So why does the government maintain such a
transparently inaccurate and misleading metric? For three reasons.
That the official rate of inflation doesn’t
reflect reality is obvious to anyone paying college tuition and
healthcare out of pocket. The debate over the accuracy of
the official consumer price index (CPI) and personal consumption
expenditures (PCE–the so-called core rate of inflation) has raged
for years, with no resolution in sight.
The CPI calculates inflation based on the
prices of a basket of goods and services that are adjusted by
hedonics, i.e. improvements that are not reflected in the price of
the goods. Housing costs are largely calculated on equivalent rent,
i.e. what homeowners reckon they would pay if they were renting their
house.
The CPI attempts to measure the relative weight
of each component:
Many argue that these weightings skew the CPI
lower, as do hedonic adjustments. The motivation for this skew is
transparent: since the government increases Social Security benefits
and Federal employees’ pay annually to keep up with inflation (the
cost of living allowance or COLA), a low rate of inflation keeps
these increases modest.
Over time, an artificially low CPI/COLA lowers
government expenditures (and deficits, provided tax revenues rise at
rates above official inflation).
Those claiming the weighting is accurate face a
blizzard of legitimate questions. For example, if healthcare is 18%
of the U.S. GDP, i.e. 18 cents of every dollar goes to healthcare,
then how can a mere 7% wedge of the CPI devoted to healthcare be
remotely accurate?
In my analysis, the debate over inflation is
intrinsically flawed. What really matters is not the overall
rate of inflation, which can be endlessly debated, but the purchasing
power of earned income, i.e. wages and the exposure
to real-world costs.
In other words, those households with zero
exposure to college tuition and the full costs of daycare, medical
care and healthcare insurance may well experience low inflation,
while the household paying the full costs of daycare, college tuition
and healthcare insurance will experience soaring inflation.
Here’s one example of how CPI fails to
capture real-world inflation/loss of purchasing power. Let’s
say an employee works for a company or agency that pays his/her
healthcare insurance. The monthly cost has risen from $1,000/month to
$1,500/month. The employee’s wage has remained stagnant but
the total compensation costs paid by the employer
have gone up by $500/month.
Now the employer shifts that $500/month to
the employee as their share of the healthcare insurance
cost. Since the average full-time worker earns around $40,000 a year,
and pays around 18% in taxes, their take-home pay is around $33,000
annually.
The employee’s co-pay of $6,000 a year
($500/month) represents 18% of their take-home wage. This is
an 18% reduction in earnings, or the equivalent of 18% inflation
(i.e. a reduction in purchasing power).
This shifting of the skyrocketing burden of
healthcare costs acts the same as 20% inflation, yet it doesn’t
even register in the current CPI.
The geography of inflation doesn’t
register, either. Soaring rents in Brooklyn, NY and the San
Francisco Bay Area have a profound effect on those exposed to these
rapidly rising costs, yet these impacts are massaged to zero by
national CPI calculations.
So once again we have a bifurcated society:
those protected by the state from rising costs and those exposed to
real-world reductions in purchasing power. Households that
receive government subsidies and direct payments have little exposure
to real-world healthcare costs, since they are covered by Medicaid,
and modest exposure to housing if they receive Section 8 benefits
(Section 8 recipients pay 30% of their income for rent, regardless of
the market price of the rental). Retirees on Medicare also have
limited exposure to the real-world costs of their care paid by the
government.
If we analyze inflation by these two
metrics, we find the middle class is increasingly exposed to
skyrocketing real-world prices. Pundits in the top 5% have
the luxury of pontificating on the accuracy of the CPI while those
protected by government subsidies and coverage have the luxury of
wondering what all the fuss is about. Only those 100% exposed to the
real costs experience the full fury of actual inflation.
So why does the government maintain such a
transparently inaccurate and misleading metric? For three reasons: 1)
it is useful propaganda; 2) it suppresses the state’s
cost-of-living increases and 3) it lowers the government’s cost of
borrowing.The benefits of reducing COLA adjustments are
self-evident, as is the benefit of borrowing money at low rates of
interest, but the propaganda benefits are more subtle.
The key to enabling the endless printing of
money that enriches the banks and the top .1% is low inflation. Asset
bubbles can be inflated, ballooning the wealth of the owners of the
assets, as long as inflation is near-zero.
Indeed, the Federal Reserve claims it must
print money to counter low inflation.
Meanwhile, in the real economy, those
exposed to the real costs of college tuition, healthcare, childcare,
etc. are seeing their purchasing power evaporate like a puddle of
water in Death Valley. The Fed needs low inflation to
justify its continuing enrichment of the financial elite, and the
Federal government needs low inflation to keep its COLAs and
borrowing costs low.
There are two ways to mask real-world
reductions of purchasing power: 1) skew the CPI by distorting the
component percentages, hedonics and how costs are measured, and 2)
protect enough of the populace from real-world increases so they no
longer care. Seniors, who famously vote in droves, have no idea what
their Medicare benefits actually cost. As a result, they have no
experience of healthcare inflation /reduction of purchasing power.
This works in all sorts of industries. As I
have often mentioned here, the F-35 Lightning fighter aircraft costs
in excess of $200 million each, roughly four times the cost of the
F-18F it replaces. This extraordinary inflation is not experienced
directly by the taxpayer who is paying for the boondoggle, as the
Federal government borrows trillions of dollars to pay for such
boondoggles, effectively passing the inflated costs on to future
generations.
These costs are hidden by the low cost of
borrowing trillions to pay for boondoggles.If real-world
inflation is (say) 5%, then interest rates would typically adjust to
a few points above that rate, to compensate capital for the erosion
of purchasing power. If the Treasury had to pay 7% to borrow money,
the interest cost would soon cripple Federal spending. People would
be forced to focus on how all those trillions of dollars are being
spent, and to whose benefit.
But with borrowing costs so low, nobody cares.
The solution? One, abolish the Fed and let
the market discover interest rates, and two, abandon the simplistic
notion that one number of inflation has any meaning in a
complex economy with numerous subsets of exposure to market costs and
the loss or gain of purchasing power.
Will we muster the will to look past failed
models and metrics? Sadly, the answer is no. Why?
