To earn one’s keep – why is fiat currency deonominated nominal growth misleading?

UK earnings have grown 330-fold over the past century
Did you know that in 2010 the average UK worker earned £23,000 a year, 6% above pre-crisis 2007 earnings? This may seem a good outcome given that the country’s economy weathered through a global financial crisis during that period. But, if we look at this in real terms, workers are actually worse off by around 2%.
Looking back further, over 10, 20, 50, even 100 years, earnings are up even higher – 42%, 120%, 4,200%, and even 33,000% respectively. But are British workers genuinely better off financially compared to the years 2000, 1990, 1960, or 1910? One way to answer this question is to look at earnings in real terms, which at 8%, 25%, 140%, and 316% respectively indicate some genuine improvements in people’s income over these periods. However, on an annualised basis, these gains become much reduced at 0.8%, 1.1%, 1.8%, and 1.1% respectively, with the pace of growth also having slowed over the past 50 years.
Explaining growth over the centuries
During the period for which earnings[1] data is available (1209-2010) there are seven identifiable sub-trends, which can be explained by various social, political, and economic factors [heading numbers below correspond to arrow labels in Figure 1].
1)   Growth declined up until around the turn of the 14th century – due to medieval over-population, land shortages and depleted soils
2)   A fast growth period between 1310 and 1380 – possibly due to the large loss of lives from the Great Famine of 1315 and the Black Death of 1348, driving up wages
3)  Slowing growth between 1380 and 1509 – likely due to the efforts of parliament to curtail upward pressures on wages and prices, as well as the effects of the late medieval economic recovery coming into play
4) Falling earnings between 1500 and 1600 – Much like how the large drops in population and subsequent shortages of workers had pushed up wages during the 14th century, the rapid rise of population in 16th century meant that wages fell. This was worsened by rapid inflation around the middle of the century.
5) Growth resumed between 1600 and 1800 – coinciding with the early beginnings of the English colonial empire and the East India Company – both of which brought about greater economic activities and wealth repatriation
6)  Post-industrial trend with elevated growth rates between 1800 and 1945 – likely caused by greater political stability following the Acts of Union, the economic benefits of the Industrial Revolution as well as expanded international trade
7)  Finally we have the fastest earnings growth trend in history since the end of WW2 (1945 onwards) – we will discuss this period below
Figure 1 –Average Annual Real Earnings (in 2010 £s)

As shown by the chart above, the UK’s average real earnings have remained on an exponential growth path, with an especially accelerated pace since 1800s [green dotted lines in Figure 1]. But unless there are unlimited resources (and unlimited new markets to earn ever bigger incomes), this growth will have to slow down. If the drops in real earnings since 2008 were not a blip but part of a larger trend [see trend line in Figure 2], could the stellar growth path that has marked the UK’s prosperity over the past few centuries be beginning to change course?
Figure 2 –Real Earnings Growth since 1950 (Entering negative territory?)

Nominal growth provides only a psychological sense of improvement
The above charts showed real earnings trends. However, real drops in earnings (or living standards) are masked by nominal figures. The best recent examples of this are the First and Second World Wars. During WWI, real earnings fell from 5,957 to 5,047 (down 15% by 1918) [Figure 1] whereas over the same period, nominal earnings went up 67% from 80 to 133 [Figure 3]. The same disconnect between nominal and real figures can also be seen during WWII, during which real earnings fell from 8,214 to 7,195 (down 12% by 1945) [Figure 1]. Meanwhile, nominal earnings went up 26% from 170 to 214 [Figure 3].
The temptation has always existed for governments to dilute the values of their currencies, and with difficulties in delivering all policy promises, this temptation only ever grows stronger. As paper currency became more widespread in international transactions, the temptation to depreciate competitively has also grown to its highest.
While the UK’s departure from the Gold Standard in 1931 was due to multiple factors such as a fall in the competitiveness of British exports, the pressures of growing unemployment, as well as aftershocks from the global recession of 1929, the change certainly helped boost nominal earnings growth from a long term average growth rate of 0.46% [blue dotted in in Figure 3] to a new ‘paradigm’ of 5.66% [green dotted line in Figure 3].
Figure 3 –Average Annual Nominal Earnings

Towards the slow end of the S-growth curve
Though it may have felt good to keep delivering nominal growth year in year out, the departure from the Gold Standard might have become the first injection of the growth drug that gets governments hooked – the 1931 move gave us the first decisive departure from the centuries-old trend [a move from the blue dotted line to the steeper green dotted line in Figure 4]. 
Figure 4 –Average Annual Real Earnings (in 2010 £s)

In 1971, the USA also joined in the wild party of ‘currency depreciation and global credit expansion’. This helped the UK achieve a second burst of even more rapid nominal growth [orange dotted line in Figure 4] that lasted until the UK property bubble finally burst in 1988 [black dotted line in Figure 4].
What is more worrying is that the 1988 popping of the UK property market could have been deeper (but in the longer term, healthier) if the biggest excesses, driven by Mr Greenspan’s ZIRP (Zero Interest Rate Policy) had not pushed the global asset bubble to its peak. The UK enjoyed a few more years of higher growth in the 90s and early 2000s, but the hangover that followed will take much longer to heal, with a likely consequence that a prolonged period of fundamentals driven, rather than credit/liquidity/leverage propelled growth will be needed. Even assuming UK earnings growth bottoms out within the post-1931 trend channel, at the centuries long 0.46% growth rate [purple line in Figure 4] it will be 2013 (to trend mid-point) or worse, 2027 (to the bottom of the trend channel) before the current correction is complete [see Nominal growth chart in Figure 3].
Measuring earnings with real money
Before the ‘new era of fiat money’, marked by the UK’s departure from the Gold Standard, earnings as measured by gold and by government-backed paper money had almost identical purchasing powers [see the two near-parallel dotted lines in Figure 5]. However, this relationship broke down during the 20th century.
Whereas the purchasing power of gold has continued along its long term trend even into the 20th century [purple dotted line, which is parallel to the prior blue dotted line, Figure 5], the ‘growth’ as measured by flat money has grown to parabolic heights. Could this signify that British ingenuity, inventiveness and productivity (as far as economic activities are concerned) has not fundamentally changed (as measured by gold), but that the boom represented by the nominal line [as measured by fiat currency, orange dotted line, Figure 5] had created a far more positive picture than reality? Is it possible to draw the conclusion that the invention of the internet had no more powerful an impact on the British earnings power than the discovery of the new world?
Figure 5 –Earnings index (in ounces of gold) vs. Earnings index (in nominal £s)

The accelerated erosion of the Pound’s purchasing power since the departure from Gold Standard is also illustrated by the fact that it took nearly 700 years for the currency’s purchasing power to fall by its first 90% in the period under our study. In comparison, the next two 90% drops in purchasing power both took place after 1950 and only took drastically shorter periods of around 30 years each! [Figure 6]
Figure 6 –Drops in GBP purchasing power (Indexed currency depreciation)

Conclusion and outlook
What the above discussion shows is that if the world’s governments succeed in maintaining this façade of fast nominal economic growth, people may not enjoy real increases in their welfare or standards of living. On the other hand, the risks of such a nominal growth driven economic strategy, with ever greater government intervention in increasing number of asset classes, imbalances in the global economy will only increase.
It might be that we will not only succeed in avoiding nominal economic growth slowdown as governments planned [blue arrow in Figure 7], but overshoot wildly beyond what is already a near vertical growth path, leading people to lose confidence in the currency altogether. So instead of the more painful red line (at the previously discussed historic level of 0.46% growth), we might see breakdowns in the status quo of economic policy making.
One of the possible consequences of a complete loss in confidence would be Zimbabwe-style hyperinflation [green arrow in Figure 7]. The line between deflation (which governments are fighting in the Western world) and hyperinflation (should their policies fail) could be very thin indeed.
Figure 7 – Nominal Earnings growth entered an exponential path in 20th century

[1] ‘Average earnings’ has a broader meaning than just wages, and includes other forms of compensation (from payments, bonuses and commissions to overtime supplements). ‘Real earnings’ are adjusted for inflation in 2010 pound term).
This article was researched and written with significant input from Charles Appleton, whose contribution is greatly appreciated.

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