation-Adjusted GDP cross in 2005

Graph #2 shows the same numbers, all "indexed" to 1980. That's a quick-and-dirty way of showing the inflation-adjusted numbers with 1980 as the base year. Note that the left-hand label now says "Index" and the numbers on the vertical scale do not represent dollars, but relative sizes:

Graph #2: Both series indexed to 1980

Similar to Graph #1, Graph #3 below compares GDP to inflation-adjusted GDP, but the inflation-adjustment is calculated on the fly. Compare the equations given in the top border: On Graph #1, a pre-calculated series is used; Graph #3 shows the calculation.

Graph #3: GDP and Inflation-Adjusted GDP (calculated for 2005 base)

That calculation takes unadjusted GDP, divides by GDPDEF to remove the price changes, and multiplies by 99.993 to convert all the values to 2005 dollars. (Why 99.993 and not 100 exactly? Can't say. Rounding, maybe. The 99.993 number is from FRED's annual GDPDEF values.)

Now that we have the graph set up to calculate the inflation-adjustment, it is easy to show it for different base years. In Graph #4 I took out the 2005 price number (99.993) and in its place used the 1980 price number (47.793). That moved the blue line, making Graph #4 comparable to Graph #2:

Graph #4: GDP and Inflation-Adjusted GDP (calculated for 1980 base)

Graph #5 is the same graph again, but with 1964 as the base year:

Graph #5: GDP and Inflation-Adjusted GDP (calculated for 1964 base)

Why 1964? Because that's just before the Great Inflation.

Two ways to look at debt

My "sales pitch" for my "Measuring the Erosion of Debt" pdf included this line:

If there is such a thing as the erosion of debt by inflation, then inflation-adjusted debt on a graph must be higher than nominal debt.

There was not a doubt in my mind. (That was 17 August)

A few days later I read Thayer Watkins' page on The Deficit of the Government. Watkins wrote:

This inflation adjustment is especially important during times of high inflation that push up interest rates and require large interest payments on the debt. The real value of the deficit would be far smaller than the nominal value.

//

Wow.

Here's part of what I have for tomorrow's post:

When you show real and nominal output on the same graph, the inflation-adjusted line always crosses the nominal line at the base year. And if, as a rule, there is always inflation, then before the base year, the inflation-adjusted line is always higher. And after the base year, it is always lower. The year we pick for the base determines where the lines cross, where the adjusted numbers are higher, and where the adjusted numbers are lower.

So then Watkins is right (the real value is smaller than the nominal) if we are thinking of a year that is *after* the base year. For example, the base year is any year in the past, and we are thinking about what we owe now, this year.

"What we owe now" is a useful way to look at debt, for sure. However, if there is such a thing as the erosion of debt by inflation, then inflation-adjusted debt on a graph must be higher than nominal debt.

If there is confusion here, it arises from the confusion of stocks and flows. Inflation affects stocks and flows differently.

That's all for now.

Nothing has changed

Joe Weisenthal thinks the Fed's recent announcement is a Game changer.

It's not.

Think of debt as a lot of arrows pointing at the people who get income from debt. The other end of the arrows, the tails, start at the people making payments on debt.

Each tail is a drain pipe, draining money out of the spending stream. (That's why deflation is a concern when deleverage is a priority.)

Here's part of the Fed statement quoted by Joe Weisenthal:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.

There are guys in Ben Bernanke's office holding the pointy ends of those arrows. Bernanke, sitting at his desk, reaches into the empty cardboard box behind him, pulls out fistfuls of money and hands them out in exchange for the pointy ends.

When it's over, Bernanke is holding lots of pointy ends. And the people who were holding the pointy ends are now holding fistfuls of money. But for the people making the payments, for the people holding arrow tails, nothing has changed.

The problem is not who's holding arrowheads. The problem is too many tails.

Arnold Toynbee

From Wisdom Supreme:

In his Study of History Toynbee describes the rise and decline of 23 civilisations. His over-arching analysis was the place of moral and religious challenge, and response to such challenge, as the reason for the robustness or decline of a civilisation. He described parallel life cycles of growth, dissolution, a "time of troubles," a universal state, and a final collapse leading to a new genesis. Although he found the uniformity of the patterns, particularly of disintegration, sufficiently regular to reduce to graphs, and even though he formulated definite laws of development such as "challenge and response," Toynbee insisted that the cyclical pattern could, and should, be broken.

Lots of Toynbee quotes at the above link. And the first four short paragraphs, under "Ideas", by the old man's picture, give a good overview of his thinking.

And from the Catholic Education Resource Center:

The historian Arnold Toynbee observed: "Out of 21 notable civilizations, 19 perished not by conquest from without but by moral decay from within."

Not sure about the 23/21 discrepancy. Either way it's a lot of civilizations, all following a pattern Toynbee lays out in great detail.

Obviously I think he's wrong about "moral decay" being the source of decline. People often see economics and say morality.

Trials and Tribulations

I have the blog set up so comments always show up in my email. I've had it that way almost since the beginning. It's handy, and I depend on it.

A week or so ago, I got a spam comment. Instead of deleting it from my email, I marked it as spam.

Since then, half or more of your comments here went to spam in my email. I no doubt missed some of them on the blog.

My bad.

Judging a book by the dates in its subtitle

Used book store. Economics shelf. Something catches my eye.

Title: Debtors and Creditors in America

Bored yet? I'm not.

Subtitle: Insolvency, Imprisonment for Debt, and Bankruptcy, 1607-1900

I saw those dates and my heart skipped a beat. I had to have this book.

Author: Peter J. Coleman
Publisher: The State Historical Society of Wisconsin
Madison, 1974

Now you're definitely bored. But check out the first two sentences of the Preface:

The cost of money is higher as this is being written than at almost any time in living memory. It presses us so hard because we depend more heavily upon credit than any society that man has ever known.

Yep. A given rate of interest would press less hard if we depended less on credit. The cost of money depends not only upon the rate of interest, but also on the reliance on credit. Coleman has it exactly right.

Everyone knows interest rates vary. Few are aware that our dependence on credit also varies. In the mid-1970s -- when Peter Coleman wrote "we depend more heavily upon credit than any society that man has ever known" -- our dependence on credit was less than ten-to-one. Before it broke our economy, it reached 35-to-one:

M1 money is the stuff that comes to you in your paycheck. "Credit in use" is debt.

Yield of Three Percent Consols for England

Click for FRED source page

Just looking.

"a more insignificant thing"

Recently I remarked

I am still astounded by the density of recessions up to the 1930s.

Jazzbumpa pointed out that

We were on the gold standard.

Now I find James Hamilton at Econbrowser supporting Jazz's view:

The NBER's business cycle dates also characterize this era as experiencing economic recessions more frequently and of longer duration than observed since the U.S. abandoned the gold standard in 1933...

Hamilton quotes Tyler Cowen,

Dare anyone critical of the gold standard bring themselves to utter these (roughly true) words?: "For the Western world, the gold standard era, defined say as 1815-1913, was arguably the greatest period of human advance ever, at least in matters of economics, culture, and technology."

and Hamilton responds:

There was indeed spectacular real economic growth in the nineteenth and early twentieth centuries. But it is unnatural to me to suggest that the monetary standard was the key cause of this. Instead I would point to real developments. For example, U.S. production of crude petroleum quadrupled between 1868 and 1878 and doubled every decade after that up through 1915...

As for myself, I am always on about excessive debt and monetary imbalance and such, and how these hinder growth. I do not mean to suggest that printing money will make the economy grow. "Real developments" are most important. But when money goes bad, it can hinder real developments. It can hinder growth.

Unfortunately, when growth is hindered by money, people have a hard time seeing it. People tend to think we need to fix the real developments -- that we must focus on the supply side, for example -- and only end up doing things that make bad money worse. Let me re-quote the John Stuart Mill that Friedman quoted in Free to Choose:

There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money ... and ... it only exerts a distinct and independent influence of its own when it gets out of order.

There may be reasons we cannot "double U.S. oil production every decade for the next 40 years". But there is no reason money should stand in the way of our efforts.

The Quotable Kenworthy

I would have gone a different direction than Lane Kenworthy does in We’re all dependent on government, and it has long been thus. But this paragraph is great:

In Eberstadt’s way of seeing things, we are either givers or takers — taxpayers or benefit recipients. This is mistaken. Every American who doesn’t live entirely off the grid pays some taxes. Anyone who is an employee pays payroll taxes, and anyone who purchases things at a store pays sales taxes. Likewise, every American receives benefits from government. If you or your kids attended a public school, if you’ve driven on a road, if you’ve had a drink of tap water or taken a shower in your dwelling, if you’ve deducted mortgage interest payments or a business expense from your federal income taxes, if you haven’t been stricken by polio, if you’ve never had a band of thugs remove you from your home at gunpoint, if you’ve visited a park or lounged on a beach or hiked a mountain trail, if you’ve used the internet….