After the United States discarded the gold standard, the  dollar remained the worlds 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 Volkswagens 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 Bundesbanks dollar-deutschmark  transaction with Volkswagen increased the German money supply. This slowed the  rise of the deutschmarks 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 Reserves Inflation Calculation

Arthur Burns [Chairman of the Federal Reserve  1970-1978ed.]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. Burnss rationale was the  blazing Yom Kippur War, over which the Fed had no control. Why the Federal  Reserves 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 Burnss seminal textbook, Measuring  Business Cycles.

Roach recalls: Alas, it didnt 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, childrens toys, jewelry, and housingabout 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  CPIa charadehas 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.

The science of economics as applied to national statistics  was (and is) more a confiscation of the truth than a midwife to it. Incumbent  and future politicians, including future Fed chairman Greenspan, introduced  and nurtured such hullabaloo as hedonics and the birth-death rate in the  highly publicized but little understood calculations of economic growth rates  and unemployment numbers. The figures were a disgrace, and so were the parties  responsible for their introduction and dissemination. Greenspans turn at the  Council of Economic Advisers was to be a screen test for a future role in the  charade, a dress rehearsal for his political, acting and dissembling talents,  the inestimable qualities needed by a Fed chairman in an economy that was  rocketing off its moorings.

In any case, numbers cannot capture inflation, which  generally works hand in hand with deterioration.

Regards,
Frederick J. Sheehan
Panderer to Power

Fred Sheehan

Fred Sheehan is a former Director of Asset Allocation Services at John Hancock Financial Services, and has worked in the financial markets for more than two decades.

In addition to Whiskey & Gunpowder, Fred has also written for Marc Faber's Gloom, Boom & Doom Report and Prudent Bear. He is the author of Panderer to Power, a biography about former Fed Chairman Alan Greenspan.

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