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Don’t Rely on the Customer Price Index to Warn of Inflation

“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.  The process engages all the hidden forces of economic destruction, and does it in a manner which not one man in a million is able to diagnose.”  -John Maynard Keynes

One of the puzzling economic issues of our time is how the government could conjure up money out of thin air and expand the FED’s balance sheet from $800 billion to over $4.6 trillion and not cause inflation. The liquidity created was used mostly to purchase bonds in both the US and the ECB, driving down interest rates to near or below zero.  Some $15 trillion worth of global debt now trades with interest rates that are negative, i.e. below zero.

This lack of price inflation not only puzzles economists who believe that the quantity of money will eventually have something to do with its value, it is being used by advocates of Modern Monetary Theory as a cover for their radical proposals.  As Professor Stephanie Kelton, adviser to both Bernie Sanders and Elizabeth Warren has suggested, if money can be created to save the banks, why not create it to fund the Green New Deal and Medicare for All?  You see, we had the bank bailout without terribly adverse consequences to the price level, why not fund everything on the Democratic Party Agenda?

Republicans too have played their part. Once the party of fiscal rectitude, they have grown strangely tolerant of trillion-dollar deficits as far as the eye can see.  They too can take solace that monstrous deficits no longer cause inflation like they did in the 1960-2000 period.  They are patently afraid to curtail entitlement programs that will grow rapidly simply due to demographics and hence drive the deficit higher in coming years.

Some commentators suggest this “lack of inflation” is because of the fall of Soviet Union and the “reforms” in China, both events which have allowed vast new productive capacity (supply) to be made available.  Others suggest demographic changes, specifically the gray age wave, is responsible for a drop-in demand.  Others cite technological advancement (we get more production with less use of commodities) as the cause of this lack of inflation.

Or is it that we just can’t tell because the Consumer Price Index (CPI) does not fully capture the phenomena? The CPI measures a sample basket of items typically purchased by consumers, calculating the inflated price of consumer goods. The index is also hedonically adjusted, a fancy way of saying the BLS estimates the value of technological improvements, implying that you are getting more features for the same money.  This causes adjusted prices to show lower than they really are.

The CPI also leaves out taxes, one of the biggest of all costs of living.  Tax burdens today equal what people pay for food, clothing, and healthcare combined.  How can a cost of living index be accurate if one of the primary costs is left out of the index? But the most glaring omission in the CPI is the inability to measure asset inflation simply because these items are not in the basket of goods being tracked.

Investments are not goods. Acquiring financial assets for those planning for or already in retirement is a huge expense.

Let’s look at this example.  Most of our readers are old enough to remember that 5% interest was typical years ago and was available to the most inexperienced investor in the form of risk-free passbook savings.  Thus, if an upper middle-class couple had saved $1,000,000, at 5% the capital would produce $50,000 in income in addition to Social Security.

Today, the yield on money markets (passbook savings were a government insured demand deposit, meaning you could get your money anytime), is about .2% or lower, which would produce $2,000 in income.  So, to duplicate 5% passbook savings income, one would have to have saved $25,000,000, not $1,000.000. You could say the cost of generating safe income for the retired person has gone up by 25 times!

Now you might counter that you can do better than 5%.  But remember to be a true comparison, it has to be government insured and totally liquid.

The same price inflation can be seen in dividend paying stocks, which provide retirement income through dividends.  They have gone up a lot in price but this event is not captured by the CPI.

The best way to think about inflation is that it really is not about rising prices. In a productive economy, which is always finding a better way to produce things, the natural course of prices is downward, like what you have experienced with widescreen TVs.  Inflation is the falling value of money.  It takes more money to buy assets that create a safe income stream.  Or, it takes more money to buy the same postage stamp than it did 10 years ago.

What can a person do?  You can’t control what the government does.

This lack of obvious consumer price inflation has lulled investors into a false sense of confidence.  Interest rates are now so low, that they hardly provide a rate of return above inflation and taxes.

The less obvious inflation of assets, is alarming once you understand that the CPI simply cannot capture something as complex as inflation by the way the sample basket is constructed.  Too many important items are left out.

Historically, the best way of hedging against the depreciation in the value of money is to own gold. Don’t be lulled into complacency because the CPI is not yet screaming inflation.  Get a 5%-10% position in physical gold as a minimal insurance policy.

gold bar with chart