On Inflation: Part 2 (CPI)
A layman's guide to understanding money supply
This is Part 2 of a multi part series on inflation, aptly named “On Inflation”. I aim to keep every part of this series short enough for a 5–8min read. This is simply to make it more digestible to the reader. If you have not read Part 1, you can do so here. It is advised to first read Part 1 but not necessary.
In Part 1 we mentioned the Consumer Price Index(CPI). This article will discuss this in further detail.
As far as 99% of economists and journalists are concerned, CPI is the be all and end all of inflation. Whatever the CPI reports, that is the inflation rate, and it is always either “to high” or “within range” or “to low”. All this is trivial bullshit which does not have one tinge of real world applicability to what inflation really is. Let me explain:
The Consumer Price Index tracks a combination of goods, decided upon by government. The prices of these goods are compared over time and the difference in price is reported as the CPI inflation rate. So far, so good.
NO! The problem lies in the very first sentence of the above explanation. Yes, you guessed it, the “decided upon by government” part.
Governments can and do “tweak” the goods measured in the CPI basket. This is almost always to make it seem like inflation is lower than what it actually is. They do this mainly in three ways.
1. Removing goods that have inflated “to much” from the CPI basket or adding goods that are not inflationary.(Not much explanation needed here)
2. Substituting goods with inferior goods.
This is where it gets interesting. To combat consumer price resistance, producers shrink packaging so there is less product sold at the same price, or substitute lower quality ingredients, or require consumers to assemble items themselves. These inferior products are then used in the CPI calculation process.
Have you noticed in your lifetime that a can of Coke or Pepsi used to be 330ml. Now a can of Coke is 200ml(this probably differs from country to country). The CPI measure tracking a “can of soda” does not discriminate between the two. They now simply use the 200ml can. Numerous other examples can be given such as an 1lb Ribeye steak being replaced with 1lb of mince or butter being replaced with margarine.
3. Changing the “weight” of a particular good within the CPI basket.
When an item’s price increases to drastically, they simply decrease the amount of weight it carries in the CPI equation. This a quote from the US Bureau of Labour Statistics website itself:
“Recorded price changes are weighted by the importance of the item in the spending patterns of the appropriate population group. The combination of carefully selected geographic areas, retail establishments, commodities and services, and associated weight, gives a weighted measurement of price change for all items in all outlets, in all areas priced for the CPI.”
Translated to laymen’s terms, that means: “We decide how each item is weighted as we like.”
Taking this all into account, it is clear that CPI is manipulated into what ever the government wants it to be. If the government pleases, they could make the CPI rate look like this:
This is not my personal opinion. I’m only explaining how this all works. Nothing I mentioned above is contested by anyone. If you do not believe me simply google the term “CPI BASKET TWEAKS”, or have a look at what you can expect to see right here:
To recap and finish off this section: CPI does not mean shit and is not a measure of anything. (If you are looking for a good twitter post, feel free to use that sentence)
It is safe to assume that whatever the concocted CPI number is, the real inflation rate is far above that. But yet again, it gets far worse than this.
This, again, from the USBLS website:
“The CPI also does not include investment items, such as stocks, bonds, real estate, and life insurance because these items relate to savings, and not to day-to-day consumption expenses.”
“Because these items relate to savings” is not a valid reason to exclude assets in inflation calculation.
A house and “other investment items” is something I intent to purchase. The fact that it is going to cost more in a few years affects my life the same way increases in other prices do. Lets have a look at the real reason why assets are excluded from CPI.
The increase in money supply affects prices of all goods differently. Principally the difference arises because of scarcity. When the price of something such as bread rises(pun intended), it is easy for suppliers and producers to allocate more resources into making more bread. In the short term, more grain and flour could be allocated from other uses into producing bread and in the medium term more agricultural land could be allocated to farming grain. This will increase the supply of bread and thus suppress the price. Any good that can be reproduced easily and cheaply is less affected by price increases from monetary expansion.
Something that can not be easily reproduced is subject to rapid increases in price as demand for such a good increases. Prime real estate is an excellent example. The amount of beachfront property in your local popular holiday town cannot be increased at will. Thus, as the prices of these prime properties rise, the supply stays the same. Because there is no increase in supply possible to suppress prices, these prices rise at a higher rate than cheap reproducible goods. It is important to remember that a lack of supply can be caused by many factors, including government restrictions or regulations.
Herewith a list of scarce goods. Decide for yourself if the price to obtain these have increased more or less than CPI in the last 20 years:
Prime Real Estate, University degrees, Medical care, Blue Chip Stocks, High end art. I rest my case Your Honour.
To conclude: The government blatantly excludes almost everything that is subject to high price increases from their calculation of inflation, then manipulates the ratio and quality of whatever tripe they chose to include.
It is safe to assume that real inflation is much higher than what the government tries to shill you by their fake CPI numbers.
This has been Part 2 of a multi part series of articles I am writing on inflation. Please follow me here on Medium or on Twitter to be notified when Part 3 is published.
