Under Pressure

What does inflation even mean?

Everybody is talking inflation. The Fed says that want to "let inflation run hot". Investors are adding inflation-hedges to their portfolios. Bitcoiners are feeling vindicated as they cheer on their "digital gold" going higher.

But, what is inflation when measured by Consumer Price Index (CPI) and how does it actually affect your wallet?

CPI is the main tool used by the Bureau of Labor Statistics to measure inflation in consumer goods. They create a basket broken into eight major groups: food and beverages, housing, apparel, transportation, medical care, recreation, education, and communication. Then they break those groups into 80,000 different goods and services within them.

After they've determined what goods they're going to track they conduct surveys and collect samples of prices and consumption behavior from around 14,000 "Average American" families.

In these surveys they measure changes in purchasing behavior (how much of what goods are being bought compared to previous surveys) and the price of the goods. Now, you might think that their next step would be to measure the rate of change in the prices of the goods.

If an apple cost $1 last month and costs $1.05 this month then the month over month change in price is 5.0%.

But, CPI is a cost of living index. That means the government factors in changes in consumer behavior into their calculated inflation rate.

For example, in the next round of surveys only half as many people purchased that apple. In a cost of living index the inflation rate would only be counted as 2.5% since half the population eating that apple went and spent their money elsewhere.

The rate of inflation would be 0% if nobody purchased that apple at all! Consumer preferences and behavior affects the reported inflation rate through CPI.

The argument for this is that the BLS desires to provide an accurate estimate for inflation based on what consumers are spending their money on. And, I agree with that motive. But, the BLS conveniently leaves out home prices from their inflation rate calculations. Instead, they substitute it with the rent equivalent of that home.

Why is that an issue? Well, home prices can and have rocketed far higher while rents remained constant. This drastically under-reports home price inflation. Interestingly, the CPI leaves out the price of investments (stocks and bonds).

Two of the largest causes of wealth inequality (inability to purchase a home and high prices of investments) are left out of the government's reporting on inflation...

Maybe the government doesn't want to pull the rug on the monetary illusion they're casting. The money printer can run ad infinitum without causing inflation. See, look how low our inflation numbers are!

A friend of mine put it well, the CPI is like using the average weather of the country to determine what clothes to wear.

Your inflation rate is unique to you based on what you spend your money on. I feel like that's the piece that is missing from all of this. We're painting the entire country with a broad brush stroke and using an average to measure something that's wildly variable person to person.

If you're currently sending a kid through college your inflation rate is much higher than the 1.4% quoted by the Fed. If you're working through a medical diagnosis you're likely experiencing much higher inflation. If you want to buy the healthiest food possible for your family, your inflation rate is probably much higher.

But, as I've said before, I'm not in the hyper-inflation camp. We might get non-trending inflation appearing now and again (like we are today), but overall the trend is going to be getting more for less.

Technology will drive down costs everywhere. When self-driving cars become ubiquitous there will be little incentive to own and maintain your own car or even multiple cars. You'll be part of a membership and a car will appear at the right time and then move on to the next member. Leaving you with the perfect service at the perfect time and none of the maintenance, insurance, tax, or title costs.

Our abundant future requires deflation. But our governments require inflation because of the trillions of dollars of debt they (hint: we) owe. How we get from one to the other is going to be the epicenter of the financial world for the next 10 years.