After the United States discarded the gold standard, the dollar remained the world's reserve currency. Trade around the world was still conducted in dollars even though it had depreciated against most currencies. This created havoc. Exporters to the United States received the depreciated dollars for their goods. OPEC (the Organization of Petroleum Exporting Countries), an exporter of oil to the United States, received less value for each gallon of oil exported. (The dollar fell about 50 percent against other currencies during the 1970s. This varied, depending on the foreign currency, and requires many qualifications.) Since OPEC could buy fewer goods for each gallon of oil sold, it wanted more dollars for the exchange.
Another example, the trade loop between the United States and Germany, presented a similar problem for Volkswagen. When an American bought a Volkswagen, the dollars wound their way to Volkswagen's headquarters in Germany. (This is a hypothetical case, with no knowledge of how Volkswagen operated.) The automobile manufacturer did not want dollars. It shipped them to the German central bank (the Bundesbank). In return, Volkswagen received deutschmarks at the appropriate exchange rate.
Americans were spending much more abroad than at home. Since dollars in circulation in Europe were rising in relation to deutschmarks spent on good from the United States, cars from abroad cost more: Americans were paying for goods with less valuable dollars. The German government did not want its exporters to suffer. The Bundesbank's dollar-deutschmark transaction with Volkswagen increased the German money supply. This slowed the rise of the deutschmark's value against the dollar, but also increased German domestic inflation. In fact, the excess dollars led to inflation around the world.
This flood of dollars led to price inflation in the 1970s. More recently, the flood of dollars has led to asset inflation, including the worldwide housing bubble.
The Federal Reserve's Inflation Calculation
Arthur Burns [Chairman of the Federal Reserve 1970-1978-ed.]followed the most expeditious route to tame inflation: changing how the measure was calculated. Stephen Roach was a young economist at the Federal Reserve. After oil prices quadrupled, Arthur Burns instructed his staff to calculate a CPI stripped of energy costs. Burns's rationale was the blazing Yom Kippur War, over which the Fed had no control. Why the Federal Reserve's influence should matter in how the rate of consumer price inflation is calculated could be better understood by reading memoirs of the Nixon administration than by studying Arthur Burns's seminal textbook, Measuring Business Cycles.
Roach recalls: "Alas, it didn't turn out to be quite that simple." Burns thought the disappearance of anchovies off the Peruvian coast caused food costs to rise. They too were removed from the price index. Next went used cars, children's toys, jewelry, and housing-about half the costs that consumers absorbed in their daily struggle with rising prices.
Today, three decades after the anchovy shortage, without much ado from the economics guild, the media announces the monthly ex-food, ex-energy CPI, produced by the Bureau of Labor Statistics. This gently rising CPI-a charade-has compounded at a much lower rate than the true costs paid by Americans. This is one reason the collapse in living standards among the lower half remains a mystery to those who trust government press releases and the media that report them.
Americans were spending much more abroad than at home. Since dollars in circulation in Europe were rising in relation to deutschmarks spent on good from the United States, cars from abroad cost more: Americans were paying for goods with less valuable dollars. The German government did not want its exporters to suffer. The Bundesbank's dollar-deutschmark transaction with Volkswagen increased the German money supply. This slowed the rise of the deutschmark's value against the dollar, but also increased German domestic inflation. In fact, the excess dollars led to inflation around the world.
This flood of dollars led to price inflation in the 1970s. More recently, the flood of dollars has led to asset inflation, including the worldwide housing bubble.
The Federal Reserve's Inflation Calculation
Arthur Burns [Chairman of the Federal Reserve 1970-1978-ed.]followed the most expeditious route to tame inflation: changing how the measure was calculated. Stephen Roach was a young economist at the Federal Reserve. After oil prices quadrupled, Arthur Burns instructed his staff to calculate a CPI stripped of energy costs. Burns's rationale was the blazing Yom Kippur War, over which the Fed had no control. Why the Federal Reserve's influence should matter in how the rate of consumer price inflation is calculated could be better understood by reading memoirs of the Nixon administration than by studying Arthur Burns's seminal textbook, Measuring Business Cycles.
Roach recalls: "Alas, it didn't turn out to be quite that simple." Burns thought the disappearance of anchovies off the Peruvian coast caused food costs to rise. They too were removed from the price index. Next went used cars, children's toys, jewelry, and housing-about half the costs that consumers absorbed in their daily struggle with rising prices.
Today, three decades after the anchovy shortage, without much ado from the economics guild, the media announces the monthly ex-food, ex-energy CPI, produced by the Bureau of Labor Statistics. This gently rising CPI-a charade-has compounded at a much lower rate than the true costs paid by Americans. This is one reason the collapse in living standards among the lower half remains a mystery to those who trust government press releases and the media that report them.
In any case, numbers cannot capture inflation, which generally works hand in hand with deterioration.
Regards,
Frederick J. Sheehan
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