Wikipedia: “Inflation is defined as the increase in the price of some set of goods and services in a given economy over a period of time. It is measured as the percentage rate of change of a price index. A variety of inflation measures are in use, because there are many different price indices, designed to measure different sets of prices that affect different people. Two widely known indices for which inflation rates are commonly reported are the Consumer Price Index (CPI), which measures nominal consumer prices, and the GDP deflator, which measures the nominal prices of goods and services produced by a given country or region.”
There’s this method of figuring out commodity valuations: you take an index value (i.e., DOW) and divide it by the price of a commodity in question and see how much you can buy. Often oil and gold are compared using this index “buying ability”. I don’t know if there’s an official name to this method/formula.
Since hard assets (commodities) are usually a better indicator of inflation than paper assets (stocks and bonds) this can be an interesting inflation exercise.
Here’s the science behind the madness (see chart if this too cryptic):
- In December 1999 the US markets were at their peak. Let’s compare peak to today.
- I then found oil, natural gas, gold and silver prices and 4 agricultural commodities corn, soy, wheat and rice prices – average from Dec’99 and today at close. And I’ll tell you, historical data is still hard to find despite the amount info available on the Internet. Most of the data is not free, so I had to dig up some government reports.
- I divided the index values (DOW and S&P) by commodity prices which gave me the number of units of each commodity I could buy for one unit of the index.
- Then I figured out the difference in the buying ability of the indices, expressed as percentages, Dec’99 vs. now. They should really be negative numbers but I need them to be positive for the final calculation.
- And here’s the payoff: I took the average difference, divided it by 4 (between the 4 commodities in each table) and then divided that number again by 8 (eight years).
Commodity price increases show these inflation rates, unajusted for GDP: 7.72%, 8.50%, 6.60% and 7.56%, with an average being 7.60%.
True inflation rate cannot be measured without factoring in the GDP deflation rate of course, so what is the average U.S. GDP over the past 8 years? 2007 GDP will be adjusted some months later, so I’ll use the latest estimates.
|Year||GDP, trillion $||Growth, %|
Inflation rate we got from the commodity prices increases (7.60%) – average GDP growth rate (4.70%)
= 2.90 % average annual inflation over the last 8 years
This is supposedly the true inflation rate. This doesn’t feel right, does it? I mean we all know that the inflation is way above this number. We know it every day, when we get out our wallets to pay for stuff. So what’s wrong with the picture? Let’s look up the GDP definition:
GDP = consumption + investment + (government spending) + (exports – imports)
Break it down some more…
Government spending or government expenditure consists of government purchases, which can be financed by seigniorage, taxes, or government borrowing. It is considered to be one of the major components of gross domestic product.
So as long as the government keeps borrowing money in sufficient amounts, the economy will be okay on paper? Amazing.
“Inflation continues till common man is completely sucked out of money, then recession sets in and continues till he becomes suckable again.” – B. J. Gupta