At least once a quarter we receive an update regarding the latest “inflation” number and how central banks are successful at reaching to that number. Except it’s a completely irrelevant and quite probably even wrong number. Whenever you walk the shelves in the local grocery store and look at the prices while comparing them to what you paid a year ago you can react in two ways:
(A) This is outrageous – the prices are up again, the shop owner is so greedy!
(B) This is outrageous – the prices are up again because the central bank destroyed my money even further…
No matter which is your preferred approach however the end result is going to be that you need to pay more. Let’s look at the (A) approach first as the greed is easy to disprove.
The Local Shop Is So Greedy
No, it isn’t greedy. We live in a world where you can order pretty much anything online and often it’s rather easy to buy from some very remote vendor even on a different continent. This acts as an insurance that we will not be ripped off by some local greedy vendor that is operating alone without any competition. In any major city with population of at least 1 million people chances are there will be multiple local grocery stores and there will be at least one online order option available. If one shop got too greedy and charged too much nobody would buy from them, including you.
The Cartel Is Pushing The Prices Up
No, there is no cartel. You might think that there is some secret agreement (aka the cartel) that holds the prices together. Even though the cartels were extremely difficult to maintain in the past as breaking the cartel agreement meant getting and immediate edge over the other members. Therefore eventually most cartels broke up on its own and in today’s globalised world we can’t really seriously think that anyone can maintain a cartel.
I encourage you to prove me wrong and to post in the comments below two cities with same rent prices where any type of grocery differs significantly (say for all groceries it’s 10% extra).
This gets us to the (B) – it’s not the greedy local shop or the local cartel pushing the prices up – it’s the Central Bank doing it by increasing the money supply which in effect means larger and larger amounts of money is chasing the same (limited) supply of goods and services. What’s interesting is that nowadays the established mass media try define inflation as the “increase in the price level” ie. on Investopedia^ however that is not accurate – increase in the price level is not the cause, it’s the effect of the increased supply. Luckily the old literature from 1960s^ is still around for reference:
“Inflation is an increase in the supply of the money that outruns the increase in the supply of the goods.”
I personally object to any increase in the money supply – why should anyone be allowed to “increase” money supply and then insist that we accept this as form of payment especially when we don’t have any idea how much money is printed or do we?
The Consumer Price Index (CPI) And Its Fallacy
Now we are getting to the core of the problem – the Consumer Price Index (CPI) that supposedly measures the inflation levels for average person – there are the word “Consumer” the “Price” and the “Index” that should cover it all, right? It is THE index all the time published by the brand name financial news outlets^. So what’s wrong with it?
What Is Inside the CPI And Why It Does Not Make Sense
United States Department of Labor, Bureaus of Labor Statistics^ the measure the CPI the following way:
“Prices for the goods and services used to calculate the CPI are collected in 75 urban areas throughout the country and from about 23,000 retail and service establishments. Data on rents are collected from about 43,000 landlords or tenants.
The weight for an item is derived from reported expenditures on that item as estimated by the Consumer Expenditure Survey.”
Which sounds reasonable but the devil is in the detail – the weight of each item inside the basket. Most people buy on daily basis food, consume energy, pay rents but very seldom buy a new LCD TV, computer or a mobile phone which is due to fierce competition and advances in technology dropping in price basically on weekly basis. So you add all this up, pretending that we are buying TVs every quarter and you get an insane number. Obviously the Department does not disclose full data with its weights as the game would be up…
Why Is The CPI Number So Horrendously Downplayed
There are multiple reasons:
(I) The central government in all countries measure its growth in Gross Domestic Product (GDP)^ however this number is typically adjusted for inflation, at least that’s the consensus, and later presented as the “real GDP”. For example if the GDP growth for year 2018 was 5% but inflation (measured in CPI) was 2% (that’s typical what most Central Banks want in 2019) then the actual real GDP growth is 3% (5-2=3).
The 3% is the news headlines number. Imagine the horror if the nominal (non adjusted) GDP number was 5% and then somebody at the department of statistics calculated that the real inflation is somewhere around 10% (more on it later), you would come up with the headline that the economy (GDP) grew by -5% (negative 5 percent). Therefore the economy did not grow but actually shrink. How likely is it that the currently ruling party would be under that scenario re-elected?
(II) Another reason is that all government expenses are adjusted for “the inflation” aka the CPI – the budgeting for this means that the next year’s salaries, pensions, treasuries yield needs to be 2% higher than they were the last year to “keep up”. Imagine the horror if the statistics department published that the inflation is 10% year over year (y/y) and that everyone and everything needs a 10% raise not once but every-single-year.
(III) This gets us to the final and the biggest reason why to camouflage the real inflation – the government bonds market – the treasuries. It is expected that USA will have to issue US$ 906 billions in treasuries^ in year 2019 and almost half of it will be to service the debt – its interest rate which for year 2017 was at 2.26% or US$458.5 billions^. If the real inflation was 10%, would the market buy a treasury yielding 2.26%?
The Real Inflation: Chapwood Index, Shadowstats and The Big Mac Index
The most pessimistic is the Chapwood Index^ which suggests that the price increase year over year in the 50 US cities the increase is between 7.1% and 13.2% over the past 5 years. They list the watched items^ to some degree but sadly full data set is not provided. In my personal opinion the upswing is caused by raising insurance costs.
ShadowStats^ has been around for long time and compares the current (2019) official CPI with those based on the methods used in 1980s and 1990s. The 1990s based CPI shows the inflation for past 5 years between 5% and 6% the method from 1980s shows inflation somewhere between 8% and 11%.
The Big Mac Index
In a sense of the best for the last – The Big Mac Index^. This particular index is very interesting because it shows inflation of the same product across multiple countries in local currencies and they publish their data on GitHub^.
The Big Mac Index In The Americas
According to their data the price of Big Mac in the USA increased by 19.71% over last 5 years or roughly 3.94% every year in past 5 years (2014-2019). That’s quite a stretch from the official target of 2% inflation per year. If you go back 10 years (2009-2019) the Big Mac price increased by 60.78% or 6.08% on average per year (!).
Looking at Brazil the price of a single Big Mac increased by 41.13% over past 5 years (2014-2019) making it an average inflation of 8.23% on yearly basis. Going back 10 years (2009-2019) shows increase by 117.93% making it average yearly inflation of 11.79%.
If someone was wondering how is the price in the collapsed Argentina – it’s not good. In the past 5 years the price increased more than 5x making it average yearly inflation of 94.29%. Looking back 10 years it’s 14x+ increase (from 8.25 ARS to 120) or average yearly inflation of 135%. Argentina had data from year 2000 so if you were wondering – the price increased 48x (from 2.5 ARS to 120 ARS) making it inflation of 247.37% per year on average. A terrifying number indeed.
The Big Mac Index in Europe
Enough of the USA data – let’s have a look at Europe starting with UK. In The United Kingdom the price of the same Big Mac increased by 43.67% over past 10 years (2009-2019) or on average 4.37% per year.
Germany has data only for the past 8 years (2011-2019) and it makes for 21.76% increase or 2.72% annually.
Switzerland did not increase the prices and the price stayed the same since June 2008 at 6.50 CHF. It’s worth noting that Big Mac in Switzerland is the most expensive Big Mac in the World therefore there is no pressure on pushing the price further.
Italy is similar to Germany – the data is available only for the past 8 years and in those years the price increased by 22.86% or 2.86% per year on average.
Kind of horrifying examples of inflation is Ukraine. Ukraine tripled (3x) the price of Big Mac in past 5 years (2014-2019), yes the price really went up from 19 UAH to 57 UAH. Effective inflation is therefore an average 40% on year over year basis. If you go back 10 years (2009-2019) the prices more than quadrupled going from 14 UAH per Big Mac to current 57 UAH. Effective inflation is on level of 30.71% per year on average for the past 10 years.
Russia is not far behind – in past 5 years (2014-2019) the price went up by 46.07% that makes it average yearly inflation of 9.21%. Going back 10 years means looking at the average yearly inflation of 9.40%.
The Big Mac Index In Asia
Let’s kick off with Japan. In Japan the price of Big Mac almost did not increase, going up a measly 5.41% in 5 years or 1.08% per year on average. Looking back 10 years it’s 21.88% increase with 2.19% increase on average. In my personal opinion is that McDonald’s is not popular at all in the area and with decline in rent prices over the years the price barely increases. I find all of this interesting considering that the M1 money supply doubled over the past 10 years^.
Mainland China has seen a much higher increase – going from 16.9 CNY to 21 CNY in past 5 years. Making it 24.26% increase in past 5 years which is translating to inflation of 4.85% per year on average. Going back 10 years points at inflation of 6.80% per year on average.
Interestingly Hong Kong experienced only a mild increase from 18 HKD in 2014 to 20.5 HKD in 2019, making it 13.89% increase or 2.78% per annum. However looking back 10 years we can see the price increase in level of 54.14%, making it average yearly inflation of 5.41%.
Inflation in India is really rather severe – the price of a single Big Mac moved from 105 INR in 2014 to 183 INR in 2019 making it a hefty 74.29% increase over last 5 years or 14.86% per year on average.
And closing the Asia with Singapore. In Singapore the price of Big Mac increased by 23.40% over past 5 years (2014-2019), making it a 4.68% increase on yearly basis. Not exactly rounding error for a well developed economy. Going 10 years back shows average yearly inflation of 3.74%.
Big Mac Inflation And The Official Inflation Summary Table
|Region||Country||Big Mac price increase since 2014||Big Mac price increase since 2009||Avg yearly inflation (Big Mac Index)||Official Government Inflation Statistics|
|Asia||Hong Kong (SAR)||13.89%||54.14%||5.41%||3.50%|
*Data available only for the past 8 years.
Looking at the table above it’s very clear that there is a huge disproportion between the official government reported inflation and the actual inflation as measured by the Big Mac Index. This disproportion is usually on level of 2x to up to 10x. It’s also worth noting that the inflation is at different pace in different countries. While most developed nations work with real inflation in range of 3% to 5% the developing nations and nations with severe economic issues suffer double or even triple digits inflation per annum.
The most interesting disproportion is in the USA – for a developed nation there is a huge gap between the official inflation reported at less than 2% and the one calculated using Big Mac Index which shows inflation above 6% or as seen in Chapwood Index being at around 10% for most of the large US cities.
The most important message though is this: If your yearly income or net worth does not grow on average at least 3% per year & every year you are lagging behind and the inflation is decimating your living standard.
- Feature image courtesy of Forbes.com
- What You Should Know about Inflation By Henry Hazlitt available at Books.Google.com
- United States Department of Labor, Bureaus of Labor Statistics
- Chapwood Index
- Big Mac Index main article and the GitHub repository