FDI 2021 0206

A few weeks ago, in Inflation Is Here, we reviewed some data that indicate inflation is rising, that is, that the value of the dollar is falling at a faster pace than was previously the case.  The latest data continue to underscore this trend.  Here is an updated chart of the Financology Dollar Index, a high frequency index of the real market value of the US dollar designed to show inflation trends before they show up in conventional inflation indices.

Financology Dollar Index 2021 0206

Note particularly the rapid descent in the value of the dollar since the spike early last year. What does is mean in terms of the rate of inflation?

It might surprise some readers that there is no single answer to that question. If that’s the case, however, it’s a consequence of the financial media’s tendency to cavalierly report inflation data without acknowledging this basic fact. Over what time frame are you measuring? You can measure inflation over the past month and report it as an annual rate, or measure it over the past five years and report it as an annual rate. Then you can report the “annual rate” of inflation and not bother to state which time frame you used. We won’t insult reader’s intelligence by following that protocol here. Turning to the data used to plot the above chart of the FDI, let’s begin with the current value of the dollar, and divide by its year ago value determined by applying an exponential moving average to the entire series. The result is 0.8921. In other words, the US dollar has lost 10.79% of its value over the running exponential moving average lagged one year.

This may strike some as unnecessarily technical, but the choice of using the moving average is based on the volatility of the high frequency data we’re starting with. We can, however, just divide the current value by the year ago value … the result is just as valid but much choppier as a result of bypassing the smoothing of the trailing data. The result using this method is .8755 … that the dollar has lost 12.45% of its value since this time last year. This figure is a bit higher than the former because it begins to capture a bit of that spike you see in the chart last year … in other words the comparison is a bit tougher since we’re comparing the current value of the dollar with that of a year ago when it was beginning to spike. So it should now be obvious why I usually prefer to use a moving average to smooth the data used for comparison.

But here is year over year inflation two ways … choose whichever you prefer.  10.79% or 12.45%

So why don’t conventional measures like the CPI show something in that range?  First, because consumer prices inherently lag trends in the value of the dollar itself.  One reason is that wages are a major component of consumer prices, and wages respond only very slowing to changes in the value of the dollar.  Some are even set by multiyear contract.  But as you may have guessed, this doesn’t mean that wage earners are exempt from the effects of inflation.  It means that inflation disproportionately affects their living standards … it’s one reason that the wealth gap has grown so much in recent years.  This inflation will work its way into into consumer prices over time.  Second, government measures have been given a statistical massage to further reduce reported inflation since the Boskin Commission’s report in 1996.

I maintain that the inflation data you see here is correct – inflation is solidly in double digit territory.


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