Inflation: You, Me, and the Government

Wealth & Wisdom Institute

The purpose of this discussion is to understand the depth of the financial challenge that inflation plays in your financial future. Traditional thinking underestimates and in some cases neglects the impact that inflation will have on your future life. A reasonable understanding of this challenge will allow you to compensate and successfully plan, more accurately, your financial future. Without this information, planning efforts could fall dramatically short of your desired results. Inflation is like your shadow, it follows you wherever you go and many times you forget that it is even there. But…..

For years we have relied on the Government’s Consumer Price Index (CPI) to measure the impact of inflation in our everyday lives. Individuals use the Consumer Price Index in an effort to maintain their standard of living and in estimating future benefits and retirement needs In the past, the government measured inflation by using the pricing of a fixed basket of goods and services, using the same components, same weighting over a period of time. Whatever the percentage of change in the cost of that basket of goods represented the amount of additional income needed to purchase the exact basket of goods and services to maintain your lifestyle. Unfortunately, the Consumer’s Price Index has been reconfigured by the government over the last forty years and underestimates inflation and blurs the reality of everyday costs and future financial assumptions. The reason for changing the way the CPI is measured and underreported by the government is simple. The underreporting cuts the cost of the annual cost of living adjustments to social security and other government dependency programs.

The reality is the CPI no longer measures the real cost of maintaining your standard of living. The CPI no longer measures full amounts of inflation and out of pocket increases in your life. Without real inflation numbers, it will be difficult to maintain a standard of living in the future and traditional planning efforts may fall well short of future cost of living estimates.

Inflation is measured by the Bureau of Labor Statistics. The index is based on a survey of 23,000 businesses and the records of 80,000 consumer items each month. This is considered the general rate of inflation and generally supported the fixed basket approach to the CPI. But in the 1990s the government wanted to change the approach in measuring the CPI. They wanted to allow substituting in the fixed basket of goods.

For instance, if someone could no longer afford steak, it would allow the substitution of less expensive hamburger. By taking such actions, the government could claim that the standard of living and the cost of living did not change and would not impact our CPI. One must wonder what the acceptable substitution for hamburger might be. This measurement that allows substitutions is called Chain Weighted CPI-U and generally reports a lower inflation rate. This type of reporting allows the government to reduce the cost of living adjustments on social security and other government dependency programs. That means that senior living on a fixed income will receive lower cost of living increases while facing increasing prices.   

What Else

Everything in your lifestyle is not measured in the CPI. Although the actual out of pocket medical bills you pay are considered in the CPI, the cost of your medical insurance is not. This is measured in the Personal Consumption Expenditure Price Index, or CPE report. The CPI does not include the price of food. What! It also does not include the price of energy. The CPI considers these factors too difficult to measure accurately. It also doesn’t consider the cost of owning a home or even paying taxes as an “out of pocket” expense. So one must consider, if the measurement is not precise from the very beginning, how accurate are the CPI results going to be? So what are the real inflation rates? How much more do you need on an annual basis to maintain your current lifestyle? Everything considered, real inflation could be as high as seven or eight percent.

Buying Power - Inflation

Lesson One
Go out and dig a hole in your backyard, put $1000 into it, cover it up, get yourself a nice comfortable chair and sit next to your buried treasure for ten years. After ten years, dig it up, what do you have? It looks like $1000, but at three percent inflation during those ten years, you only have $744 of buying power. Not only did you lose $256 of buying power, but you also lost ten years of time that can never be recaptured.

Lesson Two
Now you are going to try to make up for the losses you just suffered. You take the $744 of your buying power you have left (remember you started with $1000 of buying power) in an effort to gain back, or get back to, $1000 of buying power.

Investing $744 with a four percent rate of return and three percent inflation, it would take about 26 years to get back to about $1000 of buying power. Of course this does not include any taxes on the gains of your investment. At a five percent rate of return with three percent inflation, it would take almost thirteen years to get back to $1000 of buying power without the consideration of any taxes on the gains.

Lesson Three
Understanding that the CPI is not a complete measurement of the cost of living, real inflation amounts could be anywhere from one percent to about nine percent, depending on your lifestyle, where you live, and your ability or inability to increase your income every year. Long term inflation, twenty or thirty years, could reduce your retirement buying power thirty to forty percent.

Lesson Four
You must have a total understanding that increasing government costs and taxes, government regulations, increasing government debt and any decrease in government subsiding benefits, all have an inflationary impact on your life. 

Inflation - A Man Made Problem
The Gold Coin

Fiat money, by definition, is money that has no backing, such as gold or silver, to give it value. The tenth amendment of the U.S. Constitution disallows the government from printing fiat money. In the old days, the government had to have silver or gold to back the value of the money printed. The Federal Reserve was formed to solve this problem. You must understand that the Federal Reserve is not part of the Federal Government. The Federal Reserve is in charge of all the banks in the United States. In the early 1900s the government needed to find a way to print and control the flow of money without having the gold or silver on hand to back that money. The banks formed the Federal Reserve and said they could print the money for the government The Federal Reserve would then lend the money to the Federal Government, but a serious problem arose. The government needed to find a way (INCOME) to pay the banks (Federal Reserve) back for supplying the printed money that by law the government couldn’t print. The government introduced the sixteenth amendment of the Constitution that burdened the public with an income tax to solve the problem of repaying the Federal Reserve. Ironically the income tax law still states that this action is a temporary measure to be used by the government.

I’m sure just about everyone is aware of how inflation has and will continue to impact their lives. Some of you may be old enough to remember purchasing gas at twenty cents a gallon or bread for twenty-five cents a loaf. Those days are gone. The reason that we have inflation in our lives is because we live under a fiat money monetary system. The money we use on a daily basis has no real value since it is not backed by gold or silver. If the money we use had real value then there would be NO inflation.

As an example, let’s say you and I could go back 2000 years. There we are standing in the middle of Rome. It’s Friday afternoon according to the sundial and you say to me, hey there is a toga party tonight and we should go. I agree and then you say, hey I have one gold coin and I should buy a new toga for the party. So we walk to the toga shop, Toga Depot, and for your one gold coin you get a new toga, a leather sash and new leather sandals. Now, flash forward 2000 years and here we are today. It’s a Friday afternoon and you say, hey there’s a party tonight and I think we should go. I say OK and you say, you know I have one gold coin here and I would like to buy a new suit for the party. So we walk down to Suits Are Us and for the value of one gold coin you purchase a new suit, a leather belt and new leather shoes. After 2000 years, the gold coin has the same value as it had previously because IT HAS VALUE.  

Today, inflation is a two edged sword. We are not only losing the buying power of our money, but also some services we used to receive. I remember pulling up to a gas station and an attendant would come out and pump the gas, clean my windows and ask if he could check my oil. After all that, I would give him two dollars for the gas and he would say thank you. I’m not making this up.

Inflation is nothing more than a hidden tax on our earnings and purchases. Inflation also impacts our ability to save money. Saving rates in the United States are extremely low. According to the Government Accountability Office (GAO) today’s savings rates are as low as they were in the 1930s during the Great Depression. The average person is finding it difficult to save. Unfortunately, inflation raises the cost of goods, eats away at any attempt to save, and of course, you will be taxed on any gains you have on that savings. Inflation will continue to create financial problems for you in the future.

You may be starting to discover that there are some unintended consequences that could impact your financial future. Rates of return, risk of return, time, the value of the dollar and inflation will all play havoc in your life. And then there are taxes, the largest transfer of your wealth. With all these obstacles and challenges, attempting to prepare for your future may look like an impossible chore, but that doesn’t have to be. The real problem is traditional thinking and how it solves the problem. Traditional thinking is the evolution of transferring away most of your wealth to those who create the situations, control the outcome and profit from doing that. In many ways, traditional thinking continues to FEED THE PROBLEMS that you will be facing in the future and ignores the economic trends and shifts of the times.

The reality is that inflation is personal. We end up adjusting our lifestyles based on many factors. In our working years, we have the ability to earn an income and create a lifestyle. In retirement years, we try to maintain the lifestyle we created on a fixed income. It has become increasingly apparent that CPI measurements by the government represent only a portion of cost increases that impact our lives. 

Addressing the Problem

First, you must recognize the difference between accumulated future dollars and the actual value or buying power of those dollars. Second, recognize your ability to create additional wealth inside your family including the children, parents, and grandparents. Third, find an advisor who can intelligently discuss with you the risk, taxes, regulations, inflation and the depreciation of future buying power that impact your everyday life and your future. Any financial discussion that does not address these issues will leave you at risk in the future. 

Different Measures of the Consumer Price Index  

The Consumer Price Index is the broadest measure of inflation reported by the Bureau of Labor Statistics (BLS).

This is the seasonally adjusted inflation number reported on a monthly basis. It represents the buying habits of all urban consumers.

A narrower approach that determines the cost of living adjustments in the government programs such as Social Security. The measurement uses urban wage earners and clerical workers in determining the results.

Inflation measurement that includes business goods and services. It includes health insurance services paid for by health insurance.