Start Date: 2022

This title comes from a dear friend. It is an observation of the discrepancy between the government’s “Consumer Price Index” (CPI) and the actual increase in your regular expenses. To hear tell from the government we are to believe that inflation is somewhere around 6-8% as of 2021-2022.

Have you paid for anything recently? At my store the soup is up 25%, yoghurt 40%, entrees 70%, margarine 100%. Gasoline has varied from 50-100% up in some regions. If you have to buy a car you learned painfully that they are as much as 40% more costly

So how on earth do they come up with these modest and genteel inflation statistics? Well for the “core” inflation index they don’t include food and energy. Energy is needed for heat and  transportation. Food and energy, are, along with shelter, the most essential needs of living.

I once emailed a journalist at the Wall Street Journal to ask what equation is used to define the CPI.  She was very kind to reply and acknowledge that it is not information readily available. The Bureau of Labor Statistics calculates a weighted average of the cost of goods and services. But the specific equation seems to be as secretive as the nuclear codes. It also changes, presumably as needed to put a better face on things.

To asses your experience of inflation just look at your receipts and your checkbook as opposed to the government. Recall we have been told the following:

“We don’t have inflation.”

“Inflation will be transitory.”

“Inflation is a good thing.”

“Inflation is a high-class problem.”

“Inflation is only a problem for those households that make less than $400,000.”

For reference, roughly 99% of US households have combined pre-tax annual incomes less than $400,000. And inflation is increasingly a hardship the further below $400,000 you get.

Inflation is in essence a tax when it outpaces changes in your income. You paid more for your car than your grandparents did at your age. But you make more money than they did. So generational increases are not inherently destructive.  But sudden increases in the costs of basic necessities above the available assets of middle and low income households is a hardship. You go to the store to buy your weekly groceries and find that they cost more even though you still take home the same pension or paycheck. The store is paying more for the product. So all along the line it is similar to a tax.

Income taxes have tiers. They peak for those who are top earners. Not everyone believes in that premise, But the wealthier can survive better. Inflation, like sales tax and gasoline tax applies to all at the same rate. There is no deduction for having a sick child with an expensive illness or a business failure. So while the percentage is the same for all, the impacts of inflation are not equally painful. If you are George Clooney and the price of bread, fruit, milk, and frozen vegetables rises by 30% it will probably not affect your daily life. But if you are a yard worker or house cleaner those basic costs are a large percentage of your expenses. When they increase it is a much greater challenge to your budget.

Now let’s look at numbers. The CPI, a mercurial index, but a number, was 1.4% in January of 2021. In 12 months it increased to 9.1%. This all took place before Russia’s invasion into Ukraine and was primarily related to distribution of COVID stimulus. Whether that was a good or bad thing, that is the pressure that increased prices for that year.

Since then inflation has not been quite so stratospheric. However it has to be understood that inflation accumulates increased costs by compounding. Once you have a spike that does not correspond to your income the damage is done, absent actual deflation where prices go down.

If you own a car you are familiar with the notions of speed and acceleration. The dealer tells you the fancy sports car, which you could never afford but like to dream of, goes from 0 to 60 mph (two different speeds) in 4 seconds. That implies an acceleration.

In economics inflation is a measure of acceleration, but of increasing prices as opposed to speed.

Sticking with the idea of the car consider a more aberrant situation. Think of acceleration in percentages. If you can’t do the numbers, trust me. So if you double your speed that is 100% acceleration. 

Imagine you are driving along in a suburban school zone at 25 mph. Then something goes haywire with your acceleration and your car is zooming at 50 mph. You have accelerated by 100% and doubled your speed.

The defect starts to resolve so that your acceleration is now only 50%, meaning that your speed only increases by half from 50 mph to 75 mph. 

Then the acceleration reduces further to 33% so your speed will increase by 1/3 from 75 mph to 100 mph.

Finally the problem with the accelerator ceases entirely and your speed remains constant.  This is the equivalent of inflation of prices being 0%.

But, and this is the important point, you are still moving at 100 mph, careening around turns, trying not to jump the curb or hit pedestrians and kids on bikes. I don’t think you would find that a good outcome. But unless you experience deceleration, meaning a negative acceleration, you will never get back to anything near the manageable 25 mph speed at which you were driving.

It is the same with inflation.

Suppose we consider that December 2021 year-over-year inflation number of approximately 9%.  That means that some combination of goods and services which would have cost $100 in the previous year, now costs $109.  

Now imagine that a year later inflation reduces to 8%.  Does the cost go back down to $108. No. If inflation went from 9% to 8% the basket that cost $100, then $109 a year later does not now cost $108.  It costs $100 times the 9% increase of year 1 and the 8% increase of the second year. 

So it is 1.08*1.09* $100 = $118

Maybe in a third year CPI lowers to 5%. That means the basket of goods that was $100 three years back is now. 

1.05*1.08*1.09 *$100 = $124

The next year the Federal Reserve will tell us that the government has returned CPI to some target value of 2.5%. They declare victory because inflation is back to where it is supposed to be.  But what about all the previous cost hikes that are now built in.

So now our $100 basket costs

1.025*1.05*1.08*1.09 * $100 = $127

a 27% increase.

Had we chugged along at the 2.5% rate for all of those 4 years the $100 basket would cost

1.025*1.025*1.025*1.025 * $100 = $110

This difference, a 27% increase versus 10%,  is now baked in. It doesn’t go away unless a recession lowers prices, and maybe eliminates your job.

These huge increases in cost are very damaging to the working class. After enough time, those that can will go on strike for significant wage hikes. UPS drivers, pilots, the UAW, health care workers have all gotten, or are attempting to get, raises on the order of 40% over some number of years. Everything you buy gets transported by truck and plane. So these costs will get forwarded on to you. The economy goes into a spiral of higher costs beget higher wages beget higher costs etc. You may say the “greedy” owner should absorb the costs. But for most essentials that is impossible. Grocery stores, unlike Apple computer, do not have a unique product. If you charge too much for a can of peas the customer will go elsewhere. So they operate on a razor thin profit margin of about 2-3%. They must pass on increased costs.  

The prices of commodities do sometimes go down. So eventually it is possible that gasoline, corn, cereal, and copper will deflate and become cheaper.  But you won’t have much luck getting the UAW or any other labor unions, especially government employees, to take a pay cut in the event that the cost of basic goods goes down. Their increased wages and follow-on expenses will remain. Meanwhile the self-employed, unemployed, and retired are stuck paying the permanent inflation.

So when someone tries to tell you that they eliminated inflation remember it is a little like curing cancer by letting the host die. Yes, the disease is gone but at the cost of killing the patient.