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Inflation in America

  • By Alan Knott-Craig
  • December 28, 2012

“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both brings temporary prosperity; both brings a permanent ruin. But both are the refuge of political and economic opportunities.” Ernest Hemingway


Inflation: The rate at which your currency loses purchasing power over time


The official inflation rate in the States is about 1.8% per annum, which means you need to earn at least 1.8% per annum on your savings if you want to have the same purchasing power next year.


Based on my recent visits to America, 1.8% seems a tad understated.


When I swipe by credit card in a taxi, it gives me three choices for tipping: 20%, 30% or 40%.


Basic consumer behaviour psychology has proven that most people choose the middle option, which means the average taxi tip is 30%! When I was living in States in 2003 the standard tip was 10%, steadily creeping higher to 20% in the past couple years. But 30%?


This is new. What does it mean? To me, it means inflation is much more than 1,8%. Simple math on the increase in taxi tip increases (20% to 30%) shows it is 50% over the past 2 years. That is probably too high. The tip is being disproportionately increased in order to compensate for the insufficient increase in official taxi fares.


Why are official taxi fares not increasing enough? Because they are benchmarked to official inflation, which is grossly understated.


How does the government understate inflation? The basket of goods used to compare prices year on year is fudged to include irrelevant goods, and skew weightings to these goods (i.e.: StatsSA included VHS cassettes in the basket of goods until 2008.)


The net result of all this is as follows:


  1. The dollar will continue to weaken. Interest rates are linked to official inflation and are therefore grossly understated, resulting in much greater real inflation.
  2. The standard of living for average Americans will decline over the next few years as the purchasing power of their earnings erode in comparison to the price of goods.
  3. Retirement will be very difficult for many people, especially those in the middle class. Cash in the bank dissipates away thanks to interest rates being far lower than true inflation. The classic example is my uncle, a heart surgeon in Memphis. He makes money until his hands stop performing, then he must live off his savings until he passes away. How does he fund retirement if his cash is worth less every year regardless of where he deposits it?


The positives are:


  1. The stock market will continue to boom. The average American has nowhere else to invest his/her savings. My uncle is forced to speculate in the stock market, he literally has no other hope of beating inflation.
  2. If you have cash then you should be buying gearable appreciating yield-producing fixed assets. (i.e.: property that you can rent out). Inflation not only erodes the value of cash assets, it erodes the value of cash liabilities. This is only possible in countries where official inflation (and therefore interest rates) is understated.
  3. The manufacturing sector will improve as the dollar weakens and makes US exports competitive again. This will create jobs and counter-balance the past thirty years of “hollowing-out” of the blue-collar economy.


So, in the short to medium term, whilst big business and the general economy will benefit, for the average Joe in America, it’s game over insert coin.


PS: I know my example of “taxi tips” is very anecdotal, but after 6 weeks travelling through 13 states we saw enough examples of true inflation to confidently generalize.