Inflation is debilitating. It weakens income growth, lowers a household's standard of living, and generally eats away at a person's well-being. It's no surprise, then, that consumers and investors get nervous when inflation appears to be gaining strength.
When a scary-looking inflation chart, like the one above, shows up on social media sites (such as Reddit), people tend to get concerned and wonder if economic growth will ever return to the way it was before the Great Recession.
Gold bugs, in particular, get enthused when they see these types of charts because it allows them to argue that prices were relatively benign up until the dollar was taken off the gold standard. Obviously,the end of the gold standard (first in 1933 and formally ended in 1971), they say, is the root cause for the exponential gains seen in the CPI. Some will also throw in the creation of the Federal Reserve System in 1913 as another major contributor to the increase in prices.
We are told to ignore the fact that the three indices reflected in the chart above each uniquely measure different types of prices. The Warren and Pearson pricing data (1932) is actually a commodity index and not a consumer-based basket of goods. The NBER uses a nondescript index of general prices. The chart clearly proves that the removal of the gold standard led to an unprecedented acceleration in the consumer price level after being flat for nearly 200 years.
But, for the sake of argument, let's assume that the three indices are statistically viable and comparable. Does this prove that the end of the gold standard or the introduction of the Federal Reserve resulted in out of control inflation?
The answer is a resounding no.
The purpose of monetary policy is to minimize the volatility in inflation trends and to prevent deflation. It is not meant to prevent inflation growth.
Business investment decisions rely on expected returns, which require an understanding of where price trends will be in the future. During periods of volatile inflation growth, businesses have difficulty determining their real returns. Simply put, why would a company invest in a new piece of machinery if they can't determine or set a price for the output?
Furthermore, why would a business take out a loan in a known deflationary environment? If it is going to cost more to repay the loan and these costs cannot be recouped by charging higher prices for the output, there is no incentive for businesses to purchase new equipment.
These same conditions negatively affect consumer demand.
So which time period saw the greatest volatility in prices? That would be the time period before World War II, which just so happens to include almost all of the period the dollar was fixed to gold and before the Federal Reserve was created.
During this time, yearly price growth in the Warren Pearson data averaged 1.3%, which seems very minor. However, the data had a standard deviation of 10.9%. Essentially, businesses preparing for all contingencies would assume that yearly inflation growth could be anywhere between -21.1% and +22.3%.
From 1950 to today, the CPI averaged 3.7% per year, which was undoubtedly higher than the average growth rate during the previous 200 years, but the standard deviation was only 2.8%. That means businesses would only need to prepare for inflation between -2.0% and +9.2%.
Since Fed Chairman Volcker tamed inflation growth in 1982, yearly CPI gains have averaged 3.0% with a standard deviation of 1.3%.
The point is that looking at indices without growth rates does not tell you the entire story. Yes, prices have accelerated much faster since end of the gold standard and the beginning of the Federal Reserve. The all-important pricing trends, however, have been much more stable and conducive for economic growth.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.