The dollar is always losing value. To measure the decline, people turn to
the Consumer Price Index (CPI), or various alternative measures such as Shadow
Stats or Billion
Prices Project. They measure a basket of goods, and we can see how it
changes every year.
However, companies are constantly cutting costs. If we see nominal—i.e.
dollar—prices rising, it’s despite this relentless increase in efficiency.
This graphic illustrates the disparity (I credit Tom Selgas for a brilliant
visualization, which I recreated from memory).
CPI measures only the orange zone, the tip of the iceberg. Most people
don’t see the gray zone, and that’s a result of the greatest sleight of hand
ever.
We need an accurate way to measure monetary debasement. For example, in
retirement planning it’s tempting to divide your net worth by the cost of
consumer goods. This seems to show your purchasing power. For example, if you
have $200,000 and the cost of groceries for a year is $20,000 then you can
eat for ten years.
However, this approach is flawed. To see why, let’s briefly consider
primitive times when there was no lending or banking. People had to set aside
some of their income, to buy a durable good like salt or silver—hoarding.
When they could no longer work, they sold a little bit every week to buy
food—dishoarding. People accumulated wealth while working, and
dissipated it in retirement.
Life got a lot better with the advent of lending, because interest enables
people to live on the income generated by their savings. People no longer
consumed their principal, worrying about outliving their savings.
Don’t think of capital assets as something to sell in order to eat. An old
expression says, if you give a man a fish then he eats for a day, but if you
teach a man to fish then he eats for a lifetime. Think of a productive asset
like a fishery. It should produce for a lifetime. It should not be consumed
as a mere fish.
Capital assets should be valued in terms of how many groceries they can
buy, not by liquidation, but by production.
Unfortunately, monetary policy is making this increasingly difficult.
Interest rates have been falling for over three decades, and now there’s
scant yield to be had anywhere. We are regressing to the dark ages of paying
for retirement by dishoarding.
CPI understates monetary debasement, because companies are constantly
becoming more efficient. Dividing wealth by CPI compounds the error, because
asset prices are rising.
We need a different way of looking at monetary debasement. I propose Yield
Purchasing Power (YPP). YPP is the yield on assets divided by the
Consumer Price Index (or other index). The idea is to look at the
productivity of assets to see what you can really afford.
Let me explain YPP with a simple example. If hamburgers sell for $5 and
interest is 10%, then $50 of capital lets you eat one burger per year.
Suppose the price of the burger doesn’t change, but the interest rate falls
to 0.1%. You now need $5,000 in capital to earn that burger. Unfortunately,
if you still only have $50, then you only get one burger every 100 years.
CPI doesn’t show this collapse in purchasing power, but YPP does.
Let’s take a look at YPP since 1962. The graph is inverted, to make the
trend easier to see.
It’s interesting that the drop in purchasing power (rising in this
inverted graph) begins around 1984, when the conventional view said inflation
was tamed. CPI may have slowed down, but interest was falling too.
YPP shows us a staggering monetary devaluation—a classic parabola. The
problem isn’t skyrocketing prices, but collapsing yields.
You need more and more assets to afford the same lifestyle. If your assets
don’t keep up, then you have to liquidate your capital.
I have moved my weekly column from Forbes to the Swiss National Bank and Swiss Franc
blog. I don’t plan on posting most of those articles here (except those
that may be relevant, as I think this one is). The
column is somewhat outside the focus of Monetary Metals. So I
encourage those interested to subscribe at that site to receive notification
when new articles are up.
