[The following is an excerpt from my 30/06/05 report to subscribers]

Since 1929 the gold (or real) value of the US dollar has depreciated by roughly 95%; since 1933, when FDR took the US dollar off of the gold standard (after officially depreciating it by about 30 percent relative to gold) the gold value of the US dollar has fallen by a further 92 percent; and finally (the cause), America’s broad money stock has grown from US$73 billion in 1929 (according to Rothbard’s America’s Great Depression) to almost US$10 trillion today – which is an increase of about 130 times.

What this should tell you, besides suggesting that the currency should have lost more than 99 percent of its value by now, and besides confirming the quantity theory according to the Austrian School (the non-mechanistic version), is that somewhere around 92% of the Dow's current value is nothing but inflation. In other words, if the gold value of the US dollar remained fixed and gold itself remained stable throughout that period (which is neither possible nor desirable in reality), all else equal, the Dow would be worth between just 600 and 800 of those original 1933 gold US dollars today.

If the 130-fold expansion in the total stock of money formed a valid basis for the calculation of ultimate intrinsic loss in the value of money (which it doesn’t) the Dow could be said to be worth only 77 today in 1929 dollars.

In any case, using gold as a better proxy than the CPI (it really is) or foreign exchange alone as a measure of the greenback’s value, Dow 600 or Dow 800 would represent only a 12–16 fold real gain from the depths of the depression between 1929 and 1933 (rather than a 200-fold nominal gain) and only a double from its peak in 1929 (in 73 years!).

That makes for an annual real rate of return of somewhere between 1 and 4 percent.

In other words, the value of an investment in the index could only be expected to buy between 2 and 15 times the amount of goods that a person would consume, rather than 200 times as is implied by the nominal gain… and that is all before reconstructing the Dow Industrials index according to its original components to get a true picture of how the many inflation-induced boom/bust sequences have affected the longevity of individual stocks. It is also before dividends; but we could assume the bearish secondary effects of inflation on capital structure (just mentioned) to offset the dividends paid out over the period of time in this example. To be sure, even if the real return is that low, it is still better than nothing (putting the cash under your mattress or in your bank’s vaults would have lost you purchasing power over the duration of this period), and it was still better than owning gold – for the specific duration in this period.

But I’ve never argued explicitly that gold is the best long term investment ever. I have a predilection for stocks as claims on capital that can grow by yielding profits.

It is the best long term investment in an environment where the Inflationists run rampant amid ever-growing government largesse, and where the risk of a potential hyperinflation runs anywhere over the “let’s take it into consideration” barometer.

Murray Rothbard explained the business cycle which most people continue to attribute to the boom-bust sequence of capitalism (markets are “inherently unstable” – George Soros) by illustrating why they are solely the product of inflation – or monetary intervention which is the same thing.

The Austrian School business cycle theory (Mises, Hayek, Rothbard and others have all contributed to it) tries to integrate “cycle theory” into a general economic theory on the grounds that if economics can’t explain an economic phenomenon, like the business cycle, then either economics is wrong or the cycle theory needs work.

"Study of business cycles must be based upon a satisfactory cycle theory (cause and effect). Gazing at sheaves of statistics without “prejudgment” is futile. A cycle takes place in the economic world, and therefore a usable cycle theory must be integrated with general economic theory. And yet, remarkably, such integration, even attempted integration, is the exception, not the rule" (Rothbard, pp 3 America's Great Depression).

Assuming then that his economics is right, the attempt resulted in what used to be called the trade-cycle theory but now is called the Austrian School’s business cycle theory; it postulates that due to the way the market is supposed to work declines in one business segment usually just reflect a shift in tastes or preferences and therefore good fortune for another business (note by the way that the “multiplier effect” that is taught in most schools starts with one policy or another as its cause).

Thus he concluded that if economics is right it is plainly not possible for general cycles of depression to occur – in other words there is no inherent flaw in the free market or capitalism in theory (note here that the Kondratieff model presumes a flaw in capitalism I believe). So if that was the case, perhaps we should look to the effects of intervention where he brilliantly observed:

“In considering general movements in business, then, it is immediately evident that such movements must be transmitted through the general medium of exchange—money. Money forges the connecting link between all economic activities. If one price goes up and another down, we may conclude that demand has shifted from one industry to another; but if all prices move up or down together, some change must have occurred in the monetary sphere” (pp 6 in America's Great Depression).

“…fluctuations in general business" could now be said to be fluctuations "in the money relation" in the sense that "any cycle in general business must be transmitted through this money relation: the relation between the stock of, and the demand for, money” (pp 7 in America's Great Depression).

Anyway, the workings of the theory are generally that a build up in the production of capital goods occurs as a result of the effects of monetary policy (which is a constant intervention in the “money relation”) on judgments made by businessmen and when they prove wrong because people’s spending patterns haven’t changed in the expected way then those “malinvestments” are liquidated… but this crisis point can be postponed for great periods of time by the ongoing subsidization of the build up of malinvestments – by continuing the inflation policy in other words – by continuing the boom.

The moment the inflationary impetus (the boom) is abandoned, however, the crisis begets a liquidation of these factors which explains the general depression.

The depression he continues is actually only the market trying to return to a more normal money relation (a dynamic equilibrium) – a market determined price structure – i.e. where it would be without the constant intervention.

Rothbard did note in his book by the way that the gold standard contributed to the decline in prices because it prevented the Fed from inflating its way out of the decline in confidence that had built critical mass and resulted in a drain of gold reserves from the banking system; and that in the absence of the gold standard one could expect these depressions to occur alongside increases in the consumer price level.

In other words, as we’ve tried to point out in the past, the seventies era of stagflation was really a depression in a monetary environment that was not anchored to a gold standard… it was the same as the thirties’ depression in terms of other barometers like unemployment and “real” stock market pain. The differences were wholly nominal, or monetary. There are a few reasons to shed light on this theory.

First, it is pertinent to the current state of affairs; second, it really is the only cycle theory besides Schumpeter’s (static) general equilibrium model (of the way that “creative destruction” works) that can be explained by appeal to economic theory (i.e. logic); and third, it implies that even the existence of bull and bear markets as we know them today is an illusion. An investment in the Dow under a gold standard would have bought you more goods today if we were still on a gold standard than it in fact can!

I don’t know if bull and bear markets would exist without the Fed but I suspect there would be a modest increase in the average stock price because of the reinvestment of profits contributing to growth – but the price of any given unit of capital should fall just like any other demanded good produced in a freely competitive environment.

For instance, the price of certain technologies or machinery would fall; or house prices would actually fall on average as a fresh supply of newly constructed homes comes on stream. These are economic concepts that are unknown to over three generations of North Americans… ever since the beginning of the 20th century.

The only thing they know of them is that they don’t want falling house prices and they want stocks to fly. Hence today, economic growth causes prices to rise!!

Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com

July 2, 2005

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