Whatís the Real Inflation Rate?
July 20, 2011
Let's take a brief detour from all the debt ceiling nonsense. I want you to visit any street corner on Main Street, USA and ask someone if the money in their wallet buys the same amount of stuff as it once did.
Not only will their response will be the fastest way of gauging true inflation, but it will belie the cozy figures the government via its media puppets has been feeding to you.
Inflation vs. Deflation
In debating inflation versus deflation, we must first ask a few pertinent questions: Can inflation occur during a deflationary cycle, or is this a contradictory statement? Does inflation and deflation happen independently of one another? The answer can be found by evaluating an abbreviated history of asset prices.
Over the past 20 years, the governmentís measure of inflation, the Consumer Price Index (CPI), has steadily increased, averaging a 2.5% growth rate. Since 2005, the CPI has maintained that Steady Eddie pace. Meanwhile, major asset classes like U.S. stocks (NYSEArca: VTI), residential real estate (NYSEArca: XHB) and commercial real estate (NYSEArca: ICF) have declined in value.
What does this prove?
First, it illustrates that not all asset classes move at the same velocity in whatever direction. (Doesnít this make a credible argument in favor of diversifying oneís investments? Not interested? OK, go ahead and put all your money in Apple.) Second, the rising cost of medical services, food, rent, i.e. (inflation) can happen during a period of falling asset prices (deflation). And what about the deflationary forces of declining salaries and payrolls, while commodities prices (NYSEArca: DBC) marched steadily upward? Doesnít it show that deflation can occur within an inflationary cycle and vice-versa? For non-believers, the period of 2007-11 is enough proof.
While the CPI is the governmentís way of reporting headline inflation, itís hardly complete. Another way to gauge the real rate of inflation is by analyzing the U.S. dollarís buying power. Why is this a better reference point than CPI? Itís because the destructive forces of inflation take places when a currency loses value. It causes a corresponding rise in the cost of everyday necessities.
Letís ask a few more questions for our army of armchair economists: What happens when a country expands its monetary base at a rate faster than its GDP? Does it devalue the existing money already in circulation? Donít the laws of supply and demand come into play? When thereís lots of supply, doesnít it destroy demand and thereby cut the itemís price?
What about the value of the U.S. dollar in gold (NYSEArca: IAU)? Over the past 35 years, the dollarís value in gold has steadily deteriorated. In 1975, you could buy one ounce of gold for $165. Today, that same $165 dollars buys you around one-tenth the ounce price of gold. Likewise, the dollarís buying power versus competing currencies like the Australian dollar (NYSEArca: FXA), euro (NYSEArca: FXE), and Canadian dollar (NYSEArca: FXC) has fallen.
Inflation and Your Wallet
Hereís another disturbing question: Does the CPI measure your personal experience with changing prices? Not necessarily. It is important to understand that Bureau of Labor Statistics bases the market baskets and pricing procedures for the CPI-U and CPI-W populations on the experience of the relevant average household, not of any specific family or individual. For this reason, itís improbable that your experience will correspond precisely with either the national indexes or the indexes for specific cities or regions.
For example, if you or your family spends a larger-than-average share of your budget on medical expenses, and medical care costs are increasing more rapidly than the cost of other items in the CPI market basket, your personal rate of inflation may exceed the increase in the CPI. Conversely, if you heat your home with solar energy, and fuel prices are rising more rapidly than other items, you may experience less inflation than the general population does. A national average reflects all the ups and downs of millions of individual price experiences. It seldom mirrors a particular consumer's experience.
At close glimpse, the U.S. governmentís CPI inflation is a sub-standard measure of true inflation. Likewise, other distorted views of inflation abound. The Federal Reserve projects inflation of less than 2% for each of the next three years! Try to remember that figure because it will likely come back to haunt Bernanke & Co. along with the rest of the country.
Even though the inflation rate is up, how come itís not being fully reflected in the governmentís CPI figures? Is it because the real inflation rate is higher than whatís being projected? And if it is, how much higher is the true inflation rate than whatís being reported? What are some ways to protect your financial well-being against these subtle forces? ETFguideís next Webinar titled, ďInflation Ė How bad will it get?Ē will tell you.
As weíve seen, inflation and deflation can happen during the same time period. Itís not a question of one or the other, but rather both. And capitalizing on the next cycle, versus being a helpless victim, will separate the winners from the losers.