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94

Figure 13-2

$5,000,000

$2,000,000 $1,000,000 $500,000

$200,000 $100,000 $50,000

$20,000

$10,000

TEE FEDS HIRE JESSE

How Inflation and Taxes Wipe Out Bonds and T-Bills 1945 - 1996

"*,iii!»;ii:;S,>SS":lI"Z,"

$100,000

..... - - - - - .. .- >" " " "

Slocks $4,035,149

Stocks, after tax $913,139

Bonds $155,001 T-BUls $123,994

T-Bills, after tax $41,178 Botids, after tax $39

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995

Year

All figures are inflation-adjusted.

bonds increases dramatically. As the chart also shows, the after-tax and inflation-adjusted retum of T-biUs and govemment bonds, for an investor in a higher tax bracket, has been negative since 1946, An individual in a 50% bracket who put money into T-bills or govemment bonds after World War II,* and kept reinvesting in these instmments to 1996, lost the major part of his or her capital. Investing $100,000 in T-bills, after adjusting for inflation and taxes, left only $41,200, while in bonds it dwindled to $39,200. By comparison, if an investor had put $100,000 into blue-chip stocks, he would have $913,000 after inflation and taxes, or nine times his original investment.

* The tax bracket went as high as 75% to 90% for a part of the postwar period.



In 1940 the greenback still had 86% of its 1802 purchasing power.

Fighting the Last War

To get a better historical perspective on how radically changed the investment world became after 1945, look again at Table 13-1. Over the entire 200-year period, prices increased at only 1.3% annually. But glance at the major subperiods. In the first two, inflation was almost nonexistent, rising only .1% and .6%. Yet if you look back at the stock retums for these periods, youll see that stocks still did better than bonds, with retums almost 50% higher annually in the first major sub-period (1802-1870), and getting progressively larger in the next two subperiods. In the last major subperiod (1926-1996) stocks retumed 31 times as much as bonds annually, and nine times as much after the War.*

Columns 2 and 3 of Table 13-1, and Figure 13-2, also provide some historical background on how devastating inflation has been to bonds and T-bills. Although the real retum for bonds after inflation was 3.4% annually over the 1802 to 1996 period, it dropped to under 1% for the 50 years ending 1996. Thats right, the historic retum of bonds was cut by almost 75% after the War! For T-bills, as column 3 demonstrates, it was even worse. Their long-term inflation-adjusted retum plummeted by 87% after 1945. At best, bonds and T-bills merely preserve your purchasing power after inflation. Holding stocks would have increased your real capital 40 times in the 50 years after the war. It would have taken you 140 years in a T-bill or money market fund to even double your money in constant dollars.

Is inflation going to stop? I doubt it. It has been brought down to a more moderate 3.6% rate in the 1982 to 1996 period, but this is still higher than the 3% Arthur Bums, chairman of the Federal Reserve, considered intolerable in the sixties. Bums warned repeatedly that such high rates would mean the end of Westem Civilization as we know it.

Although chairman after chairman of the Fed has tried to stomp out inflation, price rises are pernicious. Prices have risen in 49 of the 51 years since the war. The last year prices went down was in 1954 and the decrease was under 1 %.

While this chapter is not a tract on the causes of inflation, but rather its effects on various types of investments, it is still obvious that the postwar period is different from any period in the past. E. H. Phelps and Sheila V. Hopkins published a 700-year study of consumer price indices in England-food, fuel, clothing etc.-beginning about 1250. Through 1933, inflation and deflation took place with remarkable regularity. Af-



ter remaining on a plateau for 300 years, prices exploded in the century following 1550, fueled by the plundered gold and silver of the Inca and Aztec empires, rising to about three times the level of the previous three centuries. This was the classic type of inflation economists understand so well-too much money chasing too few goods. The primitive production capacity of the time could not keep up with the vast increase in money supply, and wild inflation resulted, first in Spain and shortly tiiereafter in England. Prices then remained stationary for almost 300 years and were actually higher in 1650 than they were in 1932.

So, with the exception of odd and quickly corrected price surges (at least when looked at over the long historical time span), the world enjoyed relative price stability. For example, prices rose 75% between 1350 and 1370, but by 1380 they were lower than they had been in 1350. Similar surges and corrections accompanied most major wars. In Victorian England, prices were so stable that govemment bonds retumed only 2.5%.

Over this entire time there have been only two periods of sustained inflation (the one beginning in the sixteenth century and lasting 100 years, and the one starting after World War II). The current inflationary period is by far the worse of the two. By the end of 1974, prices had risen over 480% in 28 years, and by the end of 1996,780%. ftices were now 1 times as high as in 1250, and 34 times as high as in 1550.

As we know, the price rise in the postwar period is the only one that has shown no sign of a reversal. While other periods, even the 1500s, show deflationary dips, the current inflation has moved continuously higher with virtually no respite.

What do we make of this? It seems obvious the Keynsian revolution, a part of which is the belief that govemments could mn 8 1 8 8 in good times and deficits in bad to improve the economy, has been one of the primary causes. This country and most others in the Westem world seem to have gotten Keynes half right. They fully understand the principle of deficits (which seem to be increasing progressively in size over time), but mn them in expansions as well as recessions. They have never leamed the concept of 8 1 8 8 in boom periods, despite the pledges of even tiie most tight-fisted presidential and congressional candidates when tiiey are ranning for office.

Deficits are unquestionably inflationary, in spite of the govemments efforts to shrink them away by higher inflation. The loss of most of their investment by a generation of Americans, who scratched out their meager savings in the Great Depression and then patriotically put them into Government War bonds at 2A% or 3%, is an example of the enormous



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