Friday, December 16, 2011

Haves, Have-Nots Both Losing To Inflation

In 1971, a U.S. Army private's basic pay was $3,936 per year. Today, a private's basic pay is $19,739.  When adjusted for inflation, the 1971 Army private was paid more than his modern counterpart. 

Today, one gallon of gasoline costs 10 times more than it did in 1971. After adjusting for improved average automobile mileage rates, fuel per mile driven costs five times as much as it did in 1971. 

The U.S. Bureau of Labor Statistics recently released a chart showing that the purchasing power of $1 in 1971 has decreased to a mere 18 cents today. The dollar went off the gold standard in August 1971. Inflation is the cause for the dollar's devaluation.

People don't readily realize the withering effects of four decades of inflation because habits change and comparable goods aren't always available.  For example, television has changed drastically.  You cannot compare a 1971 tube-type color TV to a 2011 high-definition, flat screen TV.  Home video recording was not available in 1971.  Nor were programming packages with 100+ channels.

Fixed base, rotary dial telephones have evolved into cellular phones. The personal computer did not exist 40 years ago. Medical technology — the MRI scan for one — also was impossible before the silicon chip. And GPS satellites have replaced paper road maps to direct motorists to their destinations.

Automobile costs are hard to compare.  On one hand, modern autos are a bargain when it comes to routine maintenance such as replacing tires, brakes and batteries.  On the other hand, the cost of repairing a fender bender can easily total a modern car. 

There are many comparables that have not changed.  Jack Daniels whiskey is one. Disposable diapers are another. Anything made with 100 percent cotton. Aspirin. An 8-pound sledgehammer. One food economist recently calculated that Thanksgiving dinner with all the trimmings would cost 13 percent more this year than in 2010.  Plywood, framing lumber, copper wire, pipe and concrete are pretty much the same although new houses are generally bigger. Amenities and furnishings have changed, but a one-bedroom apartment is still a one-bedroom apartment.

Over the decades, the Department of Labor has collected a tremendous amount of data while tracking the prices of everything we buy.  The bean counters at the DOL face obstacles in determining the "market basket" of goods and services on which to base the Consumer Price Index.  Sometimes, the CPI calculation can overstate inflation.  If Brand X, a market basket staple, goes up in price, the consumer may very well switch to Brand Y, which sells at a cheaper price. Compiling the CPI also misses coupon shoppers and special sales. 

The CPI market basket includes food and fuel.  Due to their "weight" in the basket, an increase in either cost can ratchet the CPI upward very quickly. Elected politicians do not like this, especially in an election year. Since 2000, our government has relied more and more on the Federal Reserve Price Consumption Expenditure, or PCE, index to measure inflation. The PCE does not consider "core inflation," better known as food and fuel. 

Despite its own shortcomings, the CPI is useful and more relevant to everyday living than the PCE. 

In my opening example using an Army private making $3,936, he would need $22,000 today to stay even with inflation. His high school classmate who took a construction job at $8,000 per year would need $44,725 to stay even.

In 1971, the contractor made twice what the soldier did. In 2011, he still makes twice as much. But look how the gap in nominal dollars between the two has grown from $4,064 in 1971 to $22,725 presently. 

Year after year for 40 years, inflation has clawed away at an annual rate of 4.5 percent. Through pay raises and COLAs, wages have increased to try to keep up with inflation. But as you can see, the compounding effect of incremental percentage increases has led to the wide gulf in nominal dollars between the private and the contractor.

The populists' view of the inflation indexing phenomenon has led them to see America as a nation of haves and have-nots.  In reality, however, wealth measured in inflation-devalued dollars becomes an illusion of wealth. Even the haves are falling behind.

Next year, it appears that both political parties will gin up class warfare rhetoric to win elections.  I hope that the American people will have the good sense to realize that inflation is the enemy, not the haves who resist tax increases or the have-nots who want more income redistribution.