Worried About Inflation? It Has Been High For Years
Why The Government Keeps Inflation Numbers Artificially Low
Inflation has been on the minds of investors recently, but I believe it has been high for years. Have you ever noticed that things get conspicuously more expensive every year? Home prices are through the roof. The costs of education, health care, and child care go up noticeably every year, and yet the Bureau of Labor Statistics (BLS) inflation reading (Consumer Price Index, CPI) only increases by 1–3% annually.
Why is that?
The BLS chooses the components and weightings of inflation (CPI). They can change it how they see fit (and have made numerous changes over the years). As a result, no matter how much the cost of everyday living increases, the components of CPI can be re-weighted to stay in that same 1–3% range.
But why would the US government purposely want to keep inflation (CPI) low?
In the chart below, the left bar shows the government’s total spending and the right bar shows the total revenue. The dotted portion above the right bar shows how much we borrow/print to cover the spending deficit. You can see in the left bar that Social Security, Medicare, and Medicaid make up about 37% of our federal spending. This equates to about 72% of our revenue.
Now, why is this important? Because annual increases to Social Security, Medicare, and Medicaid payments are based on a subset of CPI. This means if CPI were higher, these benefits to retirees would have to increase by that much more annually. These payments already represent 72% of our revenue at a 1–3% growth rate. It would only be a matter of time for these benefits to surpass ALL of our revenue if they increased payments in the 3–6% range.
The BLS can also play games with how they calculate CPI. For example, about 33% of CPI is weighted towards rent increases and decreases. However, rent prices don’t take into account home price appreciation. When home prices increase, they cost more for people to purchase which is an added living expense. Even factoring in lower mortgage rates, if this 33% weighting of CPI took into account home price appreciation from the past 10+ years, wouldn’t our inflation numbers certainly be higher?
What’s the solution?
Instead of using these arbitrarily re-weighted components that keep CPI in the same 1–3% range, wouldn’t it make sense to look at how much a median wage earner’s salary needs to increase to maintain their same lifestyle over time? Then we’d know how much the cost of living is actually going up annually for a middle-class American family. The Manhattan Institute did this study. They came up with the Cost of Thriving Index (COTI) which is the number of weeks a median wage worker in the US needs to support their same lifestyle over time. The chart below shows that from 1990 to 2018, this went from 38.5 to 58.4 weeks (keep in mind there are 52 weeks in a year). This means the median American salary in 1990 could support a family in 8 months, but can’t support a family in an entire year in 2018.
This is where the government’s numbers become suspect.
From 1992 to 2018, median wage growth in the US averaged 2.9%. That is in the same 1–3% range as CPI, right? If that is the case, shouldn’t a median wage earner be able to support a family in about the same number of months in 1992 vs 2018?
Why could the median wage cover a family’s expenses with months to spare in 1992, but can’t cover these expenses in a whole year in 2018 if wage growth and inflation have been about the same?
The bottom line: Inflation has been high for years but the US government needs to keep CPI artificially low because they cannot afford to increase Social Security, Medicare, and Medicaid payments at a rate commensurate with actual inflation.
Investment implication: TIPS (Treasury Inflation-Protected Securities) are often used within client investment portfolios to combat inflation as their values increase/decrease with CPI levels. Although they may be directionally correct, my opinion is that the order of magnitude is not enough to be an effective inflation-fighting instrument within an investment portfolio.
This article is for informational purposes only. It should not be considered Investment, Financial or Legal Advice. Not all information may be accurate. Consult a financial professional before making any financial decisions.
