THE TRUE MEASUREMENT OF INFLATION

This article examines why it is that our daily experience of rising prices and increasing taxes fails to show up as inflation. It explains why governments manipulate this key target to make us believe in the soundness of our money, and exposes the techniques they use.

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With inflation at a reported level of 2-3% we can all enjoy the confidence of knowing that our savings are almost retaining their value.

This is just as well, because our savings have accumulated into a sizeable sum.  In the richest 30% of US households there are about $4,000,000,000,000 of near cash investments - representing about $120,000 per family.  In the UK in excess of £600,000,000,000 now rests in aggregate household bank accounts and national savings - representing about £30,000 [$50,000] of unspent paper money spending power for every household.  

This unnerving overhang of savings - matched, incidentally by a colossal quantity of debt from people who have over-spent - provides a strong motivation for government to persuade us all that inflation is low and our money is sound.  It would be very bad for the other 98% if even 2% of that big overhang of wealth started to look for a different means of storing its value.

Perhaps this is why each month a key government compiled statistic dutifully reports a fact contradicting our experience, namely that our money is not losing its purchasing power.

But the reality is more sanguine. The inflation issue is disguised behind three wicked statistical sleights of hand.

  1. Our central banks may have been concentrating hard on inflation - but only on retail price inflation as measured by retail price indexes, which is concerned with shoes, food, holidays, consumer electronics, cars etc; a series of things which most of us like, but which donít hold value. If we are trying to measure the tendency of money to fall in value this is only half the story because money buys more than retail goods, and two of the more important things it buys are (i) houses and (ii) unearned income for our retirement. For much of a productive life the cost of buying these two things exceeds half the average consumer's net income, yet both are left out of inflation figures based on retail prices.
     
  2. Interest rates have an entirely disproportionate effect on the cost of living because there are a large number of variable rate mortgages and other commercial and retail loans, the costs of which rise and fall substantially with prevailing levels of interest rates.  Rates can easily move from 3% to 6% for example.  But this is not a 3% price rise, it is a 100% price rise on one of the most substantial parts of many monthly budgets. However just as rates rise, so they fall, over the long term.  So it is extremely convenient for those who wish to report a low rate of inflation to include interest in the figures while rates are falling, and to exclude it when they are rising.  And that is exactly what happens.
     
  3. There is a problem with trying to measure inflation in a world of changing products. Innovation and technological advances mean we are forever being offered new products which hit the shops expensive, and then both improve in quality and diminish in price as they become popular. (Typical examples are cars, TVs, videos, cameras, home computers, mobile phones etc.). Under guidance from government our public statistical offices regularly introduce these new articles into the indexes as they develop a market presence - in other words right at the top of their price profile. This sets the benchmark for both price and technological performance moving forwards. So if a new improved computer comes out, at half the price but with twice the processing power, the benchmark machine - which is no longer available anyway - is halved twice in the index, once for the price reduction and once for the performance improvement, which makes a full 75% price cut. This continues until the original product is eventually ejected from the statistics and replaced on the grounds that it is outdated and nobody wants it anymore. Of course the time it is replaced is conveniently close to the point at which the replacement machine will be falling in price much more quickly than the original, so the retail prices index ends up incorporating all sorts of products only during the downswing of their price profile, allowing the staples of life (food, fuel, tax) to increase incessantly without causing a ripple in the RPI overall. 

The end result of all this book-cooking is that the RPI is not measuring the fall in the value of money at all.  It only measures the increase in the cost of living after having taken back the value of every technical advance that's been made.  So not only is the money you had in 1980 worth well under half what it was then, but to be worth even that much it assumes you adopt a lifestyle which refuses a new watch, a CD player, a computer, a washer/dryer, a video camera, any new car, or indeed any other technically useful thing which might have appeared.  The way the inflation figures have been made to look good is by sticking us in a statistical timewarp.

Had these tricks not been used we would have seen true inflation - or the overall reduction in the purchasing power of money - running along deep into double digits for 40 years, and evidencing the systematic evaporation of the worth of our money as it increases in supply. One day soon the sheer quantity of money in circulation will precipitate a crisis resulting in the destruction of almost all private wealth.  The 98% will be ruined.  The 2% might just be OK.

In case this process is hard to believe try to imagine the action of a modern government in the face of serious economic distress, e.g. when that $4,000bn cash pile, losing credibility, triggers bank runs as it is withdrawn and converted into something less oversupplied. 

Which of the following two is the more likely announcement to come from your government?

  1. "As this crisis has progressed we in the government have noted that 2% of the population has carefully chosen to secure its money safely and at low rates of return with the most cautiously run financial institutions - which are the only ones still solvent. Everyone else has lost their money and they are all clamouring for compensation. Unfortunately for them we have an obligation to those 2% of prudent savers not to create money by resorting to the printing press - which would of course render all remaining savings near worthless. Accordingly we will not bail out any profligate banks, or the depositors who chased higher rates from those flaky organisations. From now on only the 2% of the population who were cautious and wise will still own property, and the rest will have to start all over again.  Incidentally because with this policy we cannot possibly win the next election we are not even bothering to field candidates.  Instead the opposition will benefit from our principled and honourable stance on this important monetary issue, and we wish them well."
     
  2. "As this crisis has progressed we in the government have been appalled by the banks stupid behaviour and lax lending policy which allowed this bubble of credit to go unchecked. We have announced an enquiry, and in the meantime we hear our electorateís call for full compensation, because above all we are a listening government. Not only will we stand by our promise to print money for every depositor, as per our very wise and fair statutory deposit protection scheme, but while we are about it we will voluntarily rescue all troubled banks in these exceptional times by printing money to cover any further depositor claims above and beyond the statutory compensation limit. We are determined that every honest citizen who has deposited money with one of our national banks will benefit from the soundness of our financial system."

It is in the interest and power of governments to modify their paper money obligation and in times of crisis they will do so with wide popular support. Most voters will benefit either by having their debts inflated out of existence, or by having a (very) modest element of the lost purchasing power of their frozen deposits returned to them. Only those few who have successfully secured their money balances will be damaged, and under the circumstances no-one will care for them. 

So the economic landscape will be levelled, and the additional paper money created will be taken out onto the street, where most of it will be searching for something to hold which provides a tangible store of wealth. Prices of such things will skyrocket.  There are more and more people who believe we are approaching the final phases of this process.

"We are about to enter an era of $400 billion to $500 billion annual deficits, and reach the point where it is almost impossible to borrow the money we need. The money we have worked so hard to save all our lives will be worthless." ---Former U.S. Senator, Warren B. Rudman

Mr Rudman was speaking for the 98%.

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