keeping up with real inflation

(Excerpted from the October issue of The Elliott Wave Theorist, published October 2, 2006.)
The Real Purchasing Power of Stocks

One of the biggest scams ever perpetrated is the idea that the stock market has made people rich over the past 80 years. Almost the entire gain in the Dow is due to debasement of the currency. The first chart below shows the DJIA (reconstructed prior to 1890) priced in dollars, and the second chart shows the Dow price in real money—gold—since the founding of the Republic. If you look closely, you can see that both charts are identical for well over a century, through 1933. Then they utterly diverge.

Now look at the bullets in the second chart. The Dow today buys less gold—and by extension less in the way of goods and basic services—than it did in 1929. Because gold was fixed at $20.67 per oz. until January 1934, we may take the first three decades of the century as the nominal Dow’s benchmark, because during those years the nominal Dow and the Dow/gold ratio moved precisely together. Had the dollar remained worth 1/20.67 of an ounce of gold, then today the Dow would sell at 340. That’s right: not 11,700 but 340. That is what it does sell for today when it is denominated in constant, gold-valued dollars. The entire net gain from 1929 today is an illusion.

The real price should be no surprise. Our railroads are rusted out, the auto companies are failing, and except for computers American industry in general is so crippled by regulation that it can’t compete successfully in the global marketplace. This is the legacy of 93 years of expanding indebtedness, fostered by a wave of runaway optimism and fueled by a paper money monopoly in the form of the Federal Reserve System.

The illusion of the Dow’s value since 2000 hardly pales by comparison. Investors have broken out party hats in anticipation of celebrating a new Dow high, but in terms of real money, the Dow has crashed since 2000. At the May 2006 low, the Dow in terms of gold was down 64.28% from its 2000 high! In other words, you can buy 1/3 the amount of gold now with your 30 Dow shares than you could have in 2000. You can buy even less oil and copper. Yet people think the Dow is unchanged. If we normalize the Dow to its 1999 peak in gold terms, it would be in the 4000s today.

If deflation occurs as we expect, these values will fall substantially back in line, and the Dow will decline in dollar terms as well. Credit bubbles always lead to collapses. We hear from many quarters—both from bulls and bears—that “this time it’s different.” Time will tell.