Inflation Is Worse Than It Appears

A terrific article by Wolf Richter of Wolf Street is linked below.  The case Wolf makes will be familiar to Financology readers, but he develops it with more data and detail.

It’s Getting Serious: Dollar’s Purchasing Power Plunges Most since 2007. But it’s a Lot Worse than it Appears

We can corroborate Wolf’s conclusions. Let’s first take a look at the latest chart of the Financology Dollar Index.

Financology Dollar Index

Readers will note the broad similarity with Wolf’s chart of dollar purchasing power, an inversion of the CPI.  An overall downtrend is interrupted by a spike representing the deflationary crash of 2008.  However, as Wolf argues, the CPI itself is an inadequate measure.  I developed the FDI around fifteen years ago after reaching the same conclusion.

From the data used to generate the chart, we can calculate an annualized rate of inflation. As I’ve pointed out before, though, there’s more than one way to do this, just as there is more than one way to derive one from the CPI. It depends on the choice of time frame and smoothing factors. The one closest to the year-over-year CPI indicates a year-over-year decline in the general market value of the US dollar of 14.9%. This figure however shares the same base effect factor that the recently reported 4.2% CPI inflation rate does. It not only captures the trend we’re most interested in, but by comparing the most recent levels with the spike that occurred last year, adds the spike in as well.

We can obviate this problem with an alternative filtering method much less prone to such base effects.  This results in an annualized rate of 12.4%.  For those interested in the math, it’s the difference between the latest FDI value and that found by applying an exponential moving average that introduces a one year delay to the entire data set. By comparing the latest value with an appropriately weighted mean of its entire history, the effect of past irregularities is neutralized.

Wolf’s analysis and mine are based on different sets of data, but both show that the loss in purchasing power of the dollar is much worse than that implied by the CPI.