Wednesday, 1 April 2015

Economic Myths: "The purchasing power of the pound has fallen by 235 times in a hundred years"

On the face of it, this factoid trotted out by the gold bugs at MoneyWeek is quite true, it implies that average price inflation over the last hundred years was 5.3% per annum.

But that ignores the compound interest which £1 would have earned in the meantime. By and large, and in the grander scheme of things, the interest you can earn is equal to annual price inflation, sometimes a bit more, sometimes a bit less.

So if you'd stuck £1 in the bank a century ago and allowed the interest to roll up, you'd have about £235 and what you'd be able to buy with it today is much the same as what you'd have been able to buy with £1 a century ago.

And there are two further caveats:

1. The downward trend in the real price of manufactured goods. You can get a pretty decent TV or a mobile phone/camera/music player for £235 nowadays, you would not have been able to buy anything near as cool for £1 a century ago. Maybe a wind up 'phonograph' or something? Even if your compound interest less tax deducted is 'only' £100, you can still get a lot more manufactured for your money.

2. The upward trend in the real cost of land. Rents back in 1910 were between three and five shillings a week, so £1 was one or two months rent; nowadays £235 is more like one or two weeks rent (although the quality of rented accommodation is much better).

So all in all, so what? It is not price inflation itself which robs savers, it is negative real interest rates.


The Stigler said...

"Maybe a wind up 'phonograph' or something? "

Looking at a few ads, a gramophone was about £5 in the 1930s. By comparison, a Sansa Clip music player is about £40 today (and would have been sci-fi 30 years ago).

I was thinking back yesterday about home computers in the 80s. I knew someone who had a BBC Micro and the mortgage on my parents' (large) house was half what the BBC Micro cost.

The Stigler said...

and in the late 90s, I bought a VCR and it cost more than the mortgage on my small house in Swindon.

Jim said...

The one i never understood is deflation. Why is deflation always reported as being a "night mare"

lots of things fall in price, take the flat screen TVs we all have now. not too many years ago those things were in shops priced at £2500 or more, now you can pick up the same thing for £150. why is that a bad thing. I hear people say that deflation means no one will spend now, but that is not true either (im a fan a video games) a new game for the the PS4 will cost around £50, I can buy the same game (and I know from previous buys) 5 months in the future for £20. I dont wait though, not on all games as the £30 extra is the "have it now bonus". Sure i do wait for some games to fall in price, but if its one I really really want then i will buy it now and pay the extra for the benefit of having it now. I really cant see why deflation is a bad thing

Dinero said...

> Jim

Well deflation makes it harder to repay debts from deflated income. Hypothetically Mathematically you could numerate debt contracts with an inflation weighting, That hypothetical concept gets rather complicated. How to treat bank notes and deposits and collateral for example. A debt contract is numerated in nominal prices and so the credit system can't deal with deflation. Its considered a bad thing in that economic analysis.

Bayard said...


Yes, but the moneyweek article is talking about "purchasing power". So if you purchased something with that pound, you don't have it to stick in a savings account at compound interest, so how much it will have grown in the last hundred years is irrelevant.

There was pretty much no inflation in the 18th and 19th century, so a handy rule of thumb is a penny then is a pound now, when comparing, say incomes, or the cost of things like houses. Yes, some things are cheaper now and some things were cheaper then in real terms, but on average, the 235 figure is pretty accurate.

"Why is deflation always reported as being a "night mare"?

Because it means that debts get bigger over time, not smaller as they do with inflation, and since most people are debtors and, most importantly, the biggest debtor of them all is the government, it is a nightmare to a lot of people and the government is keen to get us to think it is a nightmare for everyone, hence the "deferred buying" lie.

Lola said...

B. I think the ratio of savers to debtors is about 12 : 1. The people that have the real problem with deflation are the government. They need inflation to finance the welfare state, or rather use it to stealthily repudiate the debts they incur in that process.

Broadly I flatly disagree with MW's post.

Mark Wadsworth said...

TS, exactly.

J, exactly, we have made that point many times. But as Dinero and Bayard explain, it is the Home-Owner-Ists who complain about deflation.

Which is double stupid, because consumer price deflation is good for everybody, borrower or not, it is only if the wages of mortgage borrowers fall that matters.

B: "There was pretty much no inflation in the 18th and 19th century"

Correct, and deposit interest rates were close to zero as well. And there wasn't as much in the way of technical innovation as there has been over the last century.

It all cancels out!!!

Mark Wadsworth said...

L: "Broadly I flatly disagree with MW's post"

Yes, I knew you'd say that. Instinctively I agree with you, but the actual facts show that it doesn't matter.

And as a taxpayer who has to shoulder part of that government debt, why should I complain if they are sneakily eroding it?

Random said...

"And as a taxpayer who has to shoulder part of that government debt, why should I complain if they are sneakily eroding it?"
I flatly disagree with this.
MW, Japanese taxpayers are quite happy to buy up risk free assets and they have had deflation for many years.
I ask anyone who worries about "debt and deficits" to offer a coherant explanation of the Japanese economy's performance since the insane land bubble in the 1980s ended.

Anonymous said...

Re 'deflation' As said if prices deflate debts inflate. That's why sustained a deflation is synonymous with depression and bankruptcy.
Also Mark, falling prices might be good for consumers, but if wages don't fall [and downwards wage rigidity is basically a fact] then profits fall and when profits fall, investment falls with it and hence employment. So deflation is only good for consumers to the extent that they remain employed [or retired].
Worth bearing in mind that it was the depression and deflation of the thirties that brought Hitler to power, not the hyper inflation of the early twenties.

Mark Wadsworth said...

R: "I flatly disagree with this"

You can disagree all you like, I am saying that I as a taxpayer who has to pay off the fucking national debt don't mind if they sneakily erode it. That's my opinion and I am entitled to it. You might as well disagree with the fact that I like Led Zeppelin.

As to your follow up question, that is one of those mysteries, isn't it?

But you misstate the position from the point of view of Japanese 'savers' as distinct from 'taxpayers'.

On one side are borrowers and taxpayers (they want price and wage inflation) on the other side are savers and people who own government bonds (they want price deflation).

What's good for taxpayers is bad for savers and vice versa, and adjusted for the decline in the Japanese working age population, their economy has done quite well, despite land price madness.

Mark Wadsworth said...

PC, Godwin's law, you win.

Random said...

"taxpayer who has to pay off the fucking national debt "
Not necessarily. You can QE the lot. And why would you want to pay it off anyway? We don't live in Euroland.

Mark Wadsworth said...

R, I think you are an MMTer. Who are turning out to be not as quite as wrong as we might have thought a few years ago.

But even if the MMTers are right on the spending front, then they ignore the fact that there is such a thing as good taxes, which are worth imposing even if there's nothing to spend it on.

Dinero said...

> Random

There is no objective reason to give a special status to the government. That is politcal view not an accounting view.

Random said...

MW, well there is nothing wrong with imposing good taxes like LVT or fuel duty. You just boost spending more, via e.g. citizens income.
Remember landlords are (barely) human and spend some of their unearned plunder.

Random said...

"There is no objective reason to give a special status to the government. That is politcal view not an accounting view."
There is as it is the issuer of the currency.
Okay Dinero, there is a depression. What do you plan to do?

Random said...

Basically Mark, you need to spend as much the landlords would in aggregate. Which for rich BTL landlords who save a lot is not much.
Or if they sell up, they will get less than they would without LVT, so you get a transfer from them to buyer and buyer to govt (as the LVT is on them eventually.)

Mark Wadsworth said...

D, good one. The govt is, or ought to be, merely a democratically owned service provider.

R, the point of LVT is not particularly to raise revenue or to boost spending. It is to prevent monopolies from sucking so much life out of the economy, and also enables us to cut bad taxes. You MMTers will never understand this.

Lola said...

Will post a clarification later - absolutely bandaged last night. If I can get it to work I have a great graph courtesy of Scot Wide that I will post. And I do agree with me about people not giving a stuff about inflation if it erodes debt - but that is actually a problem, not an answer.

Lola said...

Bandaged = banjaxed.

Lola said...
This comment has been removed by the author.
Lola said...

Me = MW. Bloody smartphones. Bloody predictive text.

Lola said...
This comment has been removed by the author.
Bayard said...

"And there wasn't as much in the way of technical innovation as there has been over the last century"

Just the entire industrial revolution and the transformation of the UK from an agrarian to an industrial economy....

Anonymous said...

MW. Well disregard the comment relating to 1930's Germany and the post still stands. Substitute the great depression more generally rather than in Germany specifically and better still just go back to the previous global episode of sustained falling prices in the 19thC which had until the 1930's formally been known as the 'great depression'. That's a perfectly logical and justifiable reason why many fear ingrained/persistent deflation as opposed to the odd year of marginally sub zero inflation due to the falling price og imported goods or energy.
Fundamentally, consumers only benefit from the latter [imported deflation] rather than the former [sustained falls in home grwon/produced goods].

Dinero said...

> Random

although there are some incorrect websites around that say otherwise, governments don't issue currency. Its a myth.
Currency is mainly deposits that are created by the credit system and governments borrow deposits that allready exist. ie the Bond market.
Private sector borrowing comes first in the process createing deposits then the government taxes or borrows those deposits.

Ian B said...

Mark, this post is total nonsense. The stated fact- that one singular pound is worth 1/235th (or whatever) today compared to 100 years ago is entirely correct. Whether a pound invested 100 years ago would have earned interest is completely irrelevant.

The point being made is the depreciation in the value of the currency unit. You need 235 times as many units to buy something. It's simply a fact.

Mark Wadsworth said...

IB, the stated fact is true - but largely irrelevant, provided interest rates and price inflation are roughly in line.