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Inflation, Lies and the Big Mac Index (BMI)

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It's no secret that I'm obsessed with inflation, rising prices and devaluing dollars. While inflation is bad enough when it's out in the open, the ill effects of inflation are even worse when they are covered up and lied about by public officials. Prices rise, wages stay flat. Taxes originally intended for the ultra-rich fall on wage-earners. Stock portfolios balloon, but their buying power deflates. This problem isn't new; even the Old Testament has something to say:

"The Lord detests dishonest scales, but he delights in accurate weights." -Proverbs 11:1


A more modern take:

"Don't piss down my neck and tell me it's raining." -Alabama hog farmer


Lie #1. The Dow advanced 17,320% in the 20th century.

In one of my favorite examples, Warren Buffet says the stock market is a great deal in observing this:

"The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions."

What he fails to mention is that, corrected for inflation, the gain was 874% (~2% annual gains), so about 16500% percent of that "staggering" gain is bluster. Even worse, you're still on the hook for big capital gains even though most of those gains were inflationary. Long story short, if you're not getting paid dividends, you're not making any money.

Dow-inflation.png

Lie #2. Inflation is under 2% right now

Ben Bernanke, who has every reason to understate inflation by as much as possible, tells us that he has the best postwar inflation record.

By combining such things as "hedonics" (the science of saying something got cheaper when the price went up) and substitution (where the price of beef doesn't mean anything because people can eat dog food), Bernanke has managed to publish a great-looking Consumer Price Index (which has nothing to do with consumers or prices).

Well, anyone who has bought anything in the past ten years knows that prices aren't stable.

So who do you trust?

b2ap3_thumbnail_Big-Mac-2010-ad.jpg

In this very specific case, I trust McDonald's. Cost-cutters extraordinaire, they pay the cheapest people to make the cheapest food on slim margins. If the price of sesame seeds goes up, it will show up in your price. There is very little padding.

So say hello to the appropriately named BMI, or the Big Mac Index, what I consider a very accurate competing measure of inflation. The chart below shows how real prices have diverged from the official CPI stated inflation since 2002.

Big-Mac-2.2.png

While the CPI tottered along at around 2 percent during this period, the BMI grew at 5.4% compounded annually. Price gouging? No, the price of food, fuel and labor have all gone up, and the BMI is reflecting the cost of what it takes to get two all beef patties on a sesame seed bun to market. What do you trust, numbers on a government spreadsheet, or the actual cost of goods and services?

Lie #3. Gold is the only protection against inflation

Lots of people talk about gold as the perfect inflation hedge. I'm not convinced.

It was touted as the perfect inflation hedge 30 years ago, when prices were approaching 800 dollars an ounce. Then prices hit a 20 year trough, and they didn't recover until only a few years ago.

Austria100Corona.jpg

Yes, gold is an inflation hedge, but so is pretty much everything besides money and debt. The problem is that gold has a glowing reputation as an inflation hedge, so money floods into it when whispers of inflation grow louder. This makes the price skyrocket. While a Big Mac hasn't quite doubled in price since 2002, the price of gold has gone up by a factor of eight.

Buying gold during tough times can benefit buyers tremendously, but should stability return, prices will again resemble the cost of production. So, if you do buy gold, beware that the price won't go up forever and ever. Gold is sensitive to inflation, and responds more strongly to high or low inflation than other assets simply because of its reputation.

I think everyone should own gold and silver, and use it as money, but people should keep in mind that owning property, money producing assets (anything from factories to vending machines) and durable goods are all hedges against inflation. The only thing that is totally unprotected from inflation is cash and debt.

 

 

 

 

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Richard is an engineer by day, and a political activist by night, fighting would-be totalitarians and government busybodies everywhere.

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