Devaluation

Last week, theUS Dollar Index finished lower in what was a pretty good week for markets in general.

It’s important to keep in mind that the US Dollar Index measures the purchasing power of the Dollar relative to the purchasing power of the currencies of the six major trading partners of the US.  It does not measure absolute purchasing power.

And, that’s the point I want to make this week.  I want to discuss absolute purchasing power but from a slightly different perspective than I have previously.

Past RLA Radio guest and economist John Williams does some work in this area.  He tracks economic data using methodologies that have been used in the past.  As many of our longer-term readers understand, as time has passed, the tracking and reporting structures of the most followed economic data has changed.

Unemployment levels and the rate of inflation were calculated differently in the past than they are currently measured.  Not surprisingly, current calculation methods make the reported economic data look more favorable.

Since our topic for this week’s issue is absolute purchasing power, we’ll focus on comparing how the official rate of inflation is calculated now versus 30 years ago.

According to Mr. Williams’ website, www.shadowstats.com, the official inflation rate is now about 2%.  But, when using the 1980- based inflation calculation, the real rate of inflation is just under 10%.

The chart on this page, courtesy of Shadow Stats, illustrates.  (www.ShadowStats.com)

Looking at this chart, the current Consumer Price Index of about 2% is between 7 and 8 percent lower than it would be if the 1980-based calculation methodology was used.

Over time, that creates a huge disparity between reported inflation and the real inflation rate which we all feel when we buy things.

Let’s just go back to the beginning of this century and look at the official CPI each year.  This CPI data was taken from the Minneapolis Federal Reserve Bank’s website ( https://www.minneapolisfed.org/community/financial-and-economic-education/cpi-calculator-information/consumer-price-index-and-inflation-rates-1913).

By my calculations that is an average annual inflation rate of 2.19%.

While this next calculation is not scientific, it does give you an idea as to how the official inflation rate compares with the actual, real-world rate of inflation.

Assuming an item cost $1 in 2000, based on the official inflation rate, that item should cost about $1.50 today.  To be exact, $1.51.

That means an item that one would have purchased for $100,000 in calendar year 2000, would today be $151,000 based on the official, reported inflation rate.

Now, let’s look at reality.

A base model Ford F150 pickup in calendar year 2000 was listed for $15,520.

Today, a base model Ford F150 pickup lists for $28,495.

If the price of the new pickup had tracked the official, reported inflation rate, the new pickup should sell for $23,435.  But, that’s not the case.

According to the US Census Bureau (https://www.census.gov/construction/nrs/pdf/uspricemon.pdf) , the average home sale price in 2000 was $163,500.  The median price was $200,300 which simply means that half the homes that transferred ownership in 2000 sold for more than $203,000 and the other half below.

Fast forward to the present time.  The average home sale price today is $299,400 and the median home sale price is $362,700.

Had home prices tracked the official, reported inflation rate, the average home sale price today would be $246,885.

There are many, many examples of this disparity that I’ll call the reported vs. reality gap.  Many are more extreme.

The point of this discussion is this:  the official inflation rate is really just the official US Dollar devaluation rate.  It’s the official measure of the loss of purchasing power of the currency.  The reality is that the real loss of purchasing power exceeds the official, reported rate by a good measure.

The reason the US Dollar Index is not a good metric to use to determine the purchasing power of the currency is that, as we stated above, it is a relative measure, not an absolute measure.  Nearly every country in the world, is devaluing its currency.  The US Dollar Index just gives you an indication as to whether the US Dollar is being devalued faster or more slowly relative to other fiat currencies.

The monetary policies being pursued by central banks presently will accelerate this devaluation process.  As we have stated in this newsletter many times before, there are only three ways to deal with sovereign debt; raise taxes, cut spending or print currency.

The latter is the policy du jour of world central banks.

As debt levels continue to build beyond any level that could ever be paid through raising taxes (which is where we are presently), the remaining two choices will lead to outcomes that are flat-out ugly from an economic perspective.

Cutting spending leads to an economic deflationary period. 

Creating more currency eventually leads to a loss of confidence in the currency.  When that occurs, history teaches us that the debt gets redenominated and an economic deflationary period sets in.

I shared the Thomas Jefferson quote with you a couple of weeks ago.  Jefferson warned that allowing bankers to control the issue of the currency would lead to inflation and then deflation.

This has been the case many times throughout history.  From John Law’s France in the early 1700’s, to Weimar Germany after World War I, to Zimbabwe more recently, the end result of this policy is predictable.

It’s difficult to make any argument to the contrary.  The outcome is certain.  When it will occur is not.

That’s why I suggest that readers consider tangible assets in their portfolios to hedge against this continued dollar devaluation that is likely to accelerate. 

Tangible assets are a critical element in the two-bucket approach which has an investor divide her money into two “buckets” of money, with the assets in one bucket invested to protect from a deflationary event and the assets in the other bucket invested to protect from an inflationary event.

As time passes and debt builds, I believe this will be critical to financial success.

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