Consumer Price Index vs. Core CPI

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No attention should be paid to manipulated numbers and flexible goalposts.

Typically, price inflation in the economy is measured through a tool called CPI, or the consumer price index. It has been all over the headlines recently, with CPI readings breaking above multi-decade highs and soaring towards double digits. In order to calculate CPI, economists divide the cost of a market basket of goods in year (X) by the cost of the same market basket of goods in a base year. For instance, economists curious on how much inflation has occurred in the prices of goods can take a measurement of the price of certain goods in 2022 and compare it to the price of those same goods in 2000.

The problem with calculating these numbers is that what goes in the basket of goods is not consistent. Over the years, the methodology used to calculate the CPI has changed many different times. According to the BLS, the changes were made with the intent of removing biases that caused the CPI to overstate the ‘true’ inflation rate. The new methodology takes into account changes in the quality of goods and substitution. Essentially, if a steak starts to become more expensive than a turkey, the index can disregard that change by supposing consumers will substitute the turkey for the steak. It also factors in improvements in quality of goods. For instance, if a TV becomes more expensive in 2022, they can attribute that to the quality of TVs being much better than they were in 2000. All of these substitutions and fingering of the numbers allows the official number to stay artificially low. It is also fundamentally flawed to assume that improvements in quality are never supposed to make things more affordable over time. With the way CPI is calculated now, every innovation in efficiency, production, and technology is supposed to be met with a subsequent increase in dollar price, therefore negating the innovations benefits for the consumer. Luckily, we have been able to do so much growth and innovation during the last half century that the average real wealth of society is still growing, and some things have actually still been able to become cheaper, much to bankers dismay.

If we go back and reassess the official inflation numbers using the methodology of 1980 or 1990, we get a much more honest projection of what the inflation rate has been over the past few decades. There is a great website which keeps an updated record of these numbers called shadowstats.com.

Real inflation rate using 1990 methodology
Real inflation rate using 1980 methodology

Going off of the data provided by shadowstats, the past few decades of economic activity start to make a lot more sense. Markets have not really experienced an annualized return of 7% or greater due to the growth of true wealth in the economy over that period of time. The growth rate of market indexes is actually something more like 1% or 2% growth in real wealth through the creation of new technology, goods, and innovations, plus the inflation rate, which simply means the same real goods are being measured by more dollars or an increased money supply.

The parabolic rise of the price of any real valuable markets versus the dollar, and the constant pull of the median point of the graphs to the bottom right corner, is not the result of compouding real economic growth and wealth. It is the result of a compounding increase of the money supply by 5% to 10% per year, which shows up in the real inflation numbers, but hasn’t as much in the CPI using our modern methodology. Until recently of course.

S&P 500 ETF
M2 Money Supply

The S&P 500 is an investment which many people like to make. People want to own parts of successful companies, rightfully so. Many peoples retirements are funded through the ownership of these companies over a long period of time, and some of that is actually due to innovation and real wealth creation.

The S&P 500 is not included in the modern CPI, and its price inflation has no bearing on the inflation readings.

Nor is the price of houses — the only measure of housing costs left in the CPI is one where home owners are surveyed and asked how much they think they could rent their house out for. These numbers are extremely unscientific and lag behind real inflation.

Houses are an interesting case too, because everyone assumes it makes sense that houses get more expensive over time. But what is a house? It is comparable to a consumable good, just one that lasts for a much longer timeframe. Like a car, if it is not maintained or imporved through material investment, it will rot, deteriorate, and become outdated over time. More houses are built, we find better ways to build them and cheaper materials to use, and new houses have much better technologies integrated into them then old ones do. There are only three potential reasons why houses should get significantly more expensive over time. One is that demand greatly increases for them, which to some extent is true. However, the ratio of people per home in existence in America is relatively flat, and even in decline over some timeframes, so I don’t see that as the reason. Another is that the supply decreases, meaning homes become unusable or are destroyed. This could be a bit of the case, but again, the ratio of people to house in America is essentially flat. The third is that the pricing tool to measure their value is decreasing in value relative to the homes because of increases in its own supply. This is what I believe the case to be, and it is fraudulent that this is not shown in CPI.

Aside from the tangent about the true value of homes, by now you should understand what the consumer price index is and how it is a dishonest way of reporting on the true inflation rate in our economy. But what is Core CPI?

Core CPI is a number which is being used more and more frequently in mainstream journalism and economics. Essentially, it is the CPI index excluding food and energy. This number is almost always lower than even the manipulated CPI, and so it is being cited now to make it seem like the problem isn’t as bad as it is.

Many people argue that this alternative measurement is fine, because food and energy are so volatile, and we don’t like to have to see volatility in our costs. But the reason why food and energy are volitile is because they have incredibly inelastic demand. People can cut out discretionary spending in other areas, but people will never be able to cut out things like food and fuel from their lifestyles. People need to heat their houses, feed their families, transport goods, and work at jobs which require the internet and other high energy technologies. To then say that increases in these prices should not be included as inflation is downright propaganda. Food and energy are the core of human needs. We have already stripped out and watered down ownership, asset prices, housing, and transportation from the official CPI. We don’t need to continue listening to these watered down numbers telling us all is fine while the bankers who printed all the money buy up all the real wealth in the country.

The moral of the story is, remain skeptical of the official numbers. And if someone tries to start telling you about Core CPI instead of the Consumer Price Index, run. Inflation is the growth in the supply of money, and the price inflation of specific goods or assets is simply a symptom of that change.