Introducing Yield Purchasing Power

The monetary debate seems artificially limited. On one side is Federal Reserve policy based on discretion. On the other is policy based on rules. It’s Keynes vs. Friedman. It’s central planning of our economy based on the reactive whims of wise monetary planners vs. central planning of our economy based on the proactive rules written by … wise monetary planners.

On the rules side, there is a sub-debate. Should we have central planning based on unemployment and the Consumer Price Index (as now) or switch to central planning based on another metric such as GDP?

Whether one is on team Keynes or team Friedman, whether one is on sub-team Friedman CPI or Friedman GDP, everyone seems to take something for granted. That is, the quantity theory of money. If the quantity rises, then prices follow. However, since prices (especially commodity prices) are not really rising, this would seem to give more leeway to the monetary planners, to inflict more monetary policy on us.

There is something about this which few acknowledge. To increase the quantity of dollars—which is not money, but that’s a whole ‘nother discussion—the Federal Reserve buys bonds. Whatever effect this may have on the price of a new Chevy, it obviously affects the price of the Treasury bond. It pushes the bond price up. Since the interest rate is a strict mathematical inverse of the bond price, we have an obvious conclusion.

The Fed is pushing down the rate of interest.

We can say that the interest rate is the collateral damage. The Keynesians and Friedmanites, in their zeal to increase the quantity of dollars, support or at least ignore the falling interest rate. OK, but who cares about the interest rate? You should care. Everyone is impacted by the 35-year global trend of falling interest rates.

The falling rate ushers in a kind of hyperinflation. You won’t see it by looking at prices, or purchasing power. If you look at the value of your portfolio and divide by the cost of living, you may be lulled into a false sense of security.

You will see the hyperinflation, if you look at it another way. Instead of the liquidation price of assets, consider the yield on assets. Instead of selling off the family farm to buy groceries, think of operating that farm to grow food. Can you live on the crops you produce? Or must you liquidate piece of it, just to survive?

The same question applies to any capital asset including a bank balance. Is it possible to live on the interest?

In the cold harsh light of yield purchasing power, we can see the erosion of our capital base. Since civilization itself depends on capital accumulation, this erosion is a retrogressive force dragging us back to another dark age.

I gave a 45-minute presentation on Yield Purchasing Power at American Institute for Economic Research in Great Barrington, MA on October 14, 2016. I am grateful to the Institute for recording video of my presentation plus extended Q&A.

Real vs. Nominal Interest Rates

What is the real interest rate? It is the nominal rate minus the inflation rate. This is a problematic idea. Let’s drill deeper into what they mean by inflation.

You can’t add apples and oranges, or so the old expression claims. However, economists insist that you can average the prices of apples, oranges, oil, rent, and a ski trip at St. Moritz. This is despite problems that prevent them from agreeing on what should be included.

One problem is that we no longer need buggy whips. If buggy whips had been in the Consumer Price Index (CPI) before the advent of the car, what do you do when it goes out of general use? Substitute driving gloves (which most people don’t use)?

Another problem is that cars are vastly superior today than they were 50 years ago. Having had a chance to drive a classic 1965 Mustang with drum brakes, I can tell you it was scary to drive on the highway at 55 mph. I didn’t dare drive it faster, as the stopping distance felt like it would probably be half a mile. But, of course, every car on the road was whizzing past me at +20mph. Cars today cost more. How much do we attribute to inflation, and how much to the fact that they are better and contain many more gadgets?

Worse still, the process of determining which items to include in CPI is politicized. Pensioners and union workers want CPI to rise as much as possible, because their income is tied to it. Pension fund managers want CPI to rise as little as possible, because their obligation is tied to it. Government officials also want a low CPI, as high inflation may be viewed as a measure of their mismanagement of the economy.

Finally, the effort to calculate the cost of living assumes that we can agree on what living means. To some, it may mean a rural lifestyle, cooking simple meals in a paid-off trailer. To others it may mean a rented urban rent loft, eating at hip foodie restaurants every night. To a large group of baby boomers, it means owning a large house, driving a BMW, and sending the kids to private school.

The very theory of measuring the CPI as an indicator of inflation is flawed. Unfortunately, that doesn’t stop the government from compiling a CPI, and helpfully providing it to the economics and finance professions.

One use for the CPI is to adjust the interest rate. Let’s look at how this works.

There is an actual rate at which actual lenders actually lend and actual borrowers actually borrow. Most days, the government conducts billions of dollars of transactions at this rate. Private parties conduct billions more.

So in keeping with the Orwellian character of our era, we’ll call this price observed in the market, the nominal rate.

Economists adjust this nominal rate. Guess what you get, if you subtract the CPI from the nominal rate of interest.

The real interest rate.

Got that? The nominal rate is the real market price and the real rate is when you subtract a controversial construct.

I often think that modern monetary economics has no redeeming virtue. However, whenever I think that’s too harsh, I come across a notion like real vs. nominal rates.

Should the Gold Price Keep Up with Inflation?

The popular belief is that gold is a good hedge against inflation. Owning gold will protect you from rising prices. Is that true?

Most people define inflation as rising prices. Economists will quibble and say technically it’s the increase in the quantity of money, however Milton Friedman expressed the popular belief well. He said, “Inflation is always and everywhere a monetary phenomenon.”

There you have it. The Federal Reserve increases the money supply and that, in turn, causes an increase in the price of everything, including gold. It’s as simple as that, right?

Except, it doesn’t work that way. Just ask anyone who has been betting on rising commodities prices since 2011. Certainly the money supply has increased. M1 was $1.86T in January 2011, and in March it hit $3.15T. This is a 69 percent increase. However, commodities have gone the opposite way. For example, wheat peaked at $9.35 per bushel in July 2012, and so far it’s down to $4.64 or about 50 percent. And the price of gold fell from $1900 in 2011, to $1050 late last year, or 45 percent.

Would you say that inflation is +69%, or is it -45% or -50%?

Most people look at retail prices, not raw commodities or gold. Retail prices have not followed into the abyss. Love it or hate it, the Consumer Price Index registers a cumulative 8 percent gain from 2011 through 2015 inclusive.

Let’s consider an example to help understand why. Suppose you own a coffee shop in a central business district. The city enacts a new regulation that limits the hours for delivery trucks. This forces you to pay overtime wages to your staff to unload the trucks, and of course, the carrier charges more for delivery too.

Next, the city allows poor people to stop paying their water bill. So to compensate, they raise the water rates on businesses. While they’re at it, they raise the fees for sewer, garbage, gas line hookups, fire inspections, and sign permits. The state passes a higher minimum wage law. The building inspector requires that you increase the size of your bathroom to accommodate wheelchairs, and you lose revenue-generating floor space. There are hundreds of ways that government increases your costs.

Is this inflation?

Not yet, costs are up but not prices. Sooner or later, all of the affected coffee shops try raising their prices. Consumers don’t necessarily want to pay more for coffee, so a few shops fail. The survivors are now charging 15% more for coffee. They have their higher prices, at the cost of lower sales volume.

The burden of government bearing down on the coffee business only increases. Every day, three constituencies conspire to drive up costs. We’ll call them the “there oughtta be a law” crowd, the “government needs more revenues” mob, and the “they served 10oz of coffee plus 4oz of ice so let’s sue them” racket.

Regulation, taxation, and litigation drive up price. Friedman was wrong. The rising price of lattes is not a monetary phenomenon (the monetary system is pressuring prices lower right now, and in my theory of interest and prices I discuss why). Rising retail prices are a fiscal, regulatory, and judicial problem.

There is no reason for the price of gold to follow retail, because there is no mechanism that connects gold to these non-monetary costs.

Interest on Gold Is the New Tempest in a Teapot

Zero Hedge published an article on Canadian Bullion Services (CBS) last week. Other sites ran similar articles. The common thread through these articles, and in the user comments section, is that CBS is committing criminal fraud. Or, if not, then it’s a conspiracy by the Canadian government to confiscate gold. Terms like fractional reserve and re-hypothecation were dusted off for the occasion.

I don’t know anything about this company other than what I read that day. I am writing today to make a different point, not to address or defend CBS.

My point is: a company offers interest on gold, and the gold community goes ballistic. Why so visceral a response? To answer that, we need to look at the backdrop of today’s bizarre financial world.

Interest rates have been falling for well over three decades. This has caused endless asset bubbles in which to speculate to make a fortune (or lose one). And now, in the terminal stage of our monetary disease, there is scant yield to be had even in the US. Negative yields already prevail in several other countries.

We have become accustomed to it. We’re trained to not expect to earn interest, to not even think about it. Instead, we’re like Pavlov’s dogs who know to salivate at the sound of a bell. Only we’re not after food, but opportunities to speculate. All we want to know is, what’s going up next. Mainstream folks prefer to speculate on mainstream assets like stocks and real estate. Gold bugs would rather bet on gold and silver. Either way, it’s the same: seek capital gains by the rising dollar price of an asset. Yield is as dead as the rotary dial telephone.

And, we’re beyond merely accustomed. People demand speculative bubbles. It feels right as rain—or the next dose of opiate painkillers. Besides, speculation is how you get rich quick. Especially with leverage. Interest is boring and slow.

As those articles I mentioned earlier show, many people who are accustomed to demand speculative capital gains are actually offended at the very promise of a yield. It’s cognitive dissonance. If speculation is how we are supposed to make money, then interest is a vestige of the old normal. It’s like a thorn under your skin that you can’t get rid of, an annoying reminder.

This touches on a point I frequently make: gold does not go up or down. It’s the dollar that goes down or up. However, if this is true, then there’s a problem: how can you speculate on gold? I think so many people are so insistent on measuring gold in dollars for a simple reason. They want gains.

They want gold to go up, so they can get rich. This requires something to use to measure gold. If gold is going up, then compared to what? The dollar!

Perversely the fiat dollar suits the gold bugs as well as it suits the Federal Reserve (though for different reasons). Both believe that if everyone is forced to use the dollar as the unit of account, then they benefit from rising asset prices.

After the fiat dollar, what comes next? There are two possibilities. One is a normal world where gold is used as money, and people can earn a return on their gold. The other is collapse into a new dark age. Even in a dark age, gold is money all right. It’s just that no one wants to risk getting killed for his metal.

There’s nothing intrinsically wrong with borrowing, lending, or earning interest. In fact, the loan is a win-win deal. It benefits the business who borrows in order to produce the things that people want. And it benefits the saver and retiree who lend to earn an income on their savings. Productive lending is an integral part of the gold standard.

They Broke the Silver Fix (Part I)

Last Thursday, January 28, there was a flash crash on the price chart for silver. Here is a graph of the price action.

Silver Fix Price
The Price of Silver, Jan 28 (All times GMT)

If you read more about it, you will see that there was an irregularity around the silver fix. At the time, the spot price was around $14.40. The fix was set at $13.58. This is a major deviation.

Many silver bugs are up in arms about how unfair the new silver fix is. That’s nothing new. They were up in arms about the old one. The old one was supposedly manipulated.

One thing is for sure, tactical manipulations can occur. A gold trader in London was found to have pushed the price down in the gold fixing by a few pennies. He had sold a multimillion dollar option, and he wanted it to expire worthless to avoid having to pay. Right after the fix, he bought back the gold he sold, pushing the price back up to where it was. He took a loss on the round trip of the gold, of course, but saved millions on the option which he did not have to pay.

This is not the long-sought proof that nefarious forces are keeping gold from attaining $20,000.

Anyways, because the silver and gold fixes were deemed to be benchmarks by regulatory changes post the LIBOR manipulations, a new process for the gold and silver fixes was implemented. Before we look at what changed, let’s consider why there is a fix price. Couldn’t they just take the price at 12:00 noon?

No, it wouldn’t work because in a live market there is not just one price. There are always two prices: bid and offer. Which would you use as the benchmark? Either price could misrepresent the current state of the market. What’s more, those prices are just quotes, not executed trades.

To be useful as a benchmark—a price that third party contracts and derivatives can be based on—there has to be a single price based on real executed trades. So they need to get buyers and sellers together, and find the price at which the most metal clears. If there is a better way than that, it hasn’t been discovered yet.

This leads to a question. How do two prices that are supposed to track each other actually, you know, stay matched? This occurs in Exchange Traded Funds that move with an index of stocks (such as SPX or GLD). It occurs in gold futures and spot.

It should also occur between the fixing process and the spot market. What use is a silver fix at $13.58 while the spot price was $14.40? We’ll get back to market action on that day, in a bit. First, we need to look at the force that keeps two prices close to each other.

It is arbitrage. Let’s use GLD as an example. Each share represents a known quantity of gold. Suppose the price of the share rises relative to the price of gold metal in the spot market, and the metal in a share of GLD is $1 per ounce higher. The arbitrageur buys gold metal, creates shares of GLD, and sells them. This tends to pull up the price of gold metal, and mostly pushes down the price of GLD.

Note that the arbitrageur takes no price risk. He is simply acting to profit from a spread (usually a very small one). Arbitrageurs will keep doing this trade, until GLD and gold metal get close enough that the small remaining profit is not worth the effort.

The arbitrageur is motivated, of course, by profit. He is as greedy as the next guy (admit it, if you could demand a 300% raise from your boss, you would). However, his activity is self-limiting. The more he puts on his trade, the more he compresses the spread. In our example, the arbitrageur buys some gold metal and sells some GLD shares, to make $1. That is the initial profit. However, he compresses that spread, perhaps to 50 cents. He can have another go, but then the spread narrows to 25 cents. Soon enough, he walks away (these are illustrative numbers only for this example).

It’s a textbook case of the Invisible Hand described by Adam Smith. The arbitrageur, seeking his own profit, ends up serving other market participants. He keeps two different prices locked tightly together. Everyone else can take for granted that GLD works as it’s supposed to.

For example, suppose you run a small gold coin store. You need to hedge your inventory just as a large dealer does. However, you sell gold one ounce at a time. Big dealers might use 100-ounce gold futures, but you use GLD. You can thank the actions of this arbitrageur.

Now let’s get back to the fix. The old process was conducted by the major market makers in each metal. They got together in one room, and each had major clients on various phone lines. The chairman would put out a price, and the market makers would talk to their clients to determine who wanted to sell at that price and who wanted to buy. Then they add up all selling and buying, and see if there’s a close match. They would keep moving the price until selling matched buying within tolerance. That was the fix price.

There was just one problem, at least so far as the gold bugs were concerned: the market maker. Since the first market maker walked into a coffee house in London where shares were being traded, most people have misunderstood the market maker. Back in the coffee house days, all potential sellers would line up on one side of the room, in order from lowest offer price to highest. On the other side, buyers would line up, from highest bid to lowest.

If one had to sell, that meant taking the best bid presented in the room. Likewise, if one wanted to buy right now, one paid the best offer price. As you would imagine, the bid-ask spread could get pretty wide, and perhaps worse yet, it was unpredictable.

Until the market maker walked in. Unlike all the others, he was both a potential buyer and a potential seller. He had an inventory of both shares and cash. He published a better price if you wanted to buy or sell and as it turns out, he was the only one who could consistently buy at the bid price and sell at the ask price.

Of course, the guy with the best bid price—or what had been the best price until the market maker strolled into the room—was upset. Who is this dodgy bloke? Why is he allowed to mess about like this? Surely it’s unethical, immoral, and maybe even illegal?

In fact, he is serving all market participants (except the few who hoped to sell and make a buyer pay a premium and the equally small few who hoped to buy from someone desperate to raise cash). The market maker is motivated by profit, sure, but in making money he is narrowing the bid-ask spread whilst also reducing its volatility.

Today, the market maker is aka High Frequency Trader, and he uses technology that the coffee house fellows could not have imagined. Nevertheless, he too encounters the same exact suspicion, if not resentment, if not envy and anger.

Now let’s tie this to the silver fix. In the old fixing process, bullion bank dealers could place orders in the spot market during the fix. For example, if the fix price looked like it might settle at $14.30, but the spot price was $14.34, the dealers would buy the fix and sell spot, happy to make four cents.

Many objected to this because it looked like information was leaking into the market. They claimed it’s so unfair, perhaps even a gateway drug to insider trading? If other market participants can’t have this privilege, the bullion banks shouldn’t have it either. And besides, they’re supposed to be just brokers and not trading their own proprietary positions. The truth was that there was nothing stopping other market participants from also trading in the spot market during the fixing process, it was just that the bullion banks’ dealers were more efficient at being market maker.

Well, in part due to the agitation of the gold and silver bugs, government regulators came down on the market makers. They fixed it so that market makers were no longer allowed to arbitrage the fix to the spot and futures markets.

Before you think “yeah, this is what we want,” let’s revisit one of our favorite and recurrent themes, namely: be careful what you wish for.

As it stands today, if the fix price is starting to deviate from the market price, the market makers’ hands are tied. Ross Norman, CEO of bullion dealer Sharps Pixley in London, expressed his frustration with this. “The real problem as we see it is that banks are increasingly unwilling or unable to place corresponding orders where they perceive a mis-pricing because of fears of being accused of abusing a situation and facing the wrath of the regulator or their compliance departments.”

The big clients who participate in the fixing process may be freer to trade. However, they don’t have the same information. Market making is hard because you’re playing for pennies or fractions of a penny, but if you screw up you can lose dollars. The clients may know how many rounds into the fixing process they are, and the order imbalance of each round. But they can’t react as quickly as the bullion banks who are making markets in the spot, futures, and ETF markets, and they don’t know as much about market conditions either. They can’t arbitrage a few pennies. They need a much bigger spread.

A wider spread, much less an unpredictable spread, is to no one’s benefit. For example, the mining companies often sell at the fix price, rather than try to time it (or be accused of breach of fiduciary duty by their shareholders if they mis-time it). How much deviation of the fix price will it take before miners are forced to embrace the next-best solution?

“The large discrepancy between the spot price and the fix is very alarming to us especially that it happened twice in a row,” KGHM head of market risk Grzegorz Laskowski told FastMarkets.

The next best solution, by definition, is less advantageous than the best.


Read on in Part II (free registration required) for a damning graph plus our analysis drilling down into what happened last Thursday just after high noon in London.


© 2016 Monetary Metals


The Economy is in Liquidation Mode

If you’re an American over a certain age, you remember roller skating rinks (I have no idea if it caught on in other countries). This industry boomed in the 1970’s disco era. However, by the mid 1980’s, the fad was fading. Imagine running a rink company at the end of the craze. You know it is not going to survive for long. How do you operate your business?

You milk it.

You spend nothing on capital improvements, slash maintenance, and reduce operating expenses. There’s no return on investment, so you cut to the bone and wring out as much cash as possible. When a business has no future, you operate in liquidation mode.

Your rink generates cash flow, but this is no profit. It’s simply the conversion of accumulated capital into present income. You are consuming capital, almost literally eating the business.

I have used a family farm as an example to paint a clear picture of capital consumption. Imagine using your farm, not to grow food, but to swap for it. You tear down the barn to sell the oak beams for flooring, auction off the back 40 (acres), put the tractor on Craigslist, then finally sell the farm and house. All to buy the produce you can no longer harvest.

Let this sink in. The farm’s falling crop yield can’t feed you any longer, but you still need to eat. You’re liquidating the farm merely to buy groceries.

The conventional view encourages you to be grateful that the purchasing power of the farm is high, that it trades for a big stash of food. While it may be true that you can eat for years on the proceeds, it’s small consolation for the loss of what had been an evergreen income.

Roller skating was just a minor entertainment trend. Only rink owners were harmed when it ended. By contrast, we would all be in big trouble if the same phenomenon happened to farming. And unfortunately it did. Not to farms—but across the whole economy, a decent return on capital is disappearing. Interest has gone the way of big hair and disco music.

Businesses borrow to expand production. The additional production increases profits. A portion of this profit is what pays interest. The problem is that fewer and fewer businesses can find decent opportunities to expand. If they could, they would be borrowing aggressively at today’s dirt-cheap interest rate. Their borrowing would push interest up. They’re not, and the proof is the fact that interest has been falling for three-decades.

The Federal Reserve is now pumping mass quantities of credit into the market, while productive demand for credit is lethargic. Borrowing—much of it for financial purposes such as share buybacks and acquisitions—now depends on the Fed and its artificially low administered interest rate.

The Fed operates on the theory that lowering interest stimulates the economy, at the cost of causing prices to rise. This is dubious, at best. However, so long as purchasing power holds steady, the Fed feels it has latitude to keep doing it. In its vain attempt to stimulate the economy, the Fed is actually suffocating it.

For centuries, people living in Western Civilization have been accumulating capital. They have not simply subsisted, and left the world the same as when they entered it. They have been creating more than they consume, passing on new wealth to their children.

The Fed’s falling interest rate has slammed this process into reverse. It has put the entire economy into liquidation mode. It has forced people to consume their capital.


This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog

Shopping Trolley / Grocery Cart Cut Out

Yield Purchasing Power: $100M Today Matches $100K in 1979

I wrote a story about poor Clarence who retired in 1979, and even poorer Larry who retired last year. I created these characters to challenge the notion of calculating a real interest rate by subtracting inflation. The idea is that the decline of a currency can be measured by the rate of price increases. This price-centric view leads to the concept of purchasing power—the amount of stuff that a dollar can buy. It’s the flip side of prices. When prices rise, purchasing power falls.

Recall in the story, Clarence retired in 1979. At the time, inflation was running at 14% but he could only get 11% interest. Real interest was -3%, and Clarence had a problem. He was losing his purchasing power.

Suppose Clarence bought gold. The purchasing power of gold held steady for the rest of his life (see this chart of oil priced in gold). Gold does solve this problem. However, gold has no yield. Clarence is only jumping out of the frying pan and into the fire. Sure, he escapes dollar debasement, but then he gets zero interest.

Let’s look at how zero interest impacts Larry. He makes $25/month on his million dollars. Obviously he can’t live on that. So he gives up his nest egg, for eggs. For a year, he feasts on omelets. Since inflation was slightly negative, the same swap in 2015 nets him the same plus a few additional quiches.

Through the lens of purchasing power, we don’t focus on the liquidation of Larry’s wealth. We ignore—or take it for granted—that he’s trading his life savings for bread. We only ask how many loaves he got.

Shopping Trolley / Grocery Cart Cut Out

Shopping Trolley / Grocery Cart Cut Out

If you had a farm, would you consider trading it away, to feed your family for a year? I hope not. A farm should grow food forever. Its true worth is its crop yield, not the pile of bacon from a one-time deal.

How perverse is that? It’s nothing more than what zero interest is forcing Larry to do.

A dollar still buys about as much as it did last year. Larry’s purchasing power didn’t change much. However, debasement continues to wreak its destruction.  Steady purchasing power does not mean that the dollar is holding its value.

It means that prices are wholly inadequate for measuring monetary decay.

Our monetary disaster becomes clear when we look at the collapse in yield purchasing power. This new concept does not tell you how many groceries you can get by liquidating your capital. It tells how much you can buy with the return on it.

In 1979, Clarence’s $100,000 savings earned enough to support his middle class lifestyle. In 2014, Larry’s million dollars didn’t earn enough to pay his phone bill. To live in the middle class, Larry would need over a hundred million bucks. That’s a pitiful income to make on such a massive pile of cash. It reveals a hyperinflation in the price of capital, which has gone up 1100X in 35 years.

It also shows that the productivity of capital is collapsing. Back in Clarence’s day, businesses earned a high return on capital. It was high enough for Clarence to get 11% interest in a short-term CD. Unfortunately, the dollar rot is in the advanced stage now. There is scant interest to be earned. Return on capital is low, and so borrowers can’t pay much.

Retirees suffer first, because they can’t earn wages. Normally they would depend on interest, but now they’re forced to live like the Prodigal Son. They consume their wealth, leave nothing for the next generation, and hope they don’t live too long. Zero interest rates has reversed the tradition of centuries of capital accumulation.

Purchasing power may look fine, but yield purchasing power shows the true picture of monetary collapse.


This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog

Kids playing with hyperinflated paper currency

There’s Your Hyperinflation

Hyperinflation is commonly defined as rapidly rising prices which get out of control. For example, the Wikipedia entry begins, “In economics, hyperinflation occurs when a country experiences very high and usually accelerating rates of inflation, rapidly eroding the real value of the local currency…” Let’s restate this in terms of purchasing power. In hyperinflation, the purchasing power of the currency collapses. Before the onset, suppose one collapsar buys ten loaves of bread. Soon, it buys only one loaf. Shortly thereafter, it buys only one slice. Next, it can only purchase a saltine cracker. Pretty soon the collapsar won’t buy any bread at all. Stick a fork in it, it’s done.

Kids playing with hyperinflated paper currency

Many critics of the Federal Reserve, the European Central bank, and others have predicted that this end is coming soon. They have been frustrated as prices are clearly not skyrocketing. For example, the price of crude oil was cut almost in half (so far). There’s little to see if one looks at the purchasing power of the dollar, euro, Swiss franc, etc. Purchasing power, as conventionally understood, is doing just fine.

Fed apologists are happily cooing about this. Last month, Nobel Prize winning economist Paul Krugman said, “This is actually wonderful.” Last year, he was gloating, comparing people who predict runaway inflation to “true believers whose faith in a predicted apocalypse persists even after it fails to materialize.”

And yet, all is not well in the realm of the central banks. Krugman may be right about prices, but nothing is wonderful. The economic downturn, which began in 2008, has been so bad that central banks persist in their unprecedented monetary policies. So if purchasing power isn’t collapsing, where can one find evidence of the problem?

Yield Purchasing Power (YPP) shows how much you can buy, not with a dollar of cash, but with the earnings on a dollar of productive capital. No one wants to spend their life savings or inheritance. People are happy to spend their income, but not their savings.

To come back to the analogy of the family farm, people should think in terms of how much food it can grow, not how much food they can buy by selling the farm. The tractor is good for producing food, not to be exchanged for it. Why, then, do people think of the purchasing power of their life savings, in terms of its liquidation value?

If they want to live long and prosper, they should think of their yield purchasing power. Their hard-earned assets should provide income. And it is here, that hyperinflation has set in.

Previously, I compared two archetypal retirees. Clarence retired with $100,000 in 1979, and Larry retired with $1,000,000 in 2014. Clarence was able to earn 2/3 of the median income in interest on his savings. Larry was nowhere near that. He would need over $100 million to do the same. In 35 years, the YPP of a 3-month CD fell more than 1,000-fold.

The collapse in YPP suggests an analogy to hyperinflation. Look at how much capital you need to support a middle class lifestyle. Measured in dollars, the dollar price of this capital is skyrocketing.

This skyrocketing price of capital has the same effect as hyperinflation: it undermines savings and causes people to eat themselves out of house and home.

What does this mean for anyone with less than what they need to support themselves—$100M and rising? They must liquidate their capital, and live by consuming their savings. It’s terrifying to anyone in that position—which means anyone in the middle class.

This problem is not well understood, because it masquerades as rising asset prices. The first tractor to go to the block fetched $1,000. The second went for $2,000. The farmland may fetch a few million. Everyone loves rising asset prices, and so in their greed and euphoria they miss the point.


Keith is speaking at FreedomFest in Las Vegas this week.

This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog

1979 2014 sm

Interest – Inflation = #REF

I have to admit that I derive some pleasure in taking on hoary old myths. For example, some economists assert that the interest rate you see on the Treasury bond is not real. You see, it’s only nominal. To calculate the real rate, they say you must adjust the nominal rate by inflation.

Real Interest Rate = Nominal Interest – Inflation

It seems to make sense. Suppose you have enough cash to feed your family for 2,000 days. Then the general price level increases by 15%. You still have the same dollars, but now you can only buy groceries for 1,700 days. You’ve been robbed, some of your purchasing power stolen. Therefore you want to earn enough interest to overcome this loss.

This view is flawed.

Normally, you don’t spend your savings, only the income on it. In ancient times, people had to hoard a commodity like salt when they worked. In retirement, they sold it to buy food. Modern economies evolved beyond that, with the development of interest. Retirees should not have to liquidate their life savings.

Now, let’s examine this idea of correcting the interest rate using the Consumer Price Index, or CPI. We’ll skip over the problems in trying to measure prices, and avoid the controversy over whether CPI does a good job. We’ll just compare two retirees from two different eras.

Clarence was retired way back in 1979. Suppose he had $100,000 saved up. According to the St. Louis Fed, the CPI was 68.5 on January 1, 1979 and it rose to 78.0 one year later. This means prices rose by about 14%—what most people call inflation. Also according to the St. Louis Fed, a 3-month certificate of deposit offered 11.23%. There are many interest rates, but let’s use this one for simplicity.

The popular view focuses on his lost purchasing power. He begins the year with $100,000. That amount could buy some meat and potatoes. Clarence ends the year with $111,230 in principal + interest. Liquidating that larger amount buys less hamburger and fewer fries at the higher prices at the end of the year. Therefore Clarence had a loss, and the loss is interest – CPI, or 2.77% of $100,000, which $2,770.

I suggest another view. The interest afforded Clarence $11,230 worth of food. According to the U.S. Census Bureau, the median income in 1979 was $16,841. Clarence made 2/3 of his former income. That’s about right for a retiree without a mortgage or commuting expenses. He could eat pretty well. Although the falling dollar did erode his wealth, we’re focusing on how Clarence experiences interest in the real world.

1979 2014 sm

Now, consider Larry, a recent retiree. Larry has $1,000,000 in savings. CPI actually fell over the past year. Interest on a 3-month CD is negligible—0.03%. Again, we’re not focused on whether CPI is accurate. Just grant for the sake of argument, that some prices dropped and this was matched by a rise in others.

In the standard view Larry appears to be better off than ol’ Clarence. Larry lost no purchasing power, unlike Clarence’s loss of almost 3%. This is deceptive and misleading.

The stark reality is that Larry earns a scant $300 in interest. He can’t afford groceries on this paltry sum, so he is spending down his savings. The median income was $52,250 in 2013 (the latest year available). To earn 2/3 of that—and match Clarence—poor Larry would need over $116 million.

The notion of nominal interest paints a misleading picture of Clarence losing purchasing power and Larry keeping even. If you look at what they can buy with the interest on their savings—Yield purchasing power—you see that Clarence was living well while Larry is quickly spending down his life’s savings.


This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog


Think Different About Purchasing Power

The dollar is always losing value. To measure the decline, people turn to the Consumer Price Index (CPI), or various alternative measures such as Shadow Stats or Billion Prices Project. They measure a basket of goods, and we can see how it changes every year.

However, companies are constantly cutting costs. If we see nominal—i.e. dollar—prices rising, it’s despite this relentless increase in efficiency. This graphic illustrates the disparity (I credit Tom Selgas for a brilliant visualization, which I recreated from memory).

Hiden Debasement

CPI measures only the orange zone, the tip of the iceberg. Most people don’t see the gray zone, and that’s a result of the greatest sleight of hand ever.

We need an accurate way to measure monetary debasement. For example, in retirement planning it’s tempting to divide your net worth by the cost of consumer goods. This seems to show your purchasing power. For example, if you have $200,000 and the cost of groceries for a year is $20,000 then you can eat for ten years.

However, this approach is flawed. To see why, let’s briefly consider primitive times when there was no lending or banking. People had to set aside some of their income, to buy a durable good like salt or silver—hoarding. When they could no longer work, they sold a little bit every week to buy food—dishoarding. People accumulated wealth while working, and dissipated it in retirement.

Life got a lot better with the advent of lending, because interest enables people to live on the income generated by their savings. People no longer consumed their principal, worrying about outliving their savings.

Don’t think of capital assets as something to sell in order to eat. An old expression says, if you give a man a fish then he eats for a day, but if you teach a man to fish then he eats for a lifetime. Think of a productive asset like a fishery. It should produce for a lifetime. It should not be consumed as a mere fish.

Capital assets should be valued in terms of how many groceries they can buy, not by liquidation, but by production. Unfortunately, monetary policy is making this increasingly difficult. Interest rates have been falling for over three decades, and now there’s scant yield to be had anywhere. We are regressing to the dark ages of paying for retirement by dishoarding.

CPI understates monetary debasement, because companies are constantly becoming more efficient. Dividing wealth by CPI compounds the error, because asset prices are rising.

We need a different way of looking at monetary debasement. I propose Yield Purchasing Power (YPP).  YPP is the yield on assets divided by the Consumer Price Index (or other index). The idea is to look at the productivity of assets to see what you can really afford.

Let me explain YPP with a simple example. If hamburgers sell for $5 and interest is 10%, then $50 of capital lets you eat one burger per year. Suppose the price of the burger doesn’t change, but the interest rate falls to 0.1%. You now need $5,000 in capital to earn that burger. Unfortunately, if you still only have $50, then you only get one burger every 100 years.

CPI doesn’t show this collapse in purchasing power, but YPP does.

Let’s take a look at YPP since 1962. The graph is inverted, to make the trend easier to see.


It’s interesting that the drop in purchasing power (rising in this inverted graph) begins around 1984, when the conventional view said inflation was tamed. CPI may have slowed down, but interest was falling too.

YPP shows us a staggering monetary devaluation—a classic parabola. The problem isn’t skyrocketing prices, but collapsing yields.

You need more and more assets to afford the same lifestyle. If your assets don’t keep up, then you have to liquidate your capital.


I have moved my weekly column from Forbes to the Swiss National Bank and Swiss Franc blog. I don’t plan on posting most of those articles here (except those that may be relevant, as I think this one is). The column is somewhat outside the focus of Monetary Metals. So I encourage those interested to subscribe at that site to receive notification when new articles are up.