June 26, 2008
The other day, on MarketWatch, a headline read, “Markets hope strong inflation warning from Fed in Wednesday statement will keep dollar firm as growth slows, delaying or eliminating need for rate rise later in the year.” I’ve read similar headlines too numerous to count in the past couple of months spinning the same false hope. If the best weapon the U.S. Federal Reserve has right now in their arsenal to keep the U.S. dollar afloat and to check rising commodity prices is mere words versus sound structural actions, then indeed we are in deep trouble.
Several years back, U.S. Federal Reserve Chairman Alan Greenspan stated that the economic behavior of rising prices was the same as the debasement of currency. Not similar, not spurred by, but the same. Today we have all kinds of voodoo economic analyses that try to attribute rising prices to everything but its primary cause — i.e., ethanol production causes higher corn prices, bad weather and lower crop yields cause higher food prices, oil speculation causes higher oil prices. Basically whatever reason the think tanks can conjure up today to distract the masses from the real cause of rising prices seems to show up in newspapers and TV tomorrow. Sure, the above reasons undoubtedly contribute to rising prices, but they are not the primary reason nor do they constitute the greatest component of rising prices worldwide.
Just last week, as I was traveling on business, I listened to the TV in the background of my hotel room one early morning as I prepared to start my day. As I was getting dressed, I heard a reporter reference a government finance official in the U.K. that was pleading U.K. workers not to ask for wage increases because he stated that such a widespread request across the entire country would create even higher prices. When I heard this statement, I literally laughed out loud. I thought to myself, “Is it really that easy to fool an entire nation with such a ridiculous notion these days? Rising wages is what creates inflation? Really?” The reality is that rising prices act as an invisible tax upon the wealth of a nation and is caused primarily by currency debasement.
If you are a worker in the U.K., ignore such nonsense and ask for a wage increase that is at a minimum, comparable to the true rate of inflation in your country. In fact, it is probably best if you tack on an additional 2% to the current real rates of inflation when you ask for your raise, because inflation is not only likely here to stay and but the grave problems in the global financial system predict that they are also likely to get worse. If you don’t ask for a wage increase, then know that you are willingly allowing the Bank of England to create a lower quality of life for yourself. Furthermore, know that any wage increase that your employer may give you that is less than the real rates of inflation will also erode your wealth (For example, if your employer in the U.S. presents you with a 3.5% cost of living adjustment increase to your salary, know that this increase has just made you poorer. But more on this soon). So this brings me to the all important title of my article: “The One Question That Will Have the Greatest Impact on Your Financial Future.”
Here it is : “What is the rate of inflation in my country?” Now bear with me. I know this sounds boring, but if you truly care about the state of your financial health as this global financial crisis progresses, you must finish reading this article.
Now it is not necessarily the question that is so important, but the response to this question that is the most important component. To arrive at a response to this question, do not unfailingly accept your government’s officially reported inflation statistic as the correct response, because this would be a mistake. In most countries, your government will purposely underestimate, and at times, grossly underestimate this statistic. To begin the process of uncovering the real rate of inflation in your country, begin with the discovery of what government entity is responsible for determining inflation. For example, in the United States, the Bureau of Labor Statistics is responsible for determining the Consumer Price Index (CPI). Once you discover this information, then search online for a website for this bureau, and having uncovered it, search for the inflation formula. In the U.S., the website for the Bureau of Labor Statistics is http://www.bls.gov/CPI If you cannot find this information online for your particular country, then call your government office and ask someone to provide the inflation formula that is used to determine the officially reported statistic. This formula is not top secret information, or at least it shouldn’t be, so any government office should have no problem providing this information to you if you can’t find it online.
Now back to our U.S. example. At the official website for the Bureau of Labor Statistics, with a little digging in the fine print, one can uncover the multitude of changes to the CPI formula that the U.S. government has made over the years. In fact, the U.S. government has altered the CPI formula so radically just within the past couple of decades that it now bares no resemblance to the formula that was used during the pre-Clinton years. It does not take a genius to determine the reasons for this radical alteration. Why should the formula that is used to determine inflation today be so different from the formula that was used 20 years ago? Math is supposed to be constant unless a new universal law is discovered that changes the foundation of past principles that were once believed to be true. If today you were given a problem and asked to find the mean, the median, the t-squared statistic, the correlation coefficient, or the derivative, the answer today would be the same as the answer from 20 years ago, 50 years ago, or even 100 years ago.
The answer would be the same because the formula one would use to determine the answer would be unchanged over time. Likewise, the formula used to determine inflation should not have radically changed unless one is seeking to calculate something other than inflation. And that is exactly what is happening in the United States to cover up real rates of inflation. If we work backwards, repairing all the changes to the formula that have been made over the past couple of decades, and use the formula that was used 20 years ago to calculate inflation in the United States, inflation would now be reported at about 8% to 10%, or possibly even slightly higher. This is a huge departure from the 3.5% to 4.0% rate of inflation that is being “officially” reported in America. Today’s CPI statistic in America should come with one of those disclaimers that we often see at the end of movies — Today’s CPI statistic is based upon an entirely fictional event. Any resemblance to real rates of inflation or real events is purely coincidental and unintended.
Whatever country you live in, when you discover the formula being used to determine inflation, take this formula to an economics professor and ask him or her if he/she believes that the formula is accurate. If there are aspects of the formula that need to be stripped or removed because they distort the real rate of inflation, then reconstruct a better formula and recalculate the rate of inflation with your new formula. Or search independent economic sites online or at the library and discover if someone has already performed these calculations for you. One way or another, determine an inflation statistic that is independently derived from the one reported to you by your government.
If your research concludes that your government’s official inflation statistic is honest, then great, this was still an exercise very much worth performing. If not, then armed with your knowledge of the truth, call your financial advisor tomorrow, or the financial advisor that has been soliciting your business every week for the past six months, and ask him or her, “What is the rate of inflation in (insert your country’s name here) today?” If your financial advisor provides an answer that is significantly lower than the one you have determined and now know to be true, then you now know that staying with that financial advisor will most likely jeopardize your financial health. If the man or woman that has been soliciting your business provides an answer that is significantly lower than the one you have determined, then end the conversation after this single question and save yourself the next hour of your life.
Someone who does not understand true rates of inflation simply is incapable of provide sage investment advice. For example, someone that believes inflation is 3.5% to 4.0% will construct an investment portfolio that looks radically different than someone that knows real rates of inflation are twice as much as this figure. If someone believes that inflation is only 3.5% to 4.0%, he or she may purchase bonds for you portfolio that have a coupon rate of 5.5% without understanding that such a rate will be providing negative real rates of return and destroying your wealth. Someone that believes inflation is only 3.5% to 4.0% may build a portfolio for you with a 6.0% targeted annual rate of return, and again, not realize that the achievement of such a goal will be destroying, instead of building, your wealth. Thus, properly answering the question “What is the rate of inflation?” may be the most important question you will ever ask in your life. To learn more information about how to prosper from the growing global financial crisis, please visit us at https://www.maalamalama.com
[tags]global inflation, rising prices, investment strategies, wealth preservation strategies[/tags]
