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The CPI vs. Real Inflation

Don't Worry, There's No Inflation

Written by Geoffrey Pike
Posted October 23, 2015

In 1966, Alan Greenspan wrote an essay called "Gold and Economic Freedom." It was included in a book by Ayn Rand on capitalism. In the essay, Greenspan wrote about the gold standard and its protection against inflation.

Greenspan said, “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold.”

Greenspan also said, “Deficit spending is simply a scheme for the confiscation of wealth.”

Unfortunately, Greenspan later went on to head up the Federal Reserve for 18 years, becoming a big inflationist himself. The loose money and easy credit of the early 2000s is what largely led to the subsequent bust and financial crisis in 2008.

Still, Greenspan was right back then. When people think of the government confiscating our money and spending our money, they think of taxation. This is certainly a big part of it. Some taxes are more hidden than others.

But in the case of the U.S. federal government, we have to deal with the issue of deficit spending and inflation. The U.S. government is able to run huge deficits, which are partially funded by the Federal Reserve creating money out of thin air.

Monetary inflation acts as something of a hidden tax. It is impossible to put a price tag on it. People walk around with money in their wallets. They have money sitting in their bank accounts. But this money is essentially being taxed, losing value due to monetary inflation.

We can’t always determine the effects of monetary inflation by looking at price inflation. Higher prices are just one consequence of monetary inflation. Monetary inflation also misallocates resources, encouraging more debt and less saving. It tricks investors into thinking that more savings exist than really is the case. This often leads to unsustainable bubbles, such as in stocks or real estate.

Inflation hides the cost of government spending. If the Fed were not able to create money out of thin air and help Congress fund its deficits, then most Americans would not stand for the increased taxes.

Imagine what the Iraq War would have looked like if Congress had been compelled to enact a special war tax on the American people. It is doubtful that the war would have even happened at all if each American family had been required to pony up a couple of thousand dollars extra per year. Instead, Congress just included it in the general slush fund and used deficits to cover the difference between taxes collected and money spent. Most people didn’t care because they didn’t see it coming directly out of their pockets, even though it was happening indirectly.

The Social Security Default

While the U.S. national debt is huge and approaching the $20 trillion mark, the unfunded liabilities are far bigger. Some estimates put them over $200 trillion, which is just unfathomable.

The majority of the unfunded liabilities are in Medicare, followed by Social Security. Government employee pensions are also included in this.

Statistically speaking, there is no possible way the government can keep all of these promises. There is going to be some kind of a default. But it will not be a typical default where the payments stop coming. There will be a combination of different cuts in benefits.

One way to reduce the unfunded liabilities quickly is to simply raise the official retirement age. The government can just declare that you have to be 75 years of age (or pick a number) to collect Medicare and Social Security. That will instantly wipe out tens of trillions of dollars in liabilities.

We should also expect some form of means testing, where high income or high net worth individuals get a reduced Social Security payment or no payment at all. This idea is even becoming more acceptable to many Republicans, so we should expect this to happen at some point.

The last major option is to simply reduce the payments to those collecting. You could say that this already happened with an announcement last week.

The Social Security Administration announced that there will be no COLA (Cost Of Living Adjustment) for 2016 for Social Security recipients. The SSA is telling us that there is no inflation. This means that the approximately 65 million people on Social Security will not get a raise next year. You could say they are getting a pay cut.

The Labor Department uses the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to calculate price inflation effects on Social Security recipients.

Since transportation costs went down significantly due to lower prices at the gas pumps, the overall weighted average showed almost no change from September 2014 to September 2015.

Aside from the fact that many retirees drive less than the average adult, there are other problems here — that is, problems for retirees.

CPI

The CPI (Consumer Price Index) measure is not that great of an indicator of actual price inflation. It is a government statistic, but price inflation is impossible to measure accurately anyway because different people buy different things. It is also difficult to account for improvements in quality and substitution products.

Still, the CPI can give us a decent picture of the overall trend. It doesn’t necessarily tell us of the harmful effects of monetary inflation because we might actually see falling prices without monetary inflation, just as we have seen in the electronics industry.

Right now, the CPI is flat year-over-year. This is largely due to falling oil and gas prices. Most Americans understand the reality that things are not getting cheaper in most areas when it comes to basic needs. Your grocery bill is probably not going down. If you are buying the same amount of food, it is probably going up.

We know that medical care and health insurance costs are rising astronomically. This alone is killing middle-class America. And while most retirees are not paying for employer-based health insurance, they still end up paying more for their medical expenses.

The median CPI, published by the Cleveland Fed, is more stable than the CPI. It had been consistently showing a 2.2% annual rate. In the last few months, it has ticked up. For September, it showed a year-over-year increase of 2.5%.

If actual consumer prices are going up by 2% per year for the average retiree and they get no increase next year for Social Security, then this will mean a reduction in income. It will be especially hard for those who rely on Social Security as their primary source of income.

For one year, it is not too hard for most people to find 1% or 2% to cut out of the budget. The problem is if this compounds for a string of several years. Five or 10 years down the line, seniors who rely heavily on Social Security may find that their real incomes have decreased in the neighborhood of 15% or 20%.

You Can’t Rely on the Government

This is not so much a commentary on what should or shouldn’t happen but rather the reality of the situation. The government is defaulting on its promises through hidden means.

The government has to default in some way or another. There is no way it can keep all of the promises (lies) that were previously made. The problem is that it is being done in a dishonest way, and it is going to catch millions of people off guard.

The average American working family is struggling right now and cannot afford to pay even more in taxes. They should not be forced to pay more in taxes to fund the lifestyles of retirees. Because the average family is struggling so much, they probably are not going to tolerate any significant tax increases.

People who rely on the government for their survival should really consider getting a backup plan. The government is going to default in stages. It will not happen all at once. It will impact those who are planning to retire down the road. As we saw with this announcement last week, it will also impact those already retired.

You obviously have to protect yourself against the government’s hidden tax of inflation. This means investing in hard assets such as gold, silver, and real estate. It means not relying solely on a fixed income, which will lose purchasing power over time.

Politicians will tell you that the government will take care of you in order to garner your vote. The math should tell you something different, just as the Social Security Administration did last week.

Until next time,

Geoffrey Pike for Wealth Daily

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