US Dollar Purchasing Power in the Wake of Depressions: Putting Things into Perspective

How did the purchasing power of the US dollar change in the Great Depression and the Crash of 2008, and what can this information tell us today three years after the Crash of 2008?

Ominous Parallels

Many have drawn parallels between the current global financial crisis and the Great Depression of the 1930s. Analysts have not been shy in claiming that the current global financial crisis is the "worst since the Great Depression". Nobel Prize-winning economist Paul Krugman even recently mentioned on his blog that he's "got that 30s feeling, all the way".

As tempting as it may be to draw parallels between the Great Depression and the Crash of 2008, we have to remember that the world of today is radically different than the world of the 1930s. In comparing the US economy of the 1930s to today, there are substantial differences in everything from what people wear to what people eat to how people get to work. Economists cannot look past these differences in comparison 1929 and 2008. Of course, we still use the US dollar and we still require economic activity to function as a society and nation. Nevertheless, perhaps there are things we can learn about the value of a currency in the wake of stock market crashes and depressions.

By the Sweat of Your Brow You Shall Eat Bread

Though the food we eat today may be different from the tastes of the 1930s, some aspects of our diet have not changed. Take for instance a staple of the human experience: a loaf of bread. Some could regard a loaf of bread as an economic standard (similar to the Big Mac Index). In 1930, you could buy a loaf of bread in the US for nine cents. Today a loaf of bread can cost you roughly $1.98 in the same currency.

That may sound like a substantial difference, but where the average salary per year in the US for 2009 was $40,711.61, the average wages per year in the US for 1930 was $1,970.00. Though price comparisons between 2011 and 1930 may not always be absolute or uniform in difference, they reflect changes in not only the societal perception of value but also the American way of life. While we discuss purchasing power differences between the 1930s and today, it is important that we do not overlook societal and microeconomic developments in American culture such as gender equality, civil rights, and key inventions like the microwave or the washing machine. Even so, from depression to depression we are all united in the one human journey.

During the Great Depression, the Consumer Price Index (CPI) stood at 17.3 in October 1929, reached a bottom of 12.6 in May 1933, stayed around 13 or 14 for the remainder of the 1930s, and did not reach 17.3 again until April 1943. In comparison, the CPI was at 216.573 in October 2008, fell a handful of points through 2009, and regained its footing to 218.178 in May 2010. This appears to suggest that where the US fell into deflation in the 1930s intensifying the crisis, the Crash of 2008 has spared us a deflationary spiral that would have prolonged a recession. Three years after the stock market crash in the 1930s, the CPI fell to 13.3. In comparison, as of August 2011 the CPI stands at 226.545. Compared to the 1930s, we are not in such bad shape (yet).

If we take a look at the inflation rate of the US following the 1930s stock market crash, we can see that the inflation rate fell into a deflationary pit (bottoming near -10%) that stuck around for about four years. In comparison to the Crash of 2008, the US appeared to slip into a slight deflationary gully (bottoming near -2%) for a single year. One might use the analogy of the 1929 economy tripping up and falling into a ten-foot-deep hole and the 2008 economy tripping up and falling into a ditch by the side of the road.

The US Dollar, Gold, and Stock Market Crashes

Now, back in 1929 the US Dollar Index was not yet in existence. Even more, at the onset of the Great Depression the US dollar was backed by gold. This changed in 1933 when the US government suspended the gold standard, restricted use of gold for transactions, and banned most private ownership of gold. Yet even in the midst of the Gold Reserve Act in January 1934 (over four years after 1929 Crash), the CPI pretty much remained unchanged for some time. A few possible reasons for this include slacked demand and an unemployment rate of 21.7% (a substantial climb from a 4.2% unemployment rate in 1928 and 8.7% in 1930). Though the value and meaning of the unemployment rate today may have substantially changed since 1930, the psychological impact and market implications of the numbers remain.

To say the least, though it may be easy to compare the Crash of 1929 with the Crash of 2008, when taking into account various factors like oil, the US dollar as a global reserve currency, globalization, societal changes, and increasing technology, one cannot help but feel that comparing the two crashes is a bit like comparing apples and oranges. On October 28, 1929, the Dow Jones Industrial Average (DJIA) dropped 12.82%; the next day the DJIA dropped 11.73%. In comparison, the next closest one-day percentage loss from October 2008 was 7.87%. Where the 1929 US economy appeared to fall and not be able to get back up, the US economy today appears to have fallen , is currently struggling to regain its footing, and is trying to get back up on its feet.

The Crash of 2008 spurred investors to take another look at precious metals. A practical standard in comparing the value of the US dollar after the Great Depression and the value of the US dollar after the Crash of 2008 rests in gold. In the 1930s, the price of gold was relatively stable.

If we contrast the 1930s with the Crash of 2008 where gold went through the roof, it is clear that the US dollar on the gold standard was a completely different animal in comparison to the fiat free-floating US dollar currency we have today. Both currencies in 1929 and 2008 were the US dollar, but in an analogous way it is as if one was a Saber-toothed tiger and the other is a Bengal tiger; they are two completely different animals. Where we have experienced inflation since the Crash of 2008, the situation was much different in the 1930s when deflation set in. Unlike the deflation of the early 1930s, the US economy currently appears to be in a "liquidity trap", or a situation where monetary policy is unable to stimulate an economy back to health.

In terms of the stock market, nearly three years after the 1929 Crash, the DJIA dropped 8.4% on August 12, 1932. Where we have experienced great volatility with large intraday swings in the past two months, in 2011 we have not experienced any record-shattering daily percentage drops to the tune of the 1930s. Where many of us may have that '30s feeling, in light of the DJIA, the CPI, and the national unemployment rate, we are simply not living in the '30s. Some individuals may feel as if we are living in a depression, but for many others the current global financial crisis simply does not feel like a depression akin to the 1930s.

The Value of a Dollar and the Rebound

What really is the value of a dollar? If we take a look at the CPI of the 1930s, we see that in October 1929 the CPI was 17.3 and in October 1932 the CPI was 13.3. At first, this would appear to show that deflation had set in, the dollar had increased in value, and that prices had fallen. However, one must also take into account the rising unemployment of the 1930s. To use an analogy, let us imagine a country called Acadia with 5% unemployment where a loaf of bread sells for 5 francs. Now, imagine that unemployment in Acadia doubles to a rate of 20% but a loaf of bread still sells for 5 francs. Though the price of a loaf of bread has not changed, the value of a loaf of bread has changed whereas the labor market value of work necessary to secure a loaf of bread has increased owing to increasing unemployment. Given the poor labor market, the worker is effectively having to work harder and longer to sustain his position in the labor market while still having francs to buy bread. Where a worker was once able to work in order to gain funds necessary to purchase food, perhaps now he would have to go without.

From the perspective of a laborer competing in the labor market, the value of a franc with 20% unemployment is considerably higher than the value of a franc with 5% unemployment. This type of interplay between consumer goods and the unemployment rate in a free market would appear to suggest that as a society or a labor force gets leaner its market for goods should get leaner as well.

If we compare the CPI in October 2008 (216.573) to August 2011 (226.545), fortunately we appear to be out of the range of the financial troubles of the 1930s. However, the situation on the planet today is much different than it was back in the '30s. To put the difference into perspective, the world population in 1930 was about two billion people; today it's about seven billion people. Today we have the Eurozone, globalization, and financial upheaval on a planetary scale the likes of which the world has never seen.

Even so, the problem with the Crash of 2008 is that it is disportionately affecting various groups and regions in the country more so than others. As such, in the midst of a financial depression we can still see the booming shopping mall in Columbus, Ohio, but perhaps we are missing the tent city in Reno, Nev. In this way, it may be easy for Americans to overlook the country's financial health given everyday economic activities. It makes sense that an individual would form his perspective on the economy based in large part on the world around him.

Thus, it becomes difficult to believe that the country is in a depression when you drive past restaurants like Carrabba's Italian Grill or Red Lobster and see that they are packed to the gills. I believe that this outlook is the difference of an economic recession with deflation and through-the-roof unemployment and an economic recession with continued inflation.

Face to Face with an Economic Depression

I can recall asking my friend after the stock market crash in 2008, "Okay, so we're entering a depression. At what point do we start selling apples on the street when there is no food in the grocery stores?" To say the least, our current plight does not appear to be the same as what occurred in the 1930s. The difference in perspective though goes back to changes in culture and the American way of life. The country may be in a depression, but alas, cars still travel the highways, people continue to go to expensive restaurants, iPhones still sell, and life goes on. Of course, there may be areas with massive tent cities or recurring rolling blackouts in the US, but I have never seen them or experienced them from my limited perspective and it would appear that not too many news agencies are reporting on such phenomena (or at the very least I have failed to notice such phenomena).

Three years after the Crash of 2008 fortunately I have yet to see masses of people standing in a bread line or waiting for food at a soup kitchen. Where we may not see individuals selling apples on the street or grocery stores with empty shelves, I know at least in the Midwestern US we see a vast number of empty shopping plazas, empty shopping malls, and empty homes. We see people holding signs on street corners begging for money or work; these become the faces of the current economic crisis. The current global financial crisis has not affected all Americans equally, and as such, though some may have suffered greatly in the past three years, others have not suffered quite as much.

In October 2008, the US Dollar Index was near 80; today, it stands at about 78. Although we are pretty much discussing apples and oranges or speaking of two different species of tigers, were the situation today purely analogous to the 1930s, given differences in inflation and the stock market I would expect the US Dollar Index to be around 60 today. From this perspective, it appears that the US dollar is in relatively healthy shape given the nature of our global economy. Suffice to say, despite problems in the Eurozone, comparatively high unemployment, and struggling sectors of the economy, it is still pretty much business as usual in America. And this is a good thing looking forward. Of course, things could change with natural disasters, a terrorist attack, increased political uncertainty, or the world abandoning the US dollar as the global reserve currency, but for now at this moment things appear to be business as usual. Nonetheless, things for the US economy could change fast in the near future.

As I alluded to above, there are other various dimensions to take into account with the current global financial crisis including the price of oil, the Middle East, the Eurozone, the housing market, a federal funds rate at zero, government dysfunctionality, and youth unemployment, but all in all, if governments are willing to take a step back to let the market correct itself, we would do well to maintain hope and not lose confidence. At the very least, as long as we continue being able to secure our daily bread, the US economy should rebound eventually -- in due time. When all is said and done, this too shall pass.