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.
- 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 don’t 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.
- 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.
- 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?
- "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."
- "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 electorate’s 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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