While the “official” CPI inflation rate appears low today, it is based on flawed methodology, which, over time, has caused it to be close to meaningless as a measure of the cost of maintaining a standard of living. In 1983 and again in 1995/96, the calculation of the CPI was modified by the then sitting governments to reflect a much lower inflation rate. The object was to save the government a huge sum in entitlement costs over the ensuing years, and, indeed, it has accomplished that goal. An inflation rate even 2 percentage points higher over the 30 year period would mean that the cost of the ongoing entitlement programs would be about 80% higher. Today, these are over $2 trillion annually. So, the math implies that the cost, at an inflation rate of 2 percentage points higher, would be about $3.6 trillion, or $1.6 trillion more than today. Both John Williams at Shadowstats.com and Ed Butowsky at Chapwood Investments have done work on the inflation bias, and both conclude that inflation reality is much higher than that reported by the official CPI.
One of the biggest issues in the political world is the growing gap between the incomes of the wealthy and the middle class. The data presented in what follows builds a very strong case that an unintended consequence of the policy of reporting a downwardly biased CPI has a lot to do with this growing gap. Think of the scenario where employees at major corporations are given “cost of living” increases each year equal to the “official” CPI. If the CPI underreports inflation, the employees actually lose purchasing power. At the same time, if the corporations raise their prices equal to the real rate of inflation, the corporations actually increase their margins and profits.
One way to look at this is to look at the share of national income from wage earners and from corporate profits. The first graph shows a definite uptrend in corporate profits’ share of Gross Domestic Income (GDI – the income counterpart of Gross Domestic Product), especially since the mid-1990s, and the downtrend in wage earnings as a percent of GDI which appears to be long-term in nature.The relationship between wage earnings and corporate profits, while a lot more volatile, shows a definite long term downtrend.
Sources: Bloomberg, & Federal Reserve Bank of St. Louis
The second graph shows the growth rates in the official CPI, Average Hourly Earnings, Corporate Profits, and the Shadowstats (John Williams) computation of inflation. As you can see from the graph, wages have only kept pace with “official” CPI, but corporate profits have grown more in line with the Shadowstats inflation rate, interrupted only by an occasional recession. It is also clear from the graph that the real divergence between the series began in the mid-1990s, about the time the government began to seriously manipulate the computation of inflation.
Sources: Bloomberg, Federal Reserve Bank of St. Louis, & Shadowstats.com
The growing gap between the wealthy, as represented by corporate profits, and the middle class, as represented by wage earnings, has been, in no small part, caused by the understated rate of inflation. The political class, of course, rails against this growing gap. Nevertheless, it appears to be an unintended consequence of the policy of that political class, which understates inflation so as to slow the increasing cost of entitlements, that is an underlying cause of that widening wealth gap.
Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.