Inflation is a Situation

Have you guys been keeping up with the Archegos crash? That looks like an absolute nightmare. Everyone believed Archegoes was solvent as well but the second there was any miscalculation, they lost everything. Worse, the banks were left to squabble over who had to incur the losses. Credit Suisse took a 4.7 billion dollar hit while Morgan Stanley got to sell 5 billion of their position before it all came crashing down. Sound familiar?

The United States could be the next Archegos or at least it is positioning itself to have a similar crash. There is a lot of evidence that suggests America is overleveraged and hiding it with an inaccurate inflation metric. This time, however, we might not be in a position to bail ourselves out of the bext bust. Read on to see what research and conclusions I’ve come to regarding the American economy. Please respond if I have it wrong. As I said, I’m far from a Ph.D. in macroeconomics.

When The National Debt Looks Like Gamestop Stock

America has a history of keeping its economy running by issuing debt. It is currently printing trillions of dollars in stimulus and has done so consistently for decades. As a result, the value of the United States is becoming more and more beholden to its debtors. Luckily, the American dollar is still the currency that foreign governments are trading with, but, at some point, we’re going to have to pay back our debts instead of just raising the debt ceiling and borrowing more money whenever we run out. Otherwise, the dollar will start to lose its value as foreign investors realize the US will have no choice but to default. We have to stop printing and spending so much money or else the below graph will become worse.

The Real Problem

When I spoke to a more financially fluent friend of mine, he quickly pointed out that my logic is not sound because the Millennial generation has yet to experience any real inflation. If we can manage inflation, then we should be able to stay on our repayment schedule. In other words, if the Consumer Price Index(CPI) hasn’t gone up, America will be fine because the purchasing power of Americans will make up the difference in debt. Therefore, America is doing fine. Sure, our debt is going up, but we are paying it off with the wealth we are creating. Everything will be fine. There definitely is some merit to that argument. It could be the case if we are to beleive our politicians.

Upon further inspection, however, I discovered the number might be, at best, misleading. When I looked into the Consumer Price Index and how the number is calculated, I came across something that was worrying. Inflation might be much worse than the US currently calculates because the United States has not been consistent in its calculation of CPI since the 1970’s. They are miscalculating CPI to make inflation look smaller. In this Youtube video, George Gammon walks through how the Fed changed the way they calculate CPI to make it look as though the US has statistically deflated their inflation number. The problem is the American people don’t actually get the truth.

What it basically comes down to is prior to 1980, the United States calculated their CPI by generating a cost of goods index(COGI). This was the difference in price a consumer could expect to pay for the same exact set of goods or services over time. For example, if, in 1970, Crest toothpaste cost 2 dollars, and in 1972 it cost 2 dollars and 20 cents, the COGI would be 10 percent. This would lead to an inflation number of 10 percent.

Starting in 1990, however, the United States shifted its methodology away from COGI towards a cost of living index(COLI). The difference was pretty simple, and sneaky. Instead of measuring the change in the price of the same goods, the government started measuring how expensive it would be to buy any version of that good. In other words, if a bottle of Crest toothpaste went up from 2 dollars to 2.20 but the store had other brands of toothpaste you could buy for 2 dollars, then the government basically says that the cost of living has stayed the same, even though the cost of goods went up 10 percent. According to the COLI number, inflation is at zero. This is how the government has been able to report a low inflation rate for so many years while simultaneously raising the debt ceiling and printing money like crazy.

Take a look at these two graphs from shadowstats. One shows the CPI relative to inflation based on the more recent COLI methodology, the other shows the older COGI number.

As you can see, with the COLI number(top photo) you can see that the inflation rate is and has remained steady at about 2% since 1990. But, if you look at the COGI(bottom photo) you can quickly see that the inflation rate has been much higher at around 10%. 

Peter Schiff a popular financial analyst, in a speech he gave back in 2006 predicting the crisis of 2008, had this to say about the CPI:

Our inflation rate is so low it compared to what it was in the past. One of the reasons for that, and probably the primary reason for that is the way the government has changed the way it keeps score. Back in the 1970s, they took housing prices out of the CPI. When we had that high inflation housing prices were in there. They’re not in there now.

In the mid 1990s, they introduced the concepts of  hedonic adjustments and substitutions, which basically rendered to CPI worthless because the government can do whatever they want with it. You know, if a price of something went up, they don’t have to count it. It’s not a fixed basket anymore. And there’s a lot of subjectivity in there where the government can take a look at something and say, well, the price went up 20%, but we think it’s 30% better. So the price went down 10%. There’s a lot of subjectivity that’s in there now that wasn’t in there back then. So when you just look at these numbers, and so there’s no inflation, I mean, that’s, you know…It’s like a government weatherman is telling you that there’s sunshine, but you look out the window and you can see that it’s raining. I’m not going to believe the government. I’m going to believe my own eyes.

Be Careful What You Believe

In any case, there is a rather strong case to be made that Americans have been misled about the reality of inflation and their relative wealth. Since 1990, the government has changed the way they calculate inflation to purposefully exclude price increases in products. Instead, they’ve chosen to use the cheapest standard of living in order to argue inflation is nothing to worry about. Unfortunately, I fear the opposite could be true and America could have another big economic fallout in its near future. 

This is why I fear the United States could follow in Archegos’ footsteps. Just like Archegos, America is highly over-levered and misleading about its actual financial health. Is inflation actually much higher than we assumed? 

The CFPB has also banned foreclosures until 2022. If enough people default and banks cannot collect mortgage payments, will we see another housing bubble burst? The aforementioned data would make me think we might be in that situation. What do I know, though.

Thx and stay tuned for some more economic and housing related articles!


1 thought on “Inflation is a Situation”

  1. Great article, I was just talking to a friend of mind about CPI and he had a similar critique. Hard to believe inflation is of no concern (or minor concern) when asset prices continue to climb at a fever pitch.

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