3 minute read / Dec 14, 2020 /
Where to Start if You're Curious about Macroeconomics Today
I remember growing up reading that a Coca-Cola cost five cents, and seeing the old New Yorker magazine covers with a price tag of 15 cents, and awing over the price of a Ford Model T of $850. Today, those prices are $1.99, $8.99 and $28,940 (for a Ford F150). I learned price increases like these are called inflation and took it for granted.
As I’ve lived through a few crises, I’ve tried to learn more about economic history and economic systems to answer questions like the one I should have asked: why is there inflation? Why should things cost more today than 10 years ago?
Lyn Alden distills history, policy, and data to answer these kinds of questions. Her latest post, “The Fraying of the US Global Reserve System,” summarises the three most recent US economic periods: the Gold Standard, Bretton Woods, and the Petrodollar System; and why today we’re entering a new monetary system that has broad impacts to the US dollar and the US economy.
It’s an economic history lesson in 15,000 words, which admittedly is a third the length of a typical business book. But it’s well worth reading because it’s an economics history course condensed into a blog post.
The key idea is this. The US used to mint money that citizens could convert to gold, called the gold standard. Over time, the banking system and the government decided to water down the dollar, so each dollar converted to less gold. The US couldn’t keep growing its gold reserve to keep up with the creation of dollars, and debts became too expensive to pay.
In the 1970s, the US unlinked the dollar from gold to enable the Federal Reserve Bank to create more money as needed. Instead of being backed by gold, the US GDP backed the dollar. In other words, citizens believe dollars are worth something but they arent convertible into anything else.
During the last 30-40 years, the US dollar became the currency of global trade. Many other countries sought to trade and invest in dollars. So the US printed more dollars to accommodate these trading partners. At this point, the quantity of dollars no longer mapped to US GDP, because the Federal Reserve printed dollars at a faster rate than the US GDP was growing.
Also, throughout this period and today, the government continues to create more money for other reasons. Most recently, the Federal Reserve increased the total number of US Dollars by about 20% to buttress the US economy through COVID.
At each step in this journey, we’ve devalued the dollar a little bit more so it is worth a bit less. Compounded over 80 years, this behavior creates the inflationary effect in the prices I mentioned above. A magazine costs 60x more today than 70 years ago, because the value of a dollar has decreased by more than 98%.
What does this mean for the US? What does it mean for prices? What does it mean for investing? These are some of the most important macroeconomic questions to ask today. And if you’re curious to understand more of the forces at play in greater depth, start with Lyn Alden’s article. It’s a terrific foundation.