Inflation, briefly.

February 9, 2012  |  Uncategorized

The question of whether the official government inflation numbers are right (currently 2-3%, depending on inclusion of food and energy) is really important. It would be hard to understate how important this is. But it’s considered a fringe topic, a settled issue. Here’s Krugman scoffing at the doubters.

We measure inflation with the Consumer Price Index, which is basically an aggregate, pared down cost-of-living metric. How much it costs, month by month, to buy life’s essentials for the average consumer. If this ‘basket of representative goods and services’ goes up, we call that inflation. As a cost-of-living metric it’s pretty good, and as Krugman notes, alternate approaches turn up about the same numbers.

But ‘how far does a dollar go for the average consumer?’ and ‘how much a dollar is worth compared to everything else?’ are very different questions.[1] Here’s my take:

When we get down to it, everyone has their own inflation rate, based on what they want and need to buy. Averages here miss a lot of trends. One trend that comes to mind is the current economic polarization and concentration of wealth. Let’s keep in mind, dollars are a commodity like any other, and inflation is just supply-and-demand. It happens when too many dollars are chasing too few goods and services. In 2012, there’s a huge oversupply of dollars held by rich people and investors; stuff that these people want to buy (investments, high-end and luxury goods and services) is getting bid way up.[2] On the other hand, in the lower tiers of society, there isn’t an oversupply of dollars. Official inflation rates are calculated based on cost of living for the majority of people— NOT, e.g., the cost of what people who hold most of the dollars want to buy. It’s an important distinction: in short, we look at inflation from the average person’s perspective, whereas we should look at it from the average dollar’s perspective.

I’m sure this alternately weighted, dollar-centric rate of inflation would be much higher than the official CPI. How could we calculate it reliably? I’m not sure. But you could make a lot of money if you figure out how.

 

Notes:

[1] Walmart-style globalization, Procter & Gamble-style manufacturing efficiency gains, and Moore’s Law-type exponential improvement should all be strongly blanket deflationary factors– that is, making peoples’ dollars go further. That such deflation tends to be narrow (only a few things get cheaper, while most keep inflating) suggests to me these factors are effectively subsidizing inflation.

[2] Some of this inflation in investment commodities is driven by the current extreme levels of uncertainty, but some isn’t. One could presumably quantify some of this by looking at option premiums. Market analysis of dollar-denominated commodities gets really complex when there may be hidden inflation, however, and government-numbers-derived tools like TIPS are pretty worthless qua tools.

[3] The money supply may be said to be one of many tools the powerful use to extract wealth from the less powerful. If there is indeed a currency crisis ahead, involving inflationary and deflationary shocks, a reasonable guide for their timing would be to look at what would benefit the central bankers’ balance sheets the most.

 

Musings:

- Is this driven by an oversupply of currency or of credit? Probably both, e.g., “Some insights from my visit to the ECB“. And due to many people being desperate to hold anything but currency (ABC).

- The US is creating a lot of currency, but this is definitely not limited to the US dollar. Every other government in the world has two incentives to print money: more competitive exports, and free money. Trends like this persist until they can’t.

- People think of inflation and deflation as opposites; I would say they’re cousins, in that they’re both products of and drivers of volatility. Both erode the leverage of the tools we use to manage our fiscal affairs, and I suspect both could happen in short succession, particularly with a whipsawing money supply– or even at the same time, in different sectors of our economy (just like different inflation rates).

- Why does this matter? Aside from skewing all economic statistics, this adds a great deal of volatility to anything connected with currency. Back in 2005 people scoffed at the possibility of a housing bust, pointing at a variety of statistics (all of which looked very solid and reasonable at the time). Now, people are scoffing at the possibility of a currency crisis, pointing mainly at the stability of the CPI. I don’t know what the future holds, but I know that’s not a good argument.

 

Additional References (but, caveat lector):

http://www.financialsensearchive.com/editorials/reality/2004/1007.html

http://www.shadowstats.com/

http://amateurvscompetent.wordpress.com/2012/12/01/who-took-food-and-gas-out-of-the-cola/



2 Comments


  1. You hit the nail on the head here and I think there are a few more implications that you might be missing. I will briefly outline them here.

    1. Deflation is scary because out debt payments tend toward fixed. That is to say, when your wages fall (as a result of deflation) you are ok if the price of everything you buy also falls, but if you have fixed debt payments you go bust. That’s the real peril of deflation, ofter referred to a a deflationary debt spiral. The relative leverage of different stratas of society and whether they were experiencing deflation or inflation would explain mass bankruptcies and defaults by certain segments of the population and not others. It may be that the over-leveraged subprime sectors of the economy are experiencing a deflation (based on their prior tendency to use their average dollar to purchase homes, which are falling in price) that may help explain the segmented bankruptcy experience we are seeing.

    2. I know how to measure inflation in the way you want. Get ahold of me to discuss if you would like.

    3. The Fed will often try to “inflate our way out” of debt problems. As i discussed before, deflation HURTS if you have fixed rate leverage, and in the same vein inflation will save you. That said, if the new money creation.. ie. the inflation.. is being confined to only those segments of the population not burdened with over-leverage, then inflating our way out of the situation will invariably fail.

    4. Our understanding of the expanding wage and wealth gap my very well be flawed. There may NOT be a gap being created or expanding, like the statistics show. If, for a sustained period of time, there are differential inflation rates for the different income segments of the population, then there can be differing wage or wealth growth without there being a gap in REAL wages or Wealth being created.

    5. There is one problem with including investments in the inflation rate. That is that while their price rising, eroding you CURRENT purchasing power of a dollar, you are actually becoming more wealthy in terms of your overall Net Worth. In essence you can sell you stocks and buy ALOT of things that haven’t experienced the same price increases. Not sure how that all fits in, but it might.

  2. Some excellent points here. I agree with (1), (3), and especially (4). If I’m right, (4) is very difficult to argue against, at some levels.

    On (5), I think it depends on how we define wealth, and just how limited inflation can be, if it’s happening. I.e., if you own a good inflation hedge, I think you can *prevent* your wealth from being destroyed, but I don’t think it improves your Net Worth in a real sense. I may be wrong.

    I also had to chuckle at one of @gselevator‘s recent comments-

    “Inflation figures that don’t include food and energy are like not counting beer as drinking.”

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