When I was a kid I liked to buy penny gumballs.  The machines were everywhere and the price was right.  They had been a penny for ages but something happened in the 70’s.  The gumballs started to become hollow.  As time went on you got less and less gum for the same penny.  In the end the penny gumball, the favorite of kids for generations, disappeared all together.  What happened with gumballs was happening to everything.  By the 1980’s inflation was in the double digits and prices seemed to be changing weekly.  What was even worse was the fact that millions of seniors who had saved for retirement saw their plans ruined as the prices went up.  As kids lamented the loss of the penny gumball reports of senior citizens being reduced to eating cat food surfaced.  The two were inextricably linked to a event that happened a decade before.

Last Monday was an anniversary that usually comes and goes unnoticed.  It was 40 years ago that President Nixon finally removed the last connections of the dollar to the price of gold.  Today, as one recent commentary by Ralph Benko pointed out, the dollar today is just worth 19 cents compared to the dollar of 1971.   The connection is not readily apparent to most folks because the economic education in our high schools is so abysmal (that is a subject for another blog).

There is probably no other subject that every major economist in the history of economics agree more on then the destructive power of debasing a currency.  David Hume, Adam Smith, David Ricardo, John Maynard Keynes, Ludwig Von Mises, Milton Friedman and even Karl Marx knew it.   The American founding fathers warned extensively about it. What is debasing the currency?  It is decreasing its value which for the common man means simply inflation (some believed in other things could cause inflation too but that is something for another day).  It means the money in my pocket today can not buy what it could yesterday nor can I live as well on the money I put aside for retirement as the day I put it in.  Like rust on an automobile, inflation eats away at the wealth a country and its citizens hold as money.  Today inflation is taken for granted and people plan their futures on the basis that in the future the money they are saving will inevitably  be worth less.  It might be surprising to many folks that there was a time when one could put your money in a proverbial mattress (or real one for that matter) and take it out years later and be able to pretty much buy the same amount of stuff as before.  What changed you might ask.

First you have to  understand what money is.  Money is just a way of representing the wealth we create everyday.  As long as the ratio of wealth to money remains somewhat constant the value of money stays the same (inflation is near zero).  Now when the good folks at the Federal Reserve in Washington DC (FED for short) start printing more money then is needed they upset the balance and we get inflation.   Before 1971 the every dollar had to have some gold somewhere backing it up, that meant before more cash could be created more gold had to be acquired.  This kept the printing presses under control and the dollar the most stable and sought after currency in the world.  After 1971 the FED was off its Gold leash and inflation was here to stay.  Now do not get me wrong, I am not one of those gold bugs that think the gold standard is the only legitimate currency system.  The fact is gold did provide a stability to the dollar and safeguarded the value of our savings.  This could be done other ways too but the present system of just “trust me I am from the government and I am here to help” does not work.   The only legitimate function of a central bank is to maintain the stability of the currency.   It is not to manipulate interest rates or generate stimulus in order to create temporary economic bonuses for politicians.  Any stimulating effects of the FED’s artificially low interest rates or turning on the printing presses comes at the expense of the dollar’s long term stability and America’s long term prosperity.  In essence the FED has turned its back on what should be its primary focus.

So next time you see a old penny gumball machine in an antique shop or hear the latest inflation statistics on TV remember President Nixon and 1971.