In January the Bureau of Labor Statistics reported that the 2021 Consumer Price Index (CPI), which is the main metric that the Federal Reserve uses to track inflation, registered at 7%, the highest reading since 1982.
40 years ago, inflation was heading down from a peak of 13.5% in 1980. Just months before that, Paul Volcker, Federal Reserve Chairman at the time, raised interest rates 4% in one meeting from 11.5% to 15.5%. It was a decisive and successful move to crush inflation. Today the Federal Reserve is still debating if we should raise interest rates from 0% to 0.25%.
Volcker understood economics and he understood inflation. In fact, he would explain that inflation can be calculated by a very simple equation. This still accepted equation states that inflation is equal to the rate of increase in the money supply times the change in velocity. Now, if we assume velocity (how many times one piece of currency trades hands before being tucked into savings) doesn’t change, which it hasn’t, then we are left with a very simple equation -- inflation will equal the rate of growth in the money supply.
You should be saying to yourself… “Well, that seems obvious. That seems like the very definition of inflation.” And you would be correct! Which brings me to my main point.
The 2021 measured growth in monetary supply (M2) as defined by the Federal Reserve, clocked in at 13%. However, the Consumer Price Index for 2021 was reported at 7%. Money creation, 13%. CPI, 7%. Do you see the problem? On the contrary, when Volcker took over in 1979, the CPI was reported at 11.8%, while money supply growth (M2) was virtually the same at 12%.
The rate of inflation, with velocity held constant, equals exactly the growth rate of the money supply. It is that simple. In the 70’s they didn’t have higher inflation than we do now, they just had honest reporting. This misrepresentation of inflation, I would argue, is the greatest lie that is being told to the American people today. And it has been for decades. The average M2 money growth rate from 2010-2020 was 6%. The average reported CPI was 2%.Those that owned assets such as stocks or real estate have benefited or at least weathered inflation during this time.
According to the National Association of Realtors, the median price for an existing home rose around 14% in 2021. Very close to the monetary growth rate of 13%. On the contrary, low-income individuals who do not own any assets just saw their cost of living rise 13%! Seniors dependent on Social Security will see their payments go up 5.9% in 2022, but it will still be a 7.1% decrease in their standard of living! From December 2019 to September 2021, the Federal Reserve themselves reported that the bottom 20% of income earners grew their wealth by 10.4%, while the top 20% grew their wealth by 18.2%. Monetary inflation is the precise reason that rich get richer, the poor get poorer, and the wealth gap widens.
Another deceptive tactic that the government likes to employ is to put the blame on corporate price gouging. A quick Google search will put this to bed. Standard and Poor’s research agency, which is a leading Wall Street research firm, reported that the top 500 US corporations had an average profit margin of 12% in Q4 of 2021. Just 1% higher than the average from the previous last 5 years. It is important to understand that the competitive function of capitalism is exactly what keeps prices low. When profit margins become exorbitantly high in any industry, competition arises and quickly forces the prices down. In fact, when I listened to dozens of investor earnings calls last year, many CEO’s during 2021 made points about trying to absorb raw material inflation and not pass it on to the consumer. Of course, businesses must make some money, and the price increases eventually get passed along. But the point is clear, inflation is not caused by greedy corporations.
So now it would be sensible to be critical and ask yourself two questions. How can the CPI be so far off? And why would the government be doing this intentionally?
Firstly, the CPI is comprised of a weighted basket of goods and services that the Bureau of Labor Statistics (BLS) says reflects, “the prices paid by urban consumers for a market basket of consumer goods and services”. The number 1 weighted expense is housing (mostly rent prices), which makes up 42.4% of the index. This year the Zillow Observed Rent Index climbed 14%, data from Apartment List’s National Rent Report of 2022 documented that the national median rent increased 18%. As I mentioned before, numerous home buying indexes recorded price increases north of 14%.
The phony CPI report in 2021 under their “shelter” category reported a shelter inflation of just 4.1%. This misrepresentation alone, assuming the number should be 14%, would move the 7% CPI print up to 11%. Renters are seeing their cost of living rise double digits, while the real estate owners at minimum keep up with the inflation.
So why does the government let this happen and do they know it’s happening? Indeed, in the early 80’s the government began to understand that inflation has a sort of self-reinforcing effect. The more people think that inflation is an issue the more it will become an issue. In 1981, in the BLS changed how it calculated the shelter component of CPI. Instead of looking at the actual reported changes in rent prices and home sales, we now poll homeowners and ask how much they would theoretically charge for rent. Voila!
Thanks to the hyperinflation of the 70s the Bureau of Labor Statistics changed the calculation of the largest segment of CPI and most economists agree that it under measures housing price increases annually by approximately 66%.
The reasons why the government would do this is very simple. Firstly, they need to fool society into thinking that inflation is not as bad as it really is. It is literally the job description of the Federal Reserve to keep prices as stable as possible. Secondly, they cannot afford to raise social security and other entitlements with cost-of-living adjustments (COLAs) by the true rate of inflation. Thirdly, it allows them a free pass to print money so they can afford to pay for government spending for which the government cannot afford. I could go on but will stop there.
The CPI is a massive lie, and it is the single biggest contributor for wealth inequality in this country. Inflation in 2021 was not 7%, but much closer to 13%, precisely the rate of growth of the money supply. We have in fact been in an inflationary environment as bad as we have ever seen. Meanwhile, interest rates are at 0% and the government at this very moment is still creating $120 billion dollars out of thin air every month, something they have been doing since June 2020.
Of course, I have excluded the recent developments in Ukraine intentionally. The pressure on prices will now be exacerbated due to this exogenous event. Particularly with regards to its impact on the world’s most important resource, oil. With that said, we should not forget the devastating effects of money printing, because shortly the government will put the entire blame on Russia. In fact, supply shocks, which the world is about face is not inflation. Someday oil will be $50 a barrel again, but rents and many of our everyday goods and services will never be lower than they are today thanks to the reckless policies of the Federal Reserve.
Matthew Stearns is the founder/president of Millennial Money Management LLC., based in Meadville.