Topic: Economics
Inflation and the Ruse of the CPI After reading so many confused recitations of what inflation is, and what its impact is on the economy, this article will help clarify some of the misconceptions that many people have.by Master C
(liberal)
Friday, October 24, 2008
INFLATION is a term that has been used as fatuously as branding a person a COMMUNIST, although so many seem to misunderstand its source, its measurement, or its meaning that I am going to clarify some of its major misconceptions.
INFLATION is defined as "a sustained increase in the general level of prices over several successive quarters of measurement"; it is a rising general level of prices. We measure this increase in prices by what is called the CONSUMER PRICE INDEX (CPI). This should not be confused as a measure of our standard of living; it is a measure of price changes for certain categories of goods. It would be impossible, and perhaps even meaningless, to monitor changes in every single good and service in the American economy; there would be billions, perhaps trillions -- maybe even gazillions! So goods and services are SAMPLED, and locations where that data is collected are also sampled. Sometimes you read that 80,000 items are evaluated when, in fact, it is really about 200 "categories" of goods that are sampled, including housing costs, food, energy, transportation, medical, et. al.
An Example. Let's take just ONE category for a moment and see what we can make of it -- HOUSING. If we were to try to sample the cost of HOUSING across the United States, how we would go about it? Would we look at house payments people make each month, even though some payments may or may not include escrow amounts for insurance or property taxes? All of them include interest, many of them are ARMs (adjustable rate mortgages) that change from time to time. Some are even land contracts between private parties with low initial payments and sudden BALLOONS that bring the remainder of the amount due very quickly at some future time. Some people don't even have a house payment if they have paid off their home or inherited one that had no mortgage. Many people even live in a home that they've lived in for more than five years, so their house payment may be deceptively low.
Even if we ignored these differences, would HOUSING COSTS include the cost of electricity, gas and oil, water and sewage, garbage service, home repairs? A telephone? Cable tv? If we ignore these costs, even though it would be hard to live in a home without most of these services, what about APARTMENTS, CONDOMINIUMS, and even TRAILERS? Do we count monthly payments for these the same way? We know that rental payments include property taxes, but many include heating and cooling, garbage disposal, even electricity, snow removal, lawn service, and swimming pool access or exercise rooms in their payments.
The CPI. Well, to avoid some of these difficulties, the Bureau of Labor Statistics, Department of the Census, who collects this data every month and publishes it in what is called the CONSUMER PRICE INDEX (CPI) -- although there are really SEVERAL CPIs published; those for urban workers, rural workers, clerical and office, even "core" indexes, et. al -- established what they call a "rental equivalence" approach to make these numbers more standardized. The rental equivalence measure "calculates homeowner costs of shelter based on the implicit rent owners would pay to rent the homes they own." This was introduced in 1985 to replace the previous method of measuring home ownership costs based upon current mortgage rates which was controversial for its own inadequacies.
Not only is this rather bizarre measure imprecise and highly discretionary, to say the least, but it is weighted to be ONE THIRD of the CPI. I, personally, contend that the ability to manipulate this ONE number in the CPI has given the government statisticians the ability to stabilize the index, through their estimates, so that INFLATION will never again become the hydra-headed monster that it once was. This methodology keeps inflation as docile as a kitten.
Comparisons. Again, even putting all that aside, what happens next is that the BLS (Bureau of Labor Statistics) puts all these sampled prices in a big caldron (or a "marketbasket" as they call it; I see it rather more like witchcraft, so I call it a caldron) giving extra weight to some numbers, and ignoring many irregularities -- mixes them together, and comes up with ONE NUMBER which they then compare to a BASE NUMBER (or Index number) to measure the amount of change that has taken place. Understand that this "base number" is one that is frequently changed so that it reflects the changing marketbasket of goods and services that are included in the CPI. This means that when cell phones, microwave ovens, CDs, new medicines and things of this type are included in the index, a new "base number" has to be selected.
Setting apart the notion that a 2008 automobile is vastly different from even a 1990 auto, let alone a 1980, 1970, or 1945 auto -- many of which now come standard with air conditioning, automatic transmissions, radial tires, rear window defoggers, safety glass, and vastly redesigned interiors for safety and convenience -- and the fact that many products that are now included in the CPI never existed before, or certainly have vastly changed, the BLS then adjusts ALL the numbers back in a process called "normalization". I remember asking a college professor of mine, when he first mentioned this mathematical procedure, what was so "normal" about it? He said that it gave the numbers a symmetry and uniformity that was now "normalized" to the base -- of course, ignoring the fact that it was actually giving the APPEARANCE of symmetry and uniformity to numbers that were actually quite difficult to compare!
How could you compare the cost of a 2008 automobile with a 1957 car? Standards, materials, numbers produced, foreign parts, stereo systems, seat belts, air bags, emission control gadgetry? How could you even compare the cost of a PORK CHOP from 2008 to 1942 or some other period of time? Many would argue that today's food products are vastly inferior to those in the past, even though food handling, packaging, labeling, inspections, grading, and bulk processing are much more extensive -- and ADD to the cost.
What about something even more difficult? What is the price of medical care? Is it the cost of an operation? If so, what operation? In what part of the country? Or is it the cost of the insurance premium you pay (or your employer pays for you) every month to have the operation?
It should be easy to see that measuring the amount of change that has taken place in prices in a ONE YEAR period of time, using ONE NUMBER to reflect those changes that have taken place in tens of thousands of LOCATIONS across the country, then to COMPARE them to other periods of time when most goods were different, some never existed, and others are very imprecisely defined makes measuring INFLATION about as accurate as measuring a CLOUD. Can it really be done?
Is an AVERAGE meaningful? What if we collected all the temperatures in different cities in the US at a certain time of day -- 42 degrees in Michigan, 74 in Florida, 82 in Texas, 51 in Colorado, (don't forget Alaska and Hawaii; do you think THAT would skew our number any?) blah, blah, blah. Now give some extra weight to this number or that one, add them all up, and come up with ONE NUMBER to represent the temperature in the United States on that particular day at that particular time. Let's say that we come up with 60.23 degrees. What is the significance of that number? Does it really represent the temperature of the United States? As Carl Jung, the famous German psychologist used to say: "The one thing we can know for sure when taking an average for any particular group of factors is that none of the factors is actually that number." Wouldn't that probably be the same for our 60.23 degrees; that NO WHERE in the US was it actually that temperature? Then, think of how inaccurate that number would be if we used an ANNUAL NUMBER to represent it!
Conclusion. Hopefully, for all you embarrassingly-devoted STATISTICIANS out there, this will at least make you a little more skeptical about the comparisons you're making. Your data is limited, your methods are weak, and your conclusions are very imprecise. Then to give these numbers some sacred and meaningful prominence in our lives would be as misplaced as measuring how much we LOVE someone or how LOYAL we are to our employer or sports team, or how devoted we are to our CHURCH or our POLITICAL PARTY.
Oh, that's easy, Republicae will probably shout! It's 72.53%! Ha! Ha! Ha! That man's a GAS!
Master C
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You really are doing your best to push that string so hard aren’t you? I hope you don’t get a hernia with all your straining!
Inflation, to the best of my knowledge and indeed to the best knowledge of economists and even dictionaries is not a measure of price changes, it is the expansion of the fiat monetary unit. Pricing of goods and services simply reflect the diminished purchasing power of the dollar. When the monetary stock is expanded or inflated it’s purchasing power shrinks. This shrinkage is to the extent that what was once a nominal supply of dollars is expanded faster than the demand to hold dollars.
The symptoms of INFLATION are the general rise in prices of goods and services. The official CIP calculations reflect little more than the loss of purchasing power of the dollar.
American Heritage Dictionary: “A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.”
New Webster’s Dictionary: "An increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued.”
Webster’s Revised Dictionary: “Undue expansion or increase, from overissue; -- said of currency.”
Since 1913, the cumulative rate of inflation has been, get this: it is much higher than 72.53%, as Master C so humorously spit out. This is much easier to see when you relate present prices with 1913 prices. It takes $22.10 to purchase what $1.00 purchased in 1913. It is also much easier to understand when you factor in the greatest single debasement event when FRD depreciated the dollar by approximately 50% in 1933. It is also easy to see the rate of inflation, therefore the depreciation of the dollar since 1971. Basically, over 95% of the dollar’s purchase value has been evaporated through the inflation of the currency.
Based on government numbers, the average annual rate of inflation during the 40s was 4.11% during that decade. In the 70s and 80s, the average annual rate was 5.63%, 7.09% and 5.55% within those two decades. Of course, when you also look at government figures on real income over the past 40 years it is easy to see that the vast majority of our hard-working people are falling far behind in their ability to not only earn a living, but to make ends meet. Inflation is a pestilence, one that is a direct result of a reckless monetary policy imposed upon this country by the Federal Reserve. Bernanke finally admitted that inflation was a hidden tax created directly by the monetary policies of the FED.
You're right. I wasn't clear about what I meant to say about inflation. I got right to the CPI without properly explaining the connection.
I was hurrying a little when I wrote this article because of a baby shower that my wife is giving for our daughter-in-law.
I made a quick edit to correct that, although I think you are still staggering up the wrong road with this money supply increase stuff. Several factors can cause prices to rise unrelated to monetary changes ~ demand pulling prices up (as for Superbowl tickets), costs pushing prices up (as with labor unions asking for more money, or electricity costs increasing), even government causing prices to rise as a result of increased regulations or policies (as when auto standards are increased, or labeling requirements are required).
Inflation is very clearly measured as an increase in the general level of prices. You call it the RESULT of an increase in the money supply, which it certainly can be, but that is not the only factor that causes prices to increase, as I have mentioned.
The purpose of my article is to show how imprecisely inflationary periods can be compared. To say that merely increasing the money supply is going to increase prices ignores all those effects that are troublesome for asset-based currencies ~ foreign trade, investment, and a growing economy. These factors NEED more money because of the increasing DEMAND for it. As soon as you (and Walt) see that money is a COMMODITY, you'll see how it follows the normal rules of supply and demand ~ it is printed, stored, stacked, borrowed, bought and sold; it is an item of trade and commerce.
In fact, it is primarily because of all the money that was pumped into the economy since the 90's going into the INVESTMENT MARKETS rather than the PRODUCT MARKETS that people got rich off of investments while prices remained at least tolerably stable. Of course, there is always a reckoning that comes ~ as it has.
Voltaire lived in the 1700's. He never knew about computers, McDonald's, or our modern, fast-paced, vainglorious economy. Besides, he would have listened to Pangloss and found that "All is for the best in the best of all possible worlds."
Indeed, Voltaire did live in the 1700s however, while computers and McDonalds may be drastic changes they do not impede the laws of monetary and economic sciences. Voltaire's observation continues to hold true to monetary law.
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