What happened to 1971?
Everything went downhill(?) from 1971... What happened? Why do we have inflation? Can we have deflation instead?
Someone introduced me to this website, which illustrated the various metrics (CPI, home prices etc.) before and after 1971. 1971 isn’t even that long ago, but so much has happened since then and we’re feeling the full on effects now. What happened?
Before that, here are some examples.
Home Prices
In 1971, the average person is bringing home a little over $10,622 a year (about $885 a month). A new house in 1971 will only require about $25,200, about 2.5x what the average person is making in a year.
Nowadays, the median income is just a little over $44,000, but the median home value is over $400,000, nearly 10x what the average person is making in a year.
Furthermore, in order to save up for a house in 1971, it took the average person 2.4 years. However, nowadays we need to take 7 years to do the same.
Why? This is because incomes have not grown at the same pace as home prices have, as illustrated below.
Consumer Price Index
Throughout history, even with WWI and WWII, the consumer price index (CPI) for United States has been relatively stable. However, this took off after 1971, as shown below.
Productivity vs Income
Ideally, you want a country whose productivity is going up, to be about the same pace as people’s income. However, similarly, even though productivity increased by 246% after 1971, wages only went up by 115%.
Income Inequality
If we compare top 1% of incomes vs the bottom 90%, we see that during 1917-1970, the bottom 90% of earners are growing. However, after 1970 it went sideways and even declined. On the other hand, the income of 1% grown exponentially after 1970. This widened inequality led to the saying “The rich get richer, the poor get poorer”.
National Debt
I believe everyone knows the insurmountable debt that the US has piled up, but did you know the debt only grew exponentially after the 1970s?
Check out the live stats on US’s national debt here. You will be shocked.
This begs the question, what has caused all this? What happened during the 1970s, specifically, 1971? Introducing, the Bretton Woods Agreement.
Nixon Shock
In 1971, President Richard Nixon ended the Bretton Woods Agreement.
During that time, US owns two-thirds of the world’s gold reserves. This puts the US in a very powerful position, and also at the top of The World Order.
Executive Order 6102
Signed on April 5th, 1933, this order made it illegal for ordinary people to own gold.
Bretton Woods Agreement
What is it?
The Bretton Woods agreement was signed in 1944, where countries agree to exchange their native gold-backed currencies for the dollar, which can be redeemed for gold.
What’s the purpose?
To set up a new system of rules, regulations, and procedures for the major economies of the world to ensure their economic stability. Also, since the US served as the Allies’ main supplier of weapons and other goods, and most countries paid in gold, this made the US the owner of the majority of the world's gold by the end of the war.
The dollar became the standard unit for exchange for all international business, making US even more powerful. As other countries now needed US’s money, it allowed US to export their own inflation.
Originally, central banks promised to keep the dollar at 1/35th of 1 ounce of gold.
All is well till the US realized that they can actually print more dollars than they actually possess gold.
And that is exactly what the US did, they started to export their dollars and handed out more loans (printing more than the amount of gold they possess)
However, as countries started to slowly redeem their currencies for gold, problems started to arise as the US realized they were running low on gold.
Eventually, Richard Nixon changed the value of the dollar to 1/38th for 1 ounce of gold, then 1/42nd…
Of course, countries were not stupid as well. They realized that the US did not actually possess the gold and could be printing money. Countries subsequently demanded their gold back from the US, which you might have expected, the US did not have.
Eventually, in order to curb the inflation and prevent foreign nations from overburdening the system by redeeming their dollars for gold, the President announced that they would be abandoning the Gold standard, ending the Bretton Woods system.
This also marks the birth of fiat currency, which is fundamentally different from commodity-based ones (gold in this case).
Fiat Currency
Fiat = To rule by decree
The only thing that is backing this dollar is the faith of the people. In layman terms, a $5 note is worth $5 in value because the US government says so.
In fact, the only thing the dollar represents today, is the amount of debt owed. Yes, debt = money. I was mindblown when I found this out.
The disconnection between gold and the dollar essentially gave the central banks even more power over money. They now have the power to infinitely print money without having to be responsible for how much gold they possess.
When you are given an option to “press a button” and money starts printing, I believe any country will choose this over anything else, as seen from historical events of past world orders. Watch this video to learn more. (It’s long but worth it)
Inflation
Inflation is what the Feds are desperately trying to solve right now, because the US has printed way too much money trying to solve the COVID pandemic 2 years ago.
For context, the US’s inflation rate for March 2022 stands at a whopping 8.5%, the highest since December of 1981. Over 2020, the US has printed almost a fifth of ALL US dollars just that year alone.
Hard Money or Soft Money?
The question is, why don’t we go back to gold (hard sound money) since data BEFORE 1971 evidently shows a better trajectory?
This is what many economists are constantly debating about. Hard sound money (gold) vs soft fiat money controlled by the government.
Why do we have inflation?
Why is inflation at 2-3% considered healthy and necessary? Why are we “aiming” for that every year? Why not just stop printing money again (basically go back to gold) or have 0% inflation?
The TLDR answer is: We need an adequate level of inflation to ensure productivity and improvement in the economy and the overall state of the world.
Imagine the extreme, where the government has completely no control over the money supply, and there is only a fixed supply of money, at 0% inflation. Now, whatever the cost of an item will remain that cost forever and ever (a $5 Filet O Fish meal will always be $5 even after 20 years)
In reality, there can never be 0% inflation. This is due to our access to cheaper labour, manufacturing, globalization and technology. Over time, things evolve to become better and cheaper. As a matter of fact, we should be experiencing deflation if that is the case, where the currency (dollars) becomes more and more valuable.
This however, may pose a huge problem.
Deflation?
Imagine a fridge costs $1000 today, would you spend your money today to buy that fridge, knowing that it will cost $100 less after a month? One may argue that it depends on the item, whether it is a necessity or not, and yes I do agree with that. But… if that is the case we will literally ONLY purchase items that are purely necessary to us. Even then, we will still choose the cheaper option (hawker food vs 5 stars restaurant food).
My point is, the problem with a currency that becomes more valuable over time is that people will not spend their money and there will not be an economy. Hence, we have to “artificially” force people to spend their money today by having an inflation rate of 2-3%. That way, we know that we have to spend our money today (perhaps buying your dream house), as it will get more expensive every single year. We are in a way “forced” to be a consumer today, so that we can make better things for tomorrow.
If we peg the currency to a fixed commodity (like gold), it will create a very rigid system. This system, due to its rigidness, will not be able to handle things such as our expanding population and global crises where we desperately need money.
Of course, I am not trying to defend the US who obviously:
Under the Bretton Woods Agreement, printed more money than the amount of gold possessed
Using their power and influence, singlehandedly ended the agreement (even though signed by so many other countries)
Told everyone now that the currency is now backed by faith in the US itself, further rendering them more power to print EVEN MORE money and have others absorb their inflation
Evidently, printed too much to the point where inflation is getting out of hand
Because the US has printed too much, they are now attempting to reduce the supply, through this process called “Quantitative Tightening”, which if done poorly, may result in a recession. We are threading on thin ice here.
The main goal here with money is to balance out the supply, alongside the population, and the levels of productivity, so that we do not print too much and items become unaffordable due to high inflation, and also not too little to the point where people start to hoard their money because it is valuable, and we lose an economy.
What’s my stance?
In my opinion, I do not think it is that simple to give a concrete answer, hard money or soft money. One must realize that the chain of events that happened after 1971 is not solely due to the decoupling of Gold and dollar, but also cheaper access to labour, globalization, modernization, corporate greed, technology and more.
I feel that hard money and the rigid system might be suited for the past, and soft money is for now and the future, with 1971 being the “transition year” that might have spurred our exponential growth in technology.
But with soft money, governments should be responsible enough to handle the money (which.. we haven’t really seen a lot of), which brings us to crypto.
Crypto?
Crypto, emerged from blockchain technology, has allowed us to regain some control from the government, and also the freedom to choose which crypto is the best to solve a particular problem at hand (Eg. Defichain for Decentralized Finance). Albeit some may fail (hint: Terra), but hey, our systems are not perfect and it is up to us to improve it.
Takeaways?
Well, one takeaway from this (or at least what I realized from this) is:
Money = Debt
Debt, if used correctly, will be able to propel your net worth significantly. Without a doubt, bad debt should be avoided at all costs (credit cards), and one should refrain from leveraging a risky, volatile asset. Good debt, on the other hand, will definitely aid your financial journey (real estate etc.)
In more layman terms, leverage by taking up loans to purchase assets that generate cash flow at a higher rate than what you will have to repay. Of course, that is easier said than done.
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