Inflation, CPI, and The Fed
“The arrogant are blind to the truth.” - Jim Rogers
There’s a lot to be upset about in 2020, but just yesterday I heard a podcast the helped illustrate one of the greatest misunderstandings in the country right now: inflation.
First, it’s important to understand what inflation is, and why it matters. Ask someone today what inflation is, and they will refer you to rising prices of products and services. If you were to verify this with an academic at an institution of higher education, or perhaps one of your academic-leaning friends, they will likely say that you are correct. This word has experienced what most things in life experience, though — mission creep. Historically, inflation referred to the increase in the money supply, and this in effect caused a rise in prices. Therefore, inflation is the cause, and rising prices are the effect.
“Today, inflation is synonymous with a rise in prices, and its connection to money is often overlooked… What was once a word that described a monetary cause now describes a price outcome.” - Michael F. Bryan, Federal Reserve Bank of Cleveland, 1997.
Second, it’s critical to understand why anyone should care about inflation. Let’s say you hold a $100 note in your wallet, or better yet, your safe at home. It’s a crisp bill showing an image of Benjamin Franklin. Lots of history, and plenty of (temporary) value held in this bill issued by the Federal Reserve. You hold onto it because you want to save money — everyone knows that saving money is a good thing! Here’s the problem, though: each year, even according to the latest Federal Reserve estimates, your $100 bill declines in purchasing power . Worse still, the Fed even tells us that they target 2% inflation annually! In 2020, the Consumer Price Index reports an increase of +1.2%; put another way, your $100 bill at the start of 2020 is now able to purchase only $99.80 worth of the same product. Your money has lost value.
Third, the most controversial point if you buy into the mainstream Fed-apologist narrative: is CPI data valid for measuring rising prices? Anyone that studies economics and inflation knows that the ‘gold standard’ of measuring rising prices is CPI — business owners, economists, politicians, the butcher, the baker, the candlestick maker. There is plenty of pushback on this point, though. One big concern is that the Fed is disincentivized to publish accurate data. If the all-knowing American central bank shows evidence that it cannot do its purported job — create rising prices of 2%, but not more! — then surely this would create mistrust in this institution. There have been several historical modifications of the CPI which changed the manner in which it was calculated, but the details were always quite ambiguous. Two major changes took place in 1987 and 1998.
Now, we arrive to a rather nerdy, but still very important reality. There is enough skepticism and to some extent discontent with the data — in that it is viewed as a fabrication — that many people have attempted to create alternative ‘baskets of goods’ in order to display rising prices in a much more accurate way than the CPI. Ed Butowsky, for example, created the Chapwood Index. Butowsky’s index for Houston shows prices increasing by 9% annually. This is extremely different than the data compiled by the government.
“I firmly believe the government gravely underestimates the national rate of inflation—a number also plagued with bias and statistical manipulation. It is universally assumed that the government’s rate of inflation is accurate. It simply isn’t… This blind acceptance is one of the main reasons people are reliant on the government entitlement programs that are bankrupting our country.” - Ed Butowsky, Chapwood Index
Below is a comparison of lost purchasing power using CPI data vs. Chapwood Index data:
As with most things, if you believe the information given to you by your government, you theoretically have nothing to worry about. The wars are for spreading democracy. The food stamps are for generating a standard of living for those that can’t afford one. The drug war is for your own good. The $27 trillion in national debt? Don’t worry about it.
Otherwise, you may see reality for what it is: we continue down a precarious path, and the value of our dollar is in decline, whether dramatic or ‘controlled.’ I’m choosing to combat the antics at the Fed — inflation — by pursuing low-risk options trades that allow me to maintain only short-term exposure to the market in any given week.
After 9 weeks, we have executed 28 trades, with 24 of them expiring worthless (i.e. we kept our premiums and got back our collateral at the conclusion of each week for those 24 trades). The rest we took possession of 100 shares and proceed to sell on Monday morning.
Regards,
John