Back in July we received a notification from our gas supplier that our rates would increase by 13% effective August 1. Not the 2.something percent that the Bureau of Labor Statistics (BLS) keeps telling us prices are rising by based on the Consumer Price Index (CPI), but several times higher. The truly puzzling part is that the double digit increase comes even though natural gas prices have fallen on the order of 40% since the fall of 2014. It’s just a single example, but it illustrates why you seem to fall behind, no matter how much you earn. Prices are going up much faster than what we’re being told by the media.
I realize that our entire economic culture bases inflation on the CPI – government, pensions, employers, economists, academics. But if you don’t mind, I think the number is completely bogus. It’s specifically designed to portray an inflation rate that can easily be tolerated, reality be damned.
Now to be sure, there are certain products that are relatively flat price-wise, and some, like oil/gasoline that have fallen in price considerably over the past 12 months. Unfortunately, the price decline in energy is not necessarily flowing through to consumers, certainly not as it relates to food and utilities as we might expect. And if you look at prices where we live and breathe, such as house prices and rents, property, income and sales taxes, healthcare, insurance premiums of all types, education and utilities, the price spiral continues unabated.
So what’s going on here?
Are the Reported Inflation Numbers Even Real?
As I just said, I’m in the camp with the people who believe that the true rate of inflation is intentionally hidden from view. David Stockman’s Contra Corner blog has an excellent article detailing just how inflation is under-reported. It’s it bit dry due to the fact that it has a lot of numbers, but it makes an excellent point.
For example, it highlights how health insurance is reported by the BLS to have increased by just 0.7% in the past year. If you’re on an Obamacare plan you know that this number is a complete fantasy. The Stockman article (actually written by Jim Quinn) points out that the employee portion of employer-sponsored health insurance plans increased by 8.0% in the same space of time. And you know that a private plan purchased on the health insurance exchange had to increase by a lot more than that. So where does the BLS get 0.7% from?
“There are three kinds of lies: lies, damned lies, and statistics.” – Mark Twain
I think that makes the point. But what does it matter to us?
What Under-reported Inflation Does to Us
The basic dilemma is that raises, Social Security cost-of-living adjustments, and interest on savings are calculated based on the CPI. If the CPI is faithfully reported as something around 2% per year – as it has been for most of the past 15 years – but actually inflation is significantly higher, we’re falling behind a little bit each year. You may not notice it from one year to the next, but over a period of five years or 10 years it’s obvious.
Let’s crunch some numbers. Let’s say that in 2005 you were earning $50,000 per year. Since it was costing you $45,000 per year to live, you were able to live comfortably and still bank $5,000.
Because of inflation as reported by the CPI, your employer increased your pay by 2% each year for the past 10 years. As a result of those pay increases, your salary is now almost $61,000. So far, so good.
But if the real rate of inflation over the past 10 years was more like 4% per year, your cost of living increased much faster than your salary. While you were able to live comfortably on $45,000 a year back in 2005, the actual 4% annual increase in prices has increased your cost of living to $66,600 per year.
Now, you’re no longer banking $5,000 a year – you can’t because it now cost you $5,600 per year more to live than what you actually earn.
This explains why you seem to fall behind, no matter how much you earn.
If you’re like most people, you’re probably making up the difference by dipping into savings, cutting expenses, and increasing debt.
Who Benefits from Under-reported Inflation
Generally speaking, institutions benefit from under-reported inflation. This starts with the federal government. A low-inflation rate means low interest rates on government debt, lower income tax indexing adjustments, and smaller cost-of-living adjustments on Social Security benefits, government pensions, and other transfer payments. It’s easy to see why the federal government wants a most modest CPI number.
But banks benefit as well. A low CPI enables the Federal Reserve to keep interest rates low. That means that a bank can borrow from the Fed for substantially less than 1%, and then charge you 19.99% for a credit card.
Employers also stand to gain. The reason why pay raises in the past few years are seldom higher than 2%, is because 2% is also roughly the published CPI number. This means that employers can raise their prices to consumers by, say, 7%, while limiting pay raises to 2% for their employees.
In this arrangement, the institutions always win, and the individual always loses. This is why you seem to fall behind despite increases in your pay. And it’s why the middle class is shrinking.
Price Increases are Built into Both the Economy and Government
So why do we seem to need inflation? Actually, WE don’t. In fact, WE’D be better off without it.
But not the institutions. Government revenues are tied to increasing prices. For example, a municipality can get more property tax revenue as housing in the community rises in price. A state can collect more in sales tax, because the tax is based on price levels. The federal government can collect more in taxes, because those taxes are generally based on the size of the economy. Speaking of which, rising price levels can give the appearance that the economy is growing, even if it is actually stagnating or in decline.
Banks of course love rising price levels. Since so many bank loans are collateralized, it’s critical that those assets rise in value. We saw what happened when collateral values dropped in the housing meltdown a few years ago. Suddenly, what seemed to be rock-solid mortgages turned in the toxic paper.
Companies/employers have a more complex relationship with inflation. If they can raise their prices enough to cover the higher price of supplier goods and services, they may be able to increase profits by keeping pay raises well below the true rate of inflation. But trying to outrun the real rate of inflation at least partially explains why companies reduce payrolls in favor of greater automation, and use of subcontractors and offshore labor. That translates to fewer jobs, and lower wages.
But as you can see, none of this works in our favor as individual citizens.
What Can We Do About It?
If you think we can somehow fix this by lobbying the government, electing the “right people”, or holding protest marches, forget about it. The institutions are too heavily vested in under-reported inflation and will never willingly give up that gravy train. And the public – while most seem to know that there’s something wrong, the whole process is too complicated to fit neatly into a political platform.
The only way to deal with it is on an individual level. Here are my suggestions:
- Don’t assume it will get better in time. For all the reasons given above, it’s just not set up to improve.
- Set realistic expectations. Under-reported inflation is affecting almost every area of life, and will continue to do so. That includes career prospects, savings goals, your ability to get out of debt, and even your plan for retirement.
- Be perpetually cutting costs. That means always looking for cheaper substitutes, or even learning to do without certain products or services.
- Become fanatical about saving money. A cash-rich position is the best strategy to deal with uncertain prices.
- Stop borrowing money and get out of debt ASAP! Given the relentless price spiral, the last thing you need is to be adding interest to the cost of everything you buy. That’s to say nothing of the effect of debt in lowering your income.
- Always be on the lookout to increase your income. I strongly recommend creating and keeping a side business. The two income household may need to become the three income household, or even four.
- Never ignore inflation in your investment calculations. I mean the real rate of inflation, not the CPI incantation. Planning on a 4% to 5% (subject to change going forward) rate of inflation in this “low-, no-inflation era”, will give you more realistic investment plans.
Using a couple or more of these strategies could keep you from falling further behind, and may even enable you to move forward despite an official inflation rate that comes incredibly close to being a complete fib. Sorry to be the bearer of bad news, but we’re dealing with forces that are not always obvious at the surface. We can’t change “the system”, particularly one that isn’t even officially acknowledged to exist, but we can and should change our behavior in response.
Do you think there’s any merit to what I’ve written here? Do you think it has a significant affect on why you seem to fall behind? If you agree that inflation is being under-reported, what do you think the approximate real rate is? And what do you think is the best way to deal with it?