How to Weather an Inflationary Storm

The following is another guest post from Free Money Finance reader Rod Ferguson.

It's been a while since I wrote for Free Money Finance; with the shenanigans of last spring, I spent more time focusing on preparing for what is happening today than trying to show people what we were heading towards.  Recently (March 18th) the Federal Reserve announced it was going to embark on a program of "quantitative easing" – a economist term for "inflate the currency" - in the form of buying more Treasuries and shifting it's asset base to absorb more toxic mortgages.  This program will reflect, almost directly, in the monetary base.

As you can see, we've already doubled it in the last few months and another rough doubling will, when the new paper begins circulating, translate to pretty severe price inflation.  Add to that the rumbles in the world about abandoning the USD as a reserve currency and moving to a fixed basket of currencies, and that spells serious trouble for the dollar.

Will this mean hyperinflation? I still believe probably not, but we're a lot closer to the condition than we were last year.  Even if we only hit inflation levels of 10% or 15% (the same as the 70's), the impact to daily lives will be noticeable.  Most people are not prepared for this, and with the recent disinflation (the drop in some prices and credit tightness that people are mistaking for deflation), many are even less prepared than they would have been a year ago.  I've spent the last few years preparing for it, and decided to spend some time outlining what I've done for those who might be interested.  I'll warn you that some of the steps I've taken and would recommend fall into what could be considered as "tin-foil-hat-wearing" mentality, but as the old saying goes, you're only paranoid if they aren't out to get you.  If we've learned anything in the last few months, its that the old rules are gone and new ones are being made up as we go along.

1) Food:  we've been stockpiling about a month's worth of the normal food items we consume.  This acts both as an inflation hedge and as a buffer for distribution interruptions.  For inflation, if you shop smart (as FMF constantly states) you can buy food at a lower cost and consume that food while avoiding higher costs and waiting for another dip in price.  Distribution interruptions are a common occurrence during economic turmoil; I don't know if anyone else has experienced this, but a few times we've gone shopping there is a big empty space on the shelf where the food we wanted to buy normally resides.  Sometimes, the shelf isn't stocked for a week or more.  We don't buy anything we don't normally consume and rotate the food to ensure we consume the oldest items first.  Even through disinflation, the system has netted us a lower cost for monthly food overall (by being able to wait for sales and discounts), and reduced our number of shopping trips per month in half.  If you decide to do the same, be certain to check your expiration dates; you'd be amazed at how long some of our food lasts (chips - about 3 weeks, tuna - about 3 years).

2) Gardening:  while we haven't done any gardening over winter (naturally), we're setting up for a larger garden than we have had in the past.  We've dug out our old canning supplies and plan on fleshing out the set to start canning this year.  Growing your own food is the most inflation-independent method for feeding yourself; you only have the cost of seeds and the labor to maintain and harvest your garden.  And, the food tastes better to boot!  We employ the square foot gardening method that yields about 2-3 times the produce as a conventional linear garden.  If you plan on gardening and don't already know how to can, you might want to consider looking at your community calendar for a class or getting a book that will teach you; the best garden in the world won't be as useful unless you can store your food longer than the week or two that it'll stay fresh naturally.

3) Money:  we have little in cash savings right now; just enough to cover about a month's expenses.  The rest of our savings are in hard assets, mainly metals and land.  As I've written before, metals tend to maintain purchasing power throughout inflation; an ounce of silver will generally buy about 4 gallons of gasoline regardless of what the price of the silver or gasoline happens to be.  We still maintain foreign currencies and stocks, but those are taking an ever-decreasing percentage of our overall portfolio.  If you wish to start converting your wealth, physical bullion and a safe or safe deposit box are your best avenues, although it's getting harder to find physical bullion these days.  Expect to pay a premium over spot when you do - the time to buy cheaply has passed.

4) Maintenance:  we've stopped replacing and started repairing things that wear out or break.  In the past, if the washing machine broke or the microwave stopped working or a pair of otherwise good shoes blew a seam, we'd replace it.  Now, we get a repairman out or attempt to repair it ourselves (I'm a decent leatherworker - one of my hobbies.)  We only replace if the cost of repair would exceed a replacement, and we go without using whatever it is until we find a sale.  It helps to have goods that are already in working order and can be repaired, but the market for used appliances especially is growing.  Craigslist, Freecycle and your classifieds section in the paper are your best routes to research.

5) Miscellaneous:  we purchased some land (part of our long-term retirement plan) that we were going to develop over the next three years (road, well, septic, cabin, etc,) that we are now going to let sit for those three years.  Our plan now is to relocate some of the saplings on the property to fill out the gaps in the unforested parts of it.  This will allow us to save more by not spending any more (the trees are already on the property, we're just going to move them around) except in labor; we'll also get the added benefit of more mature trees when we do finally use the land.  This will adjust our retirement plans slightly, but we both feel it's a necessary evil with the uncertainty in the economy now.

So, in short, we're stockpiling what we need and holding off on what we don't while converting our wealth into something that will still have value when this is all over.  There are a lot of things we were already doing that are natural inflation buffers:  eating at home 6-7 days a week, carpooling, shopping for bargains, waiting to purchase until we felt prices were reasonable, buy cars and drive them into the ground, keep the thermostat down in the winter and up in the summer, etc. - many of the things that FMF suggests.  But, last year I thought it best to "kick it up a notch" and have been preparing while it was still possible to do so easily.  It's still not too late, however; most of the inflation analysis is saying we'll start feeling it between 6 and 12 months from now (granted, that was before the Fed announcement, so I'd imagine that range might be dropped a few months).

Comments

[rwh]

Some of your ideas are useful whether or not we're experiencing inflation. Shopping for bargains, spending less than you make, reducing debt etc.

Time will tell if you're correct regarding inflation. The current 10 year government bond is yielding 2.695%. That indicates the market doesn't yet accept the idea that inflation is right around the corner. Many economists still advance the view we are heading into a long period of price deflation or stagnation, similar to the decades following the panic of 1873.

True, we are in effect printing money. Bernanke stated that in those exact terms during his interview on 60 minutes. But monetary policy by itself may not result in inflation if global demand remains low.

If other governments (and ours) resort to protectionist measures that could artificially increase demand and lead to price inflation, but I'm hopeful cooler heads will prevail.

We shall see. Right now I'm only buying 12-18 month CDs because I think there is at least some possibility rates will rise in the future. So I guess I'm at least considering the possibility of inflation, but I'm not certain of it.

[Mike Hunt]

Interesting thoughts.

However I think we are still in for a big bout of deflation. The fact that gold is still so high is quite fascinating considering it's at all time highs in most currencies besides the USD & the Yen.

Consider this: printing money is one meausure of the cause of inflation but for it to manifest into the CPI (the measure of the effect of inflation) that money has to come out into the general system and be spent. If the velocity of money increases then this will kick up inflation even higher.

Right now the velocity of money is stagnant. Banks aren't lending. Job losses are rising. People like you are growing vegetables and shopping less. Where is this inflation going to come? If $100K USD is worthless then why is it so hard to get a job that pays this much?

For sure the administration is hurting the economy in the medium / long run and they are enriching the banking elite at the expense of the taxpayer.

The bigger risk is that nobody will buy the US treasury bonds and the Fed is forced to buy them all and eventually the serpent eats it's tail. The only way to avoid that is to have interest rates shoot up which cripples us by our high debt. The other way is defaulting on the debt and killing the dollar.

Now for either of those scenarios all the steps you are taking will help you and your family. But hyper-inflation is not one of the likely outcomes, in my mind.

Take a look at Mish's analysis (globaleconomicblogspot.com) to see the relative cases of inflation vs deflation.

-Mike

[Matt H]

It's not so much what the Fed is doing right now that has me worried about inflation. It's, as Mike alluded to, the amount the federal government is spending (aka wasting). What happens when that debt comes due? I figure in one way or another, in 10 years or so, the dollar is in big trouble.

Unfortunately, the most effective ways to hedge against inflation run against the grain of responsible personal finance: save less, borrow more. If you do that, you're betting against the dollar. You get to pay back a 2009 loan with cheaper 2019 dollars. Fortunately, there's a way to do it that's not too financially irresponsible, and may be a great idea for lots of other reasons, depending on your situation: go buy a house if you don't own one already.

[Rod Ferguson]

Mike - I do read Mish. We disagree on one major point; I believe deflation/inflation is caused by growth in the monetary base and he believes its caused by credit expansion/destruction. I acknowledge that credit functions as money, but I believe it takes a second seat to the money base which is "out in the economy". He acknowledges that money supply is a contributor to inflation/deflation, but believes that because the credit market is so much larger than the money supply, it's more important. Just like a Christian talking to an Atheist, we just have to agree to disagree because we aren't going to change each others minds :)

You're absolutely correct about the velocity being stagnant. That's the point I'm round-about trying to make: that there is a huge backlog of money just waiting to enter the general economy - at least twice what is currently in circulation with another equal chunk being printed as we speak. Once it does, it'll be like floodwaters breaching the dam - there won't be a trickle of it as it's been in the past. As it was unthinkable 3 years ago to have the EUR/USD fluctuate by as much as a penny per day, that sort of movement is common these days; in the future, we might see that fluctuation be as much as 5-10 cents per day. It's that sort of uncertainty about the cost of replacement goods that facilitates sharp price inflation. I was talking to a fellow a few weeks ago about that idea. He couldn't understand that he wasn't buying something at the price the thing was, but rather the price to replace the thing.

I still don't think hyperinflation is knocking at our door. But, we've taken several steps towards it in the last year. The biggest one is monetizing debt - the serpent has begun to eat it's own tail, as you say. The historical outcome of such an effort, without exception, is hyperinflation followed by currency destruction. For me, the question isn't 'if', it's 'when'. The only unique position the USD has is it's reserve currency status; that's something new tossed into that historical pot. We could avoid the usual pattern for a while, or at least that pattern might change.

[Apex]

I think inflation will eventually come. I personally think the 6-12 month time frame is far too aggressive given how weak things are right now, I look more for it to really start hitting something like 5 years out (I expect we will likely ease into it but coming from where we are now to a few percent inflation is not inflationary, its when we start moving into 7 or 8 percent that you can call it inflationary, because in the past decade we have had an odd year here or there with 5% CPI and most of them on the order of 2-3% which is all considered normal. I don't see the 7-8% number as very likely in the next 12 months.

Anyway, thats just all my opinion.

One thing I find curious in this post is all the things being done NOW to protect against inflation. Sure you could argue you are preparing yourself, but things like repair instead of buy new? Why now? Inflation is lower now than it has been in 20 years, so if you could buy new 2 years ago, why not now. In fact, if inflation is coming, why not buy new now, so you have something that will last longer and you won't have to replace it when things cost much more. I was a bit surprised by the repair not replace comment. It seems like that is what you would want to do when inflation is here, not when you think its coming. Otherwise its just a spend less money now strategy and if money is going to be worth less in the future better to spend it now on something you need, wouldn't that be a logical conclusion?

[Andie]

Any thoughts for an apartment-renting, city dweller? We are thinking about moving to a lower cost of living area where we can buy property, but may or may not do so "in time" to garden, improve property, etc.

[Rod Ferguson]

Apex - the idea is conserve cash now, convert it to something inflation-independent (or walks in step with inflation) to come out the other end with wealth preserved. Also, that 6-12 month time frame is the current figure being tossed around in economic realms; while by no means perfect, it does show a conclusion by economists using different methods ending in the roughly same time period. That's usually a good indicator of what's going to happen, even if it's not guaranteed.

Andie - 1 and 3 are your best bets. If you can't get your property before you can plant, then just prepare the land for next year; get a soil test then put up some raised beds, dig up the garden plots, fertilize according to the test results, etc. Many people try and garden with non-hybrid seeds, but some hybrids might be useful for you. There is one hybrid of tomato, for example, called the 'Fourth of July Hybrid' that starts bearing fruit about 50 days after you plant and continues all season. Just look for 'quick harvest' or sometimes 'early harvest' (although 'early harvest' usually means early planting) vegetables. Also, some urban areas have "garden co-ops" that you might be able to join if you don't believe you can purchase before late summer or fall.

[Apex]

Rod,

Thanks for the explanation on using repairs to conserve cash and then buy inflation protected assets.

The timeframe I mentioned is clearly just my opinion. I have no economists to back me up.

I would be interested in what your 6-12 month window means in concrete terms. What would you expect the inflation rate to be in 6-12 months to meet your criteria of the current situation having led to inflation. i.e. - if inflation is 4% 12 months from now would you consider that to meet your criteria? 6,8,10%. What number do you expect to see in 6-12 months?

[Baker @ Man Vs. Debt]

This was a very interesting read indeed. I must say that some seem a little extreme, however I know the point is to whether an inflation "storm". I do agree that several of the points can apply to all economic situations. Very interesting, I'm goig to reread and see what I can apply.

[Rod Ferguson]

Apex - well, personally, if we see 70's-style rates of 15% yoy, then that's the scenario I'm talking about. However, the CPI measurements are different now than in the 70's (to the tune of about 8% to the downside today, or 1% today = 9% using the old method), so the CPI would have to hit north of 7% in today's terms. We got close to that level in 2008 when we nearly hit 6%. Now, we're around .2%.

Admittedly, the pain of the 70's felt more poinant because people had been used to around 1% or less inflation yoy and jumping to 10-15% from 1% (or less) is quite a shock, while we've been used to 3-5% inflation rates for the last decade or more. But, having said that, the savings rate in the 70's was much higher than currently and people had not been using thier homes as ATM's for the last 5 years; it's here where I think we're unprepared. We have practically nothing to fall back on for an economic upset of this magnitude. Our grandparents survived the Depression and learned a lot of survival skills for that environment. They tried to pass those along to thier children, but thier children bought fully into the materialism of the 70's and 80's and *thier* kids (mainly, us) were never taught the lessons learned by the Depression, by and large. Since most of those grandparents are no longer among us, we have to re-learn those skills. I'm afraid that the need to have those skills will be present long before people in general try to learn them.

[Apex]

I agree with the savings rate being a much bigger problem now.

I am confused by your CPI comments. You argue that our CPI is basically 8% too low.

This would mean that for the last decade we have already had 10-14% inflation pretty much the whole time.

Then you said that in the 70s they went from 1 to 15% which was painful and you say we are coming from something more like 3-5% for the last decade. But now it would seem you are mixing numbers because if these numbers are 8% too low then you really mean we are coming from 11-13% so going to 15% from there should be very little noticeable change.

I am not sure exactly what is it that you are saying because you seem to be saying that basically we have already had very high inflation for a long time, but yet you suggest we are on the cusp of some bad inflation which it appears you are defining around the 15% range. However you mentioned above that due to CPI being 8% too low that when we hit 6% a last year that we already were only 1% shy of the 15% number you are now preparing for.

I guess I am having trouble understanding how to make sense of this viewpoint given what seems to be some contradictions between inflation getting much worse but yet inflation was apparently already much worse due to the CPI numbers being much worse than actually reported.

Can you clear that up?

[Rod Ferguson]

Baker - I did warn that some people might find some of my actions a bit extreme :) One other benefit I haven't talked about is the habits formed. If it should come to be that we dodge the kind of inflation I fear, then I can always relax some of these habits. If it hits, then I (hopefully) already have the habits I need to survive it.

[Sarah]

Great info everyone! I'm learning a lot about inflation just through reading your comments!!

[Mike Hunt]

Rod,

Great discussion.

My advice would be to look for signs that the money that is being created by the Treasury and lent through the FED is making it's way into the general population. Whether this is in the form of salary increases or another mechanism to get cash into peoples hands so this can chase goods and services. With high unemployment going higher I don't see this until another 2 years.

The last asset bubble was very destructive because rising housing prices acted as a cash machine by allowing people to re-finance and do a HELOC loan. This was putting money into peoples hands in excess of annual salaries. Needless to say, this has now stopped.

Keep looking for signs and act accordingly. Good luck with your garden this summer!

-Mike

[MasterPo]

Two points:

Regarding gardening that just isn't practical or safe in many urban and suburban areas. The ground soil is too contaminated for edible veggies. You would need to buy many many pots and bagged soil or at least build an above ground soil bed. That costs and takes time.

Regarding money, while inflation will kill the value of cash metals are no that liquid. Yes they can be sold but you have to shop around for a good price. You never get spot value. And that takes time. Land is even worse. Selling can be hard in a bad economy. Even a loan on the equity can be hard to get and time consuming (not to mention the costs). You can't take an acre to the store to buy milk.

ps- I'm with the gold bugs. This nation's economy is spiraling down the crapper while Nero, I mean Obama, laughs on TV. The end of Rome is at hand. Never thought it would happen, especially in my life time. :-((

[Rod Ferguson]

Apex - I apologize. In the link posted at the beginning of the article that points to an article I wrote last year on inflation in general, you should see that price and wage inflation since the 70s has been pretty high comparative to the centuries prior. In that article, I measured inflation rates from the beginning to the end of a decade for simplicities sake; the period I'm generalizing as "the 70's inflation" is actually from 1973 to 1981. Using that period, we had wage inflation of approximately 96% and price inflation of approximately 95%, cumulative. Since prices almost always rise before wages, going from 1% to 10% or more was a shock - as wages hadn't 'caught up' with the inflation. Since 1994 (when the inflation rates began to pick up steam again) we've had wage inflation of approximately 47% and price inflation of approximately 53% (I haven't yet integrated any 2008 data, so those numbers might be off when finally do integrate them.)

If we have a 7% (or 15% under the old accounting) yoy rate of price inflation and our wage inflation stays at the 'historical' few percent below that we're going to feel the effects of inflation much more severely than we have in the last decade or so. Bear in mind that wage inflation calculations are not adjusted through any sort of model like the CPI is - it's just average wages across the population. 7% or more price inflation using the current CPI plus that 5 or so percent lag in wages brings the 'shock factor' in line with what we went through during the 70's inflation period until wage inflation (hopefully) catches up.

[Rod Ferguson]

MasterPo - true about the soil quality. That's why you get a soil test done to find out what you need to do to it to make it ready to produce food. I'd imagine that an urban gardening co-op would have gotten some dirt that wasn't going to produce poisonous food already. At least, I'd hope they would.

I haven't crossed the line into being a bug of any sort, I think.. yet, at any rate. I don't believe we're going to collapse as a civilization or anything so Mad Max. Enough nations have gone through this recently to prove to me that something like the Dark Ages is highly unlikely. It'll hurt, and we're not going to be happy as standards of living will drop, but people will still work and trade will still occur. My goal is to try and "weather the storm" and come out on the other side not being a pauper. Right now that means metals and land, if history is any guide. In 5-10 years, that might mean stocks and bonds or even cash. As Mike said - you have to keep your eyes open and not be afraid to make decisions that go against the common wisdom.

[Apex]

The numbers in your comment make sense to me. What doesn't is this CPI off by 8% number. If that is true then shouldn't the numbers from 1994 on be more like 200-300% instead of 47-53%? Or are you claiming that the 8% missing from the CPI only occurred in the last couple years.

Perhaps you could expound upon how you determined the CPI is missing 8% of inflation, what changes were made to make it miss 8% and when or over what time period this change crept into the CPI.

[Rod Ferguson]

Apex:

http://www.shadowstats.com/alternate_data

John Williams creates current charts based on old models, and overlays those charts with the official numbers. The closest we got to 70s style inflation was last year, for about 6 months - which while was nerve wracking, didn't really last very long. If you look at the data for unemployment (his chart re-introduces the "discouraged worker" metric eliminated under Clinton; people who have simply given up looking for a job because none are available) you'll see the unemployment rate at about 19%, compared to the official U6 of 13% and U3 of 8%. You can accept his numbers or not as valid today, but when doing apples-to-apples research, it's good to use the same model for both periods you are looking at.

As for why the numbers changed, please refer to another article I wrote last year:

http://www.freemoneyfinance.com/2008/06/inflation-and-i.html

The percentage difference has risen sharply since 1994; from 1983-1994, the difference was only 2%, but 1994 to now, it's nearly 8%. You also have to remember that gradual inflation is less noticable as wages will rise to meet that inflation. It's the shock of going from a few percent to double digits in a short time span that creates panic (i.e. - CPI rose 5% from 2007-2008, which was the period where people began noticing it) With our current low of .2% (or 7.8%), if we jump right back up to the mean, that will be a huge shock to people - and with the Fed monetizing debt, once that money enters the general economy we could see a parabolic spike.

[Apex]

Thanks for the links and explanation. I have read both your previous article referenced above and the shadow statistics site you link to (I am familiar with that site).

In your article you mentioned 4% official number in June 2008 versus 12% shadow number and ask which feels more accurate to you. I can say without doubt the 4% number. I see very few signs of high inflation in the past decade. Most things I buy seem to stay fairly stable or get cheaper (except for the last few years of energy and food and persisten inflation in health care and those things definately found their way into the CPI over the last couple years).

The shadow chart on the page you link to above shows real inflation running from about 10% in 1999, dropping to 7-8% in 2002 and back up to 13% in 2008 for an average of about 10% over the past decade. If inflation has been running around 10% for the last decade we would have to see wages increase more than 2 1/2 times just to keep up. Wages instead have increased very little. Does anyone really feel like their dollar buys 40 cents of what it bought in 1999 while getting very little increase in wages?

That certainly isn't my experience. I bought Blue Jeans for around 30 bucks in 1999, still cost about 30 bucks. Shirts about the same. Cars up a little, computers way cheaper, TVs way cheaper (and the new plasmas and LCDs are a totally different item and they are getting drastically cheaper too). Cell phones cheaper, long distance service way cheaper, cable a bit more expensive, health insurance a lot more expensive, but my portion while it is going up is not going up as fast as the inflation portion which I do admit is a problem, entertainment slightly more expensive, fast food not much increase, more expensive restaurants larger increase but not horrible, rent hardly any increase at all (I rented a 2 bed 1100 sq ft apartment in 1998 for 1050.00 in a Minneapolis suburb. The exact same unit in the exact same complex rents for about 1150.00 today less than 1% increase per year) ..... but other than health care, where is the 2 1/2 times increase in costs that 10% inflation over 10 years would create.

I wanted to give you a chance to explain your view but just because some site puts up shadow charts doesn't mean anything. I challenege you or anyone here to show me how you get to 2 1/2 times increase in the cost of living over the last 10 years. I feel quite confident no one can come anywhere close to doing so and while its easy to throw out 12% inflation numbers and have people not realize what that means, when you do the math and realize that 10% inflation for 10 years means that you would need 2 1/2 times the money to buy the same things you bought 10 years ago I think most people would agree that is a grossly inaccurate view of what people have experienced the last 10 years. People may be behind where they were 10 years ago due to mostly stagnant wages but even people who feel squeezed I think would be hard pressed to indicate that their costs went up 2 1/2 times since 1999.

Stagnant wages and 2-4% inflation would be painful. Stagnant wages and 10% inflation would be unbearable, you would be straight in the poor house. How could most of America have experience very little wage growth and have their costs go up 2 1/2 times across the board on average? You could argue the negative savings rate is helping to deal with this but I would argue that is representative of over consumption combined with stagnant wages and modest inflation. You can't get from 5% savings to negative 1% savings and use that to account for a 2 1/2 times increase in costs. You come up way short.

I too believe inflation is coming but I fear an actual increase in costs, not just a shadow chart that attempts to tell me that my wallet is a liar.

[Mike Hunt]

Apex,

What about food prices at the grocery store? That has increased quite a bit, and feels like a dollar doesn't take you as far there.

Health care has also gone up quite a bit and so has education / tuition. Relentless price increases there.

-Mike

[Apex]

Mike,

I mentioned food and energy at the top of my post. Those have definately gone up in the last few years as the commodity bubble spiked. I also specifically mentioned persistent inflation in health care. You are correct that I left out education and I should have mentioned it because it's inflation is high.

I don't deny that there has been inflation and even high inflation in some isolated categories (health care, eductation and in the last few years food and energy)

However even those categories where inflation was high are barely able to meet the 10% numbers that are being argued for here and they are just a small portion of most people's total costs.

Energy is now coming drastically back in price (although it could easily go back up again if the economy gets going). Food is likely to stagnate in price here for quite a while as agricultural commodities have come way down but that doesn't usually quickly find its way back into food prices so I expect food to be flat for a few years.

If you account for 10% inflation in health care and some recent high inflation in food and energy, when you add that to the lack of inflation in nearly every other category, you come up with the more reasonable 2-4% inflation that has been reported over the last decade.

My point was that with 10% inflation people's budgets would be such that they would spend 2 1/2 times what they did in 1999 to buy the exact same basket of goods today. Do you feel this is remotely close to reality for you? Just to put dollar terms on it, that means if you had to spend $40,000 on living expenses in 1999 you would have to spend $100,000 today to get the exact same level of living. I know that my experience is nothing like that.

[Rod Ferguson]

Apex - sorry, I meant to respond yesterday, but life reared its ugly head and I had to engage it.

As I stated, when comparing time periods, it's best to use the same models or you do not get an accurate comparison; John does a good job of recalculating using the old models. Also, I'd appreciate it if next time you are "confused" about where I get a number from, but you already know where that is, you'd just ask if that's where I'm referencing.

The big problem with trying to nail down inflation to the price of certain things is that the price of those things will not always follow the general inflation rates. Eggs, for example, have increased on average about 175% since 1999 (US average $1.08/dz in 1999, now $2.89/dz - and down from about $3.50 a dozen last year). Gasoline has risen 65% (US average $1.22/gallon in 1999, now 2.01 - down from about a $3.90/gallon average last year). Yet, aside from one month last year, we have had consistent inflation regardless of whether or not you use the old model or the new (a .2% or 7.8% increase is still an increase, not a decrease.) And, BTW, those 2008 highs happened right about when I wrote that article, so - at the time - we were seeing 200-300% inflation in things like eggs and gas compared to 1999 and it felt, at least to me, a lot more like 12% yoy than 4% yoy.

I've said before that I believe inflation is an effect of money creation. Many of the dollars created never make thier way into the general economy. They "sit" in foreign central banks, foreign companies, the hands of private investors, etc. But just because they haven't made an entrance into the economy doesn't mean they won't.

Having said that, I can tell you why we haven't seen the 247% COLA increase. A large portion of our lack of "perceived" inflation comes from our importing pretty much everything we use from (relative) low-cost countries (one of the ways our dollars get into foreign hands.) Toss in our reserve currency status (people trading dollars in international trade, which means a huge demand for them) and you have a great inflation management model. Take those retail imports out of the picture and you have a slightly different story; gold has risen about 350% since 1999. Silver as well. Copper is up over 400%. Even a barrel of sweet, light crude has risen 400% and a bushel of wheat has risen over 50% in the last decade - and those numbers are off thier highs of last year. But, from a retail standpoint, we massage the numbers with substitution and toss in some hedonics and everything looks fine (but ignore the man behind the curtain.)

The point of this article was to share some of the steps I've taken to protect against something I believe is going to happen. If you disagree with my methodology, then don't follow what I've done - do what you feel you need to do or do nothing at all.

[Apex]

Rod,

I appreciate your continuing to engage on this. I didn't know you got your stats from the shadow site. And I didn't know intimate details about their site. I mostly know of them with respect to Money supply and unemployment, rather than CPI and I also know there are others who feel the CPI is artificially low so I was curious which source you were basing it on. It wasn't a trap, I just wanted to understand what the calculations were based on.

I would like to comment on a couple things that tell me we might be talking about different things.

You say the following above:

"I've said before that I believe inflation is an effect of money creation. Many of the dollars created never make thier way into the general economy. They "sit" in foreign central banks, foreign companies, the hands of private investors, etc. But just because they haven't made an entrance into the economy doesn't mean they won't. "

When I talk about inflation I am talking strictly about price increases. What you are talking about above is something I would classify more as potential pent up inflation. I agree that is a possibility and could lead to higher inflation down the road. I just wouldn't classify that as inflation now.

You also mentioned that we have been able to keep prices down by importing cheaper foreign goods. I agree. Along the lines of my definition of inflation being an increase in prices that is perfectly fine. That game may run its course and no longer work and when it does then you get potentially large inflation but for the time being in people's lives based on their paycheck, I can't classify it as inflation just because the goods came from somewhere else now (isn't that the point off trade?) To the consumer it doesn't matter, their money still goes a long ways but if you calculate inflation by something less concrete than prices then I am not sure what it means to say that the dollar is worth less than half of what it was when the prices you pay show it to still be worth 80% of what it was.

So perhaps we are not talking about the same thing. Perhaps what you are talking about bodes poorly for the future. In that respect your post might be even more relevant as far as preparing for the future. And it is true that this discussion of current inflation is not something you specifically were trying to address in your article and more of a tangent that my questions got us off on to which was not my intention, my intention was only to find out what inflation you expected. The tangent occurred because knowing that you were couting inflation as 8% higher than reported made it unclear to me what level of inflation you are expecting and actually made me think maybe the inflation you are worried about is not so bad if you are talking about numbers not much higher than currently reported due to them being too low.

I think we actually mostly agree on what might be coming. We just seem to have potentially different views on what we have recently been experiencing and how to measure it. My concern is a real increase in prices across the board that does make 100K today worth only 40K in 10 years as far as what I can buy when I go to get all the stuff I need to live and that is something I hope doesn't happen.

[Mike Hunt]

Hi Apex,

I think in 2008 inflation seemed worse because of the housing and commodity bubble that was going on - and was exacerbated by the Fed keeping rates low at the time in the face of rising prices. Today housing is cheaper, rents are cheaper, consumer goods are cheaper, labor is cheaper. We are experiencing big deflation. Electricity still stays high as do education & health care, although they will eventually succumb to deflation. Gov't spending doesn't appear to be in deflation, especially with Mr. Obama in charge!

When the gov't reports inflation it usually understates when prices are rising. That's because their calculation includes the hedonistic deflator (meaning that if the speed and storage capacity of a computer goes up by 10X and the price only goes up by 20% then the gov't treats the computer as something that should cost 10X more). The hedonistic deflator is nonsense because even though technology gets better you don't have a choice to go back. Like try using your old TI 99/4A from 1980's to do anything- it's useless. So there is some mis-reporting going on.

The other mis-reported factor is called the substitutive effect, meaning when prices go up people get hamburger instead of steak so that way they adjust for rising prices. Doesn't take into account that hamburger is less satisfactory than steak.

Lastly I think the gov't excluded housing in the inflation calculation, that provided a big effect during the bubble years.

That is why shadowstats are more useful- they don't use these elements in the calculation.

In a deflationary environment I would think that the gov't understates deflation as well mainly because of housing.

Hope this makes sense to you. Let me know if you think otherwise.

-Mike

[Apex]

Mike,

There is some adjusting to the govt numbers that people can dispute. I accept that. I certainly don't hold them out as some kind of gospel truth. Some of the points you make are certainly valid concerns. I am not experienced enough on the adjustments to comment definitively on how much impact those numbers have, but I accept that its not zero.

As to housing the inflation numbers don't use house ownership but owners equivalent rent. I think this makes sense for three reasons. One is housing can be very regional and due to drastic changes in certain regions where supply is tight. Secondly the price of a house is not really how 98% of people experience the cost of owning a house. Their cost is mostly associated with what their monthly payment is. When the interest rate comes down so drastically that allows the same salary to afford a much more expensive house. When you calculate the cost of a house over 30 years, a 100K house @10% interest might cost you 500K where a 200K house @5% interest might also cost you 500K. So what is the real cost of the house. Thirdly anyone who buys has the option to rent and its a more accurate guage of the marginal cost of shelter.

What I very much dislike is people who were in favor of owners equivalent rent when house prices were rising who then want to argue things are getting cheaper because house prices are falling and they then want to move away from owners equivalent rent. No, if the measure is owners equivalent rent you stick with that through booms and busts, and I think its right.

As to the adjustments, my personal experience doesn't support the concept of any real concerning inflation until the last few years. Housing was a bubble and the rent rates show how out of wack it was. The cost of housing was not greatly increased, just the cost of buying a house which was driven by rampant debt and speculation, its slowly readjusting. Energy and food were real and will stay higher than in the past and might go even higher again. But as I said so many other things got so much cheaper. In 1991 I bought a computer with 1/50th the speed and 1/50 the memory for 3600 dollars, today I can buy the one that has 50 times more meory and is 50 times faster for 800 dollars or less. So adjusting for hedonics or not, its just way cheaper. And many other things show similiar effects or stagnant effects. We can all point to food and energy and those are important because we all need them, but except for those on bare subsistence, they are a minor portion of our budget, not a major portion.

I just keep coming back to my money example. If I needed to spend 40K to live in 1999 how much do I need to spend today? 50K? 60K? Perhaps, but certainly not anywhere near 100K. Thus as I observe it, inflation in real prices for real goods that I buy has been in the ball park of what the govt numbers indicate.

Thats all I am trying to say.

[Mike Hunt]

Apex,

Fair enough. Are you living the same standard today as you were in 1999? Better or worse?

Actually I need less to live comfortably now then back in 1999 but that's because I moved overseas and own my fully paid place vs renting.

I agree with you that if there is one metric (owners equivalent rent) then that should stay in place. However during the boom property taxes did rise thereby increasing the monthly payment - should adjust OER upwards.

-Mike

[Apex]

I am living in the exact same house in the exact same location and living I would say a similiar standard of living (I would say my standard would be higher than 1999, if it wasn't for the addition of kids which has increased my costs) And my salary has increased from 75K to 100K in that time so I also think that is in line with govt reported inflation. Also my property taxes are basically flat over that period of time, maybe a slight increase but less than increase in my salary and in general inflation.