Measures of Inflation – Understanding the CPI

If you were to ask 100 people on the street what inflation is, you would either get a blank stare or they would say it’s ‘rising prices’ for goods and services.

Historically though, this definition is incorrect…rising prices are a symptom of inflation, which is more accurately defined as an increase in the money supply. When more gold was discovered or more money was printed, inflation occurred. Over the years though, people have been trained to think inflation is synonymous with rising prices.

There’s many ways to measure inflation, oops, I mean rising prices with the most popular being the Consumer Price Index, or CPI.

Even though this is impossible in reality since the prices of some goods go down (…think electronics like computers) while the prices of other goods go up, the CPI attempts to broadly measure prices in an aggregate sense. This of course isn’t really possible since there’s no way of measuring the price of all things in all places at all times. It’s also impossible to know how each item should be weighted to reflect the average person.

This reality though doesn’t stop the government from attempting to measure rising prices in a broad sense through the CPI. It attempts to do this through an arbitrary ‘basket’ of goods that it thinks reflects the ‘overall price level.’

By this measure, the CPI soared in the 1960s, ‘70s and early ‘80s. Anyone around in those days should remember these times – themes for many songs and even movies were centered on these price increases – or what’s commonly referred to as inflation.

But in the ‘80s, the CPI plunged. Was this the result of good leadership? Does this mean inflation was a thing of the past?

Hardly…per the historical definition, inflation was still going on. But the methods that measured its effects changed in an attempt to mask the true impacts inflation was having on prices.

Sometime in the mid-‘80s, the government changed the CPI to exclude housing. Since housing prices were increasing at a pretty good pace, removing this from the definition led to a big drop in the index. Literally overnight, ‘inflation’ as it was commonly known was tamed while housing prices continued to soar.

The next big tinkering occurred in the mid-‘90s in a practice known as ‘substitution.’ When the price of T-bone steak was seen as getting too high, the government substituted chicken breast in its place and voila, the CPI’s numbers were once again tame.

So while it seems increasing prices have moderated significantly since the 1980s, price inflation as measured against the CPI’s original methodology has continued to soar, remaining above 5% every year since 1987.

Shadow Stats is a website that uses the original CPI methodology to measure rising prices. Under the original formula, the CPI is currently hovering around 10%. However, the government is reporting this number to be only 2.5%.

Therefore through deletion and substitution, the government has been able to grossly under-report the true increase in prices.

Other factors to mask the true impacts of inflation, namely gains in productivity and subsidies, help suppress the CPI numbers as well.

For example, we said earlier how computers consistently go down in price. This is due to gains in productivity. A computer you bought in 2008 for $900 may only be $600 today. But without inflation – meaning an increase in the money supply – that price may be $450. So even though it appears the price of the computer decreased due to gains in productivity, that price drop would have been more significant had the money supply remained stable.

As you can see from Shadow Stats’ chart above, the real rate of inflation (…or rising prices) is much higher than what’s officially reported.

This reality is what drives the interest in gold and silver for many of us. Since metals are not subject to the same manipulation as paper money, it is possible to retain the purchasing power of your wealth through these kinds of investments.

While some talk of the distant prospect of bad price inflation, the reality is that it’s been here all along. Sadly though, it’s poised to get much worse.

Buying gold, silver and physical commodities is the one way to protect yourself and even thrive in this situation.