Chronicle - Jun 16, 2024
The True Inflation
Have you ever wondered why the prices of the things you buy are always rising faster than the official inflation rate? Are you simply buying more expensive items, or is the official inflation rate consistently underestimated?
The widely used measure of inflation is the Consumer Price Index (CPI). It tracks the average change in prices paid by consumers for a basket of goods and services, such as food, clothing, housing, and transportation. Government officials use the CPI as a performance indicator, with a low CPI considered better. It is very common for country leaders to boast about their nation's low CPI. Central bank officials adjust interest rates to achieve their ideal CPI target. Companies benchmark their wage increases to the CPI. The CPI has an impact on the interest rate at the central bank, which is the benchmark for your investment in government bonds.
The official CPI number affects us in a big way. Yet, we often feel that the prices of the items we buy increase much more than the CPI suggests.
The Problem With Official CPI Numbers
There are a number of reasons why official CPI figures are frequently lower than the actual inflation that the majority of people experience.
The CPI calculation assumes that customers will always seek lower-cost alternatives to products and services. For example, suppose a country sells two types of gasoline: subsidized and non-subsidized. Subsidized gasoline is always included in the CPI calculation because it is less expensive. This is done despite the fact that subsidized gasoline is quite limited, and most individuals end up purchasing non-subsidized gasoline.
Another issue to consider is that the CPI calculation includes quality adjustments. If the perceived quality of a product has improved, the price increase is attributed to quality improvement rather than inflation.
The CPI calculation also assumes a basket composition of goods and services based on an imagined consumer spending pattern, which may not reflect the majority of people's purchasing. For example, education spending may be given a 10% weight in the CPI formula. But many people may spend half of their salary on their children's education.
Another issue is the variation in data collection, sampling, and statistical procedures used to calculate the CPI.
These characteristics may alter over time based on who sets the CPI calculation: the government. Many variables can be modified, including the basket composition, the weight of each item, quality adjustments, and the statistical methodologies used.
So, how much is the discrepancy between actual and official inflation rates? One should look for alternative inflation data, such as those from the Chapwood Index and Shadow Government Statistics.
The Chapwood Index
The Chapwood Index gathered almost 4,000 items from friends and associates around the U.S. about what they spend their money on. They then reduce the list to 150 items that are bought the most frequently. The Chapwood Index is based on these 150 items.
In comparison, the official CPI numbers are calculated for 80,000 items. By utilizing such a large number, the official CPI has lost its meaning. Nobody bought 80,000 items for their everyday necessities. As a result, the Chapwood Index is a more accurate proxy for our spending habits and inflation.
According to Chapwood, the official CPI print is designed to increase at a minimal rate. As illustrated in the graphic below, the official CPI figure is outrageously low.
John William’s Shadow Government Statistics
ShadowStats.com provides alternative inflation figures. Their numbers are more consistent than those of the official CPI because they have followed the same procedures since 1980.
As illustrated here, a consistent process for calculating CPI results in significantly higher CPI numbers.
Don't imagine you're immune to the problem of faulty official CPI data just because you're not a U.S. resident. In every country, the official CPI is more likely to be lower than the true CPI, at least when measured against the BigMac Index.
The BigMac Index
The BigMac Index is clearly not the appropriate benchmark for a country's inflation because it only measures one item, the McDonald's BigMac, which not everyone purchases on a daily basis.
However, the Big Mac Index measurement has three advantageous characteristics for measuring inflation. First, it measures the price of a BigMac very consistently, with no absurd modifications. Second, the price of a BigMac includes numerous components of the BigMac supply chain, such as wheat, beef, dairy, and other BigMac ingredients; fuel prices for transporting the items; transportation services; MacDonalds store rent; employee wages; and many more. The last one, the BigMac Index, is essentially free of government intervention, with the exception of import tariffs (if the ingredients are imported) and minimum wage rules.
Thus, we can gain a sense of how much the official CPI is underestimated.
Using the BigMac dataset, we collected the local BigMac prices in 27 countries from 2000 to 2023. We track pricing fluctuations and compare them to the official CPI numbers for each country.
The results are as expected: the BigMac price increased significantly more than the official CPI. And this occurred in practically every country.
The Dangers of Using the Official CPI as a Financial Benchmark
You now know that the official CPI figures are probably underestimated. Nonetheless, everything is measured, directly or indirectly, against the official CPI. Companies negotiated salaries depending on several factors, one of which was CPI. Coupons on government and corporate bonds are indirectly benchmarked to the CPI . As a result, many people's pension savings are expanding in line with official CPI figures that are lower than the true inflation rate.
Act accordingly.
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