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?
As I noted
yesterday in What's the Difference Between Fascism, Communism and
Crony-Capitalism? Nothing, a system set up to enrich political
and financial elites is incapable of reform. the only way the CPI will ever
be replaced is when the Status Quo collapses in a heap of lies and insolvency.
Until then, propaganda and gaming the system to protect vested interests will
rule.
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