When people talk about inflation they generally refer to the government published consumer price index. The Federal Reserve uses this CPI number to set monetary policy and declares this to be the official “inflation rate” which in turn is used to set all kinds of government benefit adjustments. Currently Stocks are not included as part of the CPI and this makes sense if you consider the name Consumer price index. Consumers don’t buy stocks. What this post would like to explore is the idea that either the CPI must include stocks OR it is not an accurate measure of price inflation.
Why do we care about price inflation anyway? From a practical point of view it lets us know whether or not our standard of living is rising or falling. It tells us how much interest we should expect on loans and how much of a pay raise we should expect each year just to keep up. It tells us whether we should save or spend. In the case of crypto-currencies it has been suggested that it could be the foundation for creating a stable currency.
In a recent discussion with Vitalik from Ethereum I mentioned that the dollar is not a stable currency because it has much higher inflation than the CPI indicates. One of the reasons I cited was that the CPI did not include stocks. It is the debate over what items to include in a price index and how to weight them that makes me prefer monetary inflation as a far more accurate measure of how a currency is being robbed of value.
There is a wide spread belief among economists that “stocks” are somehow different than food, shelter, and clothing when it comes to measuring the impact of money printing. They have use many reasons to justify this exception, but all such explanations fail even simple critical thinking. About the only thing these economists do is define “standard of living” into a box so small that it loses all meaning.
If we really wanted to measure the value of a currency relative to “everything else” then we would have to take the price of everything times the quantity of everything and add it all up. This would represent the “market cap” of every good and service in the economy in terms of money. Assuming the number of goods and services in the economy remain constant then any growth in the “market cap of everything” could be directly attributed to the value of the currency falling.
There are two problems with that approach:
- You cannot possibly enumerate and count all goods and services in the economy
- You cannot assume that their quantity is constant.
The Consumer Price Index is an approximation. It attempts to use a weighted representative sample similar to scientific polling to estimate the result. I will ignore the fact that such an approach is open to so many arbitrary decisions that the resulting index can be manipulated to produce just about any number desired.
One of the ways the CPI is manipulated is by excluding stocks. Perhaps one of the easiest ways economist use to justify not including stocks in the CPI is because most people consider rising stock prices to be a good thing and want stocks to rise as much as possible. Every evening on the news you hear people praising rising stock prices while at the same time calling for low (but not 0) inflation. People praise rising house prices (which are not included in CPI) but condemn rising rents (which are included in the CPI).
There is a clear bias in the selection of prices that get included in the CPI. Income producing capital assets are excluded at every turn. These assets compete for dollars just like every other asset, but they are not generally purchased by the middle and lower class individuals. Those that hold these assets generally pay capital gains taxes on the appreciation and almost always assume the price is going up because the value of the asset is growing and not because the value of the currency is falling.
How does this impact that average Joe who is concerned about price inflation? Lets assume Joe has a constant salary. The cost of rent, food, and clothing are flat so the government reports 0% inflation and Joe gets no pay raise. Year after year the stock market is up 20% and housing is up 15%. Each year Joe is able to afford fewer and fewer income producing assets. While house prices started out 3x his salary, by the time he saved up enough for a 20% down payment house prices climbed to 6x his salary and he no longer qualifies for a loan. Each year that goes by he is able to afford fewer and fewer income producing assets.
By excluding stock prices from the CPI the FED and government are able to print money to purchase income producing assets around the world while pretending there is no impact on the standard of living of the average man. They get to claim the economy is healthy with low inflation while stocks are rising at 16% per year. Did the value of the largest companies income streams and assets really grow 16% or did the dollar fall? How can we tell?
By not including stocks the implicit assumption is that all growth in stocks is due to other goods and services falling in value relative to stocks. That people opted to buy less food and more stocks. That people opted to invest more in capital than in consumption. That this is presumed to go on continuously and that any fall in the price is a temporary correction of something that should on average grow year after year without contributing to inflation at all.
At any point in time the economy should have some ratio of capital allocation between all asset classes. Those ratios can go up or down from year to year, but on average the ratio of capital that can be allocated to stocks cannot change. The only way for stock prices to grow without contributing to price inflation is if their ratio grows. The logical conclusion is that eventually stocks would represent 99% of all wealth and we should still expect them to grow in value without contributing to inflation.
So if your only goal is to measure consumer prices then the CPI is a crude metric. If your goal is to measure the declining value of the currency then using CPI is a cruel deception. So next time you see a stock market rally remember it is a sign your dollars are losing purchasing power and your salary will buy you less than before. It is not a sign of economic growth, it is evidence of the slow theft of all income producing assets by those granted the privilege of printing money.