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The Consumer Price Index (CPI), the most common metric to measure year-over-year consumer inflation, has increased by 8.5% over the last 12 months.
This is the highest CPI print since 1981 – the largest annual increase in the last 40 years. However, prices for goods and services seem to have gone up much more than 8.5%.
So, is consumer inflation higher than CPI? Or is a single, scalar metric just not capturing the complex market forces of supply and demand in a globalized economy across various tax brackets of market participants and dozens of industries?
Questioning CPI from First Principles
The “Shelter” category of CPI is assigned a 33% weighting in the total calculation for CPI. According to the CPI data, “Shelter,” which is designed to capture price increases in the goods and services that people need for day-to-day living, increased 5% over the last year.
Question: how does Shelter increase 5% when the national rent price for a one-bedroom unit increased 24.4% over the same period, the national rent price for a two-bedroom unit increased 21.8% over the same period, and the cost to acquire a home increased 20.0% over the same period?
According to the Consumer Expenditure Survey, transportation costs are the second largest expense for the average American household. This includes gasoline and vehicle purchases. According to your data, Gasoline, a category of CPI that is assigned a 3.9% weighting in the total calculation for CPI, increased 48% over the last year.
Question: how does the second largest expense for the average American household account for only 3.9% of the total CPI calculation?
Follow-up: How is CPI 8.5% when the components of Americans’ second-largest expense increased 48% (gasoline), 13% (new cars), and 35% (used cars and trucks) over the same period?
Food is the third biggest expense for the average American household. The “Food at home” category of CPI accounts for 8.2% of the total CPI number, and the subcategory of “Meats, poultry, fish, and eggs” accounts for just 1.9% of the total CPI number – a subcategory that has seen a 13.7% increase in the last year.
Question: How is CPI 8.5% when the main course for most American homes – meat, poultry, fish, and eggs – has increased 13.7% over the same period?
Inflation Is a Vector
Michael Saylor argues that inflation is not distributed equally; inflation is a vector and not a scalar.
Trying to quantify the infinite number of market dynamics into a single scalar quantity is futile. And while that doesn’t mean we shouldn’t try to quantify how the infinite number of market forces impact annual changes in prices, it does mean that we should be aware of the limitations of this metric.
“Inflation” depends on the specific good or service you’re acquiring. Here are a few examples:
- If you’re buying gasoline in California, your annual inflation rate is 47%.
- If you’re renting a one-bedroom unit in Jersey City, NJ, your annual inflation rate is 44%.
- If you’re looking to buy one share of the S&P 500, your annual inflation rate is about 14%.
- If you’re in the market for a used car, your annual inflation rate is 41%.
Each person has their own personal inflation rate depending on where they live, what they like, income, goals, etc.
CPI Moves the Goalposts
The Consumer Price Index adjusts prices for changes in quality, which it calls hedonic quality adjustments.
The BLS defines hedonic quality adjustments as a method for adjusting prices whenever the characteristics of the products included in the CPI change due to innovation or the introduction of completely new products.
For example, the Honda Accord added new features to improve its driving experience over the last five years. Even if the car’s sticker price doubles over those five years, the BLS can make a “quality” adjustment to the car’s price as the CPI’s methodology captures it.
Effectively, the increase in the car’s quality cancels out the increase in the car’s price, so the car’s price – as reflected in the CPI numbers – didn’t actually increase according to CPI.
These subjective interpretations corrupt the data.
CPI Assumptions & Replacements
The BLS also makes assumptions regarding replacements of certain goods and services, as pointed out by Lyn Alden.
For example, the BLS will assume that you rotate to a lower quality of meat when the price of the prime cut of meat you were buying increases beyond a certain degree.
These assumptions grant CPI the power to change what it measures.
That’s why comparing the observed inflation in the Meat subcategory from 2002 to the Meat subcategory in 2022 is trivial. The definition of the input “Meat” has been changed several times over that period.
And as you might imagine, each hedonic adjustment and replacement assumption is done to lower the official CPI number.
These adjustments and assumptions make it difficult to track the true price increases of goods and services over time because the contents of the “basket” are always changing.
If the Consumer Price Index is unable to achieve what it has set out to do – that is, accurately quantify the average changes in prices of goods and services in the US – then it should at least stop changing the definitions of its input variables so we can more precisely analyze changes in CPI over time, even if the numbers we’re comparing do not accurately reflect what is observed in the actual world.
If we cannot expect accuracy from CPI, we should expect precision at a minimum.
While this may be setting the bar rather low, I want to be fair and acknowledge that CPI is trying to do an impossible task. The economy is simply too complex for a single number to sufficiently capture price changes.
However, I think there’s value in considering CPI *a* data point and not *the* data point for consumer inflation.
Alternatives to CPI
A couple of alternative inflation barometers can be used to analyze inflation.
Like CPI, they each have their limitations and should be used in conjunction with one another to paint a more comprehensive picture of price fluctuations.
M2 Money Supply
M2 measures the money supply, including cash, checking deposits, and easily convertible “near money,” like money market securities.
Here’s a look at the M2 money supply over the last 20 years:
The line went vertical in response to the COVID-19 outbreak in 2020 as trillions in stimulus were injected into the economy.
From February 2020 until today, the M2 money supply has increased by 41%.
By no means does M2 expansion directly equate to inflation, but it’s ludicrous to think a 41% increase in monetary units chasing the same (or even less) number of goods and services won’t result in unprecedented distortions in price signals.
It’s easy to Monday-morning quarterback this, and there’s a reasonable argument that the alternative of not printing would have been even more disastrous, but emotion aside, we are now in uncharted waters.
Working Hours to Buy the S&P 500
According to data shared by Dan Held, the average worker in the United States must work around 126 hours to acquire a single share of the S&P 500 index.
In 1980, it was 20 hours.
This is the reality of a working person trying to outpace the rate of monetary expansion.
The person must work exponentially harder to keep up with the supply of the currency that is exponentially expanding.
An economist known as John Williams releases data that offers alternatives to government economic statistics.
His website, Shadowstats, is best known for its alternative inflation statistic that attempts to quantify inflation using methodologies the government previously used to calculate inflation before hedonic adjustments and replacements.
Williams’s inflation metric is known as SGS Alternate CPI. As you might imagine, it suggests that inflation is much higher than the official CPU number.
These unofficial numbers put U.S. inflation somewhere around 16-20% in 2022.
Bottom Line: Making Sense of Today’s CPI
Inflation is a vector that depends on the good or service you’re acquiring on a case-by-case basis.
You have your own personal inflation rate that may be higher or lower than the official CPI number.
Is actual inflation higher than the number suggested by CPI? Probably.
CPI may not be accurate, but it can still be useful if it improves the consistency of its methodology.
There are alternative barometers to gauge inflation.
- Is Bitcoin a Good Inflation Hedge?
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- The New Monetary Order
This article is for informational purposes only, and it is not intended to be investment advice. Read our editorial guidelines and public equities research methodology to learn more about how we researched CPI.