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Why BPP is flawed

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OptimizedPrime

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I have recently been puzzling over why the Billion Prices Project--which on the face of it seems like a great approach to aggregate price tracking--shows inflation in this environment when all of the other macro factors point to DEflation.

Then it hit me: they treat prices at Walmart.com and NeimanMarcus.com the same way--they do not (and in practicality probably could not) account for volume. In short, if prices fall very slightly at Walmart, it will make up for a very large price increase at every luxury retailer combined--the latter perhaps being driven by product mix instead of say inflation.

I've made a case for forthcoming deflation: ongoing massive deleveraging from decades of deficit spending, and a new penchant in Washington for a fiscal pullback. Combine this with a demographic bump from Baby Boomers, which will remove many from the workforce and will deepen the housing problem ("moving from a large house near work to a small house in the middle of nowhere"), this will crush demand for our single largest durable good. (Unprecedented in our history is the fact that grandma lives in a huge house long after the kids have moved out--so we have twice as much housing as we need, so to speak).

I've also made the case that intentional significant inflation is also in practicality impossible, based on a) the very different debt holder mix from times in the past (domestic citizens, China, Japan), b ) the much larger size of the debt meaning that a default (even partial through intentional inflation) on the debt would have much larger, geo-political effects; c) the fact that our current debt service level is incredibly small--and our solvency depends on it staying low, which means that any potentially inflationary policy the government institutes now will instantly effect the market in multiples of the actual movement.

Turning to the practical upshot of all of this, here's my advice.

First, don't buy a house unless it's P/E is VERY low and you are willing to take a long-term minor loss in the long-term.

Second, sell your gold. Gold's current price portends not just inflation, but RUNAWAY inflation with a 500% run-up in the last ten years. Whereas it is true that ONE reason for a rise in gold prices is inflation, gold is also just like any other investment instrument which can be subject to a speculative bubble. Inflation is being used as a scare-tactic to advance a particular political party's fiscal policy. Whether you agree or disagree with the policy is no matter--pay attention to the driver of your investment, and understand it's ability to go away overnight. In other words, when inflation becomes so false as to be laughable, Fox News will concoct some other scare tactic to push lower taxes on the rich to the unwashed masses.

When that happens, gold will crash. It might already be happening, or it might be a while, but I can't see it going anywhere but down.

OP

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BPP indicate that they use different weights for different retailers. Anyway, they only use prices from online retail, leaving out the bulk of economic transactions, and missing complete industries like housing and autos. However, I wouldn't fault them for not doing something they do not intend to do in the first place.

On gold, the price rise isn't solely indicative of high inflation expectations. Perhaps that is the primary motivation, or perhaps it is the secondary one -- I don't know.

Some people see gold as a type of money, and the increased demand reflects an increased demand to hold money. The same increased demand for money that has ensured that the huge expansion of "high-powered money" does not translate into a significant expansion of (money-like) credit, thus keeping a relative check on prices. The same underlying increased demand for money also means people want to increase their gold holdings even as they increase their US dollar holdings. So, in a sense, there is a medium-term (and possibly multi-decade) move where people are not just trying to hold more money, but also trying to diversify the type of money they hold (with gold being one type).

As I say, I don't know which of the two motivations is stronger.

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I actually scoured their site for methodology and couldn't find anything specific. This page alludes to weighting, but a quick think-through of that task would indicate that such an endeavor would be very hard to get right--and it can be wildly wrong if it's not close to perfect.

And yes I admire the ambition of the project, and would love to see it blown out (they should commercialize it and make it real) but in the current form I wouldn't give this index much weight either. I guess I needed to go through the learning process myself.

As for gold, I would love to buy lots of gold for all of the reasons you mentioned--at about $500/oz. In the current form--nearly 4x that--it looks a lot like a panic-driven bubble to me. Holding other forms of money is fine, but it seems like gold in particular is driven by the incorrect assumption that the dollar is going to turn into toilet paper soon.

OP

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The assumption driving rational investors to purchase physical gold is not that the USD will become toilet paper in the near future. Rather, it is an assumption that the unprecedented monetary expansion over the last 3-4 years (equivalent to nearly 70 years worth of expansion before that) will inevitably percolate through the economy over a series of years, gradually driving prices across all goods and services ever higher.

Remember that inflation is a form of indirect taxation: a form of theft through the destruction of your purchase power. It matters not whether the government takes $1 from your pocket physically, or makes the amount of money in your pocket worth $1 less in terms of what you can buy.

Gold - however - is immune to those effects. If you happen to have inherited 100oz of gold acquired in 1971, the day before Nixon closed the window and broke the peg, those 100oz that cost you about US$3,500 would be worth approximately $185,000 today.

It's a notion often repeated but not really understood. Capitalism requires savings. What does it mean for capitalism if another individual happen to put his US$3,500 under his pillow in 1971? It would be worth something in the neighbourhood of $175 today.

As I like to remind people - the darling of the stock market, Mr. Value Investor himself - Warren Buffet - has only returned his investors a 10 year return of about 75%. Gold, in that same time, has returned nearly 500%.

Tragically, I'm too young and still paying off student debts to have been able to build any kind of portfolio. But the parallels I've noticed between Objectivist philosophy and Austrian Economics have illuminated the failings associated with - quelle surprise - government intervention (sponsored) in the monetary system.

Edited by Dairdo
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The assumption driving rational investors to purchase physical gold is not that the USD will become toilet paper in the near future. Rather, it is an assumption that the unprecedented monetary expansion over the last 3-4 years (equivalent to nearly 70 years worth of expansion before that) will inevitably percolate through the economy over a series of years, gradually driving prices across all goods and services ever higher.

...and devalue the dollar 500%. That's what gold has done in the last few years, so THAT is what you are banking on happening in the next few (assuming gold doesn't go even higher, which is probably what it would do if there were actually REAL inflation indicators).

So yeah goldbugs, you are envisioning a world where a Toyota Camry goes for about $125,000 when the price of the thing has gone from $22k to $26k in the LAST ten years. Good luck with that.

The assumption about monetary expansion automatically leading to price inflation is like assuming a storehouse of TNT will inevitably blow up because you assume somebody will put a match to it. But a potentiality is not an actuality.

(...)

It matters not As I like to remind people - the darling of the stock market, Mr. Value Investor himself - Warren Buffet - has only returned his investors a 10 year return of about 75%. Gold, in that same time, has returned nearly 500%.

"Past performance is no guarantee of future returns". Which is to say that, the same applies to AAPL, GOOG or some other home-run stock or a thousand other investments you can come up with that did really well. The early investors in Facebook are on-tap to make 1000x their initial investments. What is your point?

OP

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. Rather, it is an assumption that the unprecedented monetary expansion over the last 3-4 years (equivalent to nearly 70 years worth of expansion before that) will inevitably percolate through the economy over a series of years, gradually driving prices across all goods and services ever higher.

Do you mean in percentages or raw numbers? Also, could you source that for me? Just seems a bit higher than what I have seen.

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...and devalue the dollar 500%. That's what gold has done in the last few years, so THAT is what you are banking on happening in the next few (assuming gold doesn't go even higher, which is probably what it would do if there were actually REAL inflation indicators).

Not sure I understand your comment, or tone, here. I was only responding to your "gold looks like a panic-driven bubble" opinion. I am no goldbug - but I do question the dismissive nature of such a statement. The use of the term is nothing more than a weak smear. I apologize if you inferred some condescension in my response that precipitated your retort - I meant no offence.

With respect to the relationship between gold and paper currencies - it goes back far longer in history than the last 10 years. It is intimately tied to capitalism (principles of money) and individual confidence in economic matters. Those that do choose to bank on gold do so with the expectation that its price has not yet topped out - which is a position driven by successive government's inability to curb the modern State's aggressive growth and interference in economic matters.

To a certain extent, yes, many investors that use gold as part of a larger portfolio of assets do so because they calculate real inflation at levels much higher than the government approved (Bureau of Labor Statistics) rates. Since Clinton first removed energy and food from the standard inflation metrics in the early 90's - successive governments have been aggressively introducing "hedonic" statistical adjustments to all inputs to the calculation. You should investigate those methods - and the results - when compared to the standard pre-1990 calculation methodology. Not surprisingly, each "new" adjustment to the method significantly reduces the inflation rate over the straight year-over-year price increase.

So yeah goldbugs, you are envisioning a world where a Toyota Camry goes for about $125,000 when the price of the thing has gone from $22k to $26k in the LAST ten years. Good luck with that.

This is quite the out of context, appeal to ridicule. I'm not here to hijack your thread, nor be the subject of such tactics.

The assumption about monetary expansion automatically leading to price inflation is like assuming a storehouse of TNT will inevitably blow up because you assume somebody will put a match to it. But a potentiality is not an actuality.

This is certainly a fair point. Though, to ignore the strong correlation between the rising monetary base and the price level since the Fed was formed is to ignore some pretty persuasive evidence that monetary expansion leads to price inflation. It's not inevitable, just probable.

"Past performance is no guarantee of future returns". Which is to say that, the same applies to AAPL, GOOG or some other home-run stock or a thousand other investments you can come up with that did really well. The early investors in Facebook are on-tap to make 1000x their initial investments. What is your point?

I'm sorry - is your argument here that because gambling can produce fantastic results, we should all be gambling - regardless of the probabilities involved? To invoke facebook, google or apple without any context (namely, the fact that these success stories are dwarfed by the number of failures in the same industry) is particularly misleading.

I compared gold's 10 year return to Berkshire Hathaway because I find the common excuses for avoiding gold are baseless (ie: doesn't pay dividends, goes up and down, has no intrinsic/industrial value, etc.) - when gold as a unique CLASS of asset has exceeded the best performing stock portfolio by huge margins over the same time period.

Though, to bring us back to your opinion about gold as a bubble, consider the following: There is roughly $3 trillion of above ground bullion. The average investor holds less than 1% and the average pension fund holds less than 0.1%. Does that sound like a "bubble" - especially when contrasted against the recent real estate or tech bubbles of the last 10 years?

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So yeah goldbugs, you are envisioning a world where a Toyota Camry goes for about $125,000 when the price of the thing has gone from $22k to $26k in the LAST ten years. Good luck with that.

I have followed your posts on economics here for awhile and generally appreciate them. I agree that the value of gold has blown up beyond sensibility but wander if you are not discounting the effects of inflation a bit much. Just anecdotal of course, but value meals at fast food restaurants have gone from $2 to $6 in the last 20 years(300%). New low end cars have gone from $999 to $9,999 in 30 years. I know they've been telling me with the cpi that we have 2% or 3% inflation a year, but any who's lived that long knows that it's a lie. Any product that hasn't changed significantly seems closer to 15%/year when you look at decade long changes. Obviously, anything with massive technological improvement(like PCs)counters that with prices so including those sorts of items is only going to contribute to the facade.

In a free market without this wholesale currency manipulation, short of massive gold finds, technological advance should cause fairly consistent deflation over time. So any item remaining stagnant even, is to me a sign of wealth erosion....or more accurately, transfer. So essentially, my view now is that there is significant inflation but it is largely obfuscated by erroneous measuring techniques, long time delays, and political mouth pieces.

So with that in mind, my question is, do you think it's possible that there is direct causation between increasing the money supply and stealing everyone's wealth even if it is not immediately apparent? Also, with regard to gold specifically, do you think that the recent run up could just be a catching up period from the previous 20 years where gold remained almost totally stagnant, which would be inflation related, or do you believe that it is almost totally caused by irrational fears driven by right wing talk show hosts?

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Do you mean in percentages or raw numbers? Also, could you source that for me? Just seems a bit higher than what I have seen.

Sadly, like most metrics these days, it depends entirely on which metric you're using.

I've posted a few links that take you to a variety of sources. I believe all of the links themselves link back to actual Federal Reserve data sources.

Link 1

Link 2

Link 3

While the charts speak for themselves, and my point still stands, my reference was certainly skewed - thanks for asking about it. I admit that I tossed it out in haste - and acknowledge that I crossed it with the debt trend. Specifically, it took something in the neighbourhood of 70-80 years for the US to accumulate $1T in debt - and in the last 3-4 years, it's increased it by a factor of 3-4. Apologies.

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Aequalsa:

I referenced the changing nature of the CPI calculation in a response to OP - but realize I didn't link a follow up reference. As you've inquired, I've linked it here for you. It explains how the CPI is calculated these days incorporating hedonics (subjective quality evaluations) into all inputs to the CPI calculation.

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Most goldbugs don't think it's a "smear" to call them(selves) that. It's just a shorthand term for somebody who is bullish on gold as an investment. It's common in investment lingo, etc. No offense implied.

My phrasiology aside, a 500% run-up in gold, insofar as you believe it's an index for actual price inflation, would imply that we are seeing or soon will see, a 500% run-up in dollar-denominated prices. What I am hearing here seems to imply (tell me if I'm wrong) that the price of gold proves that massive price inflation must be underway. Many don't seem to accept that gold is just one kind of investment like so many others, and as such can be subject to a speculative bubble wherein it's price makes a drastic departure from its fundamental value and/or investors can be wrong in their assessment of its value.

And yes, I've looked at all of the various forms of inflation measurement, up to and including my own anecdotal evidence: I personally remember ten years ago, and I don't recall everything being 1/5th the price everything is now. I actually feel like everything is approximately the same price, give or take. If we had massive inflation during this time, it seems like the average person would have noticed it and it would be very obvious.

OP

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The only thing that the current price of gold is evidence of - with any certainty - is that a great many people have lost confidence in their respective paper currencies and their government stewards. Whether or not broad price inflation happens next - is up for debate. There are a great many persuasive arguments for significant price deflation.

Personally, as is clear by my comments, I fall in the inflation category - for no other reason than I enjoy studying history, and the signs are all there - especially when coupled with a study of Objectivism, and the identification of flawed ideas that drive contemporary politics and government decisions in the economy.

Gold rose to record heights in the 70s - during which some considerable price inflation was experienced. For the next 20 years or so, gold hasn't really budged. However, prices over that 20 year period from 1980 to 2000 increased significantly. The 500% increase we've seen in gold in the last 10 years could be indicative of a larger price inflation on the horizon - sure. However, this is not the 1970's economy. There are many differences both in industrial composition, technology, global economic relationships and cultural influences that must certainly have an impact on the future prices.

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Many don't seem to accept that gold is just one kind of investment like so many others, and as such can be subject to a speculative bubble wherein it's price makes a drastic departure from its fundamental value and/or investors can be wrong in their assessment of its value.

People made this same mistake about housing during the housing bubble. You might remember the rationalizations of 'housing prices never fall' used to justify the outrageous spike in housing prices as sustainable. This is just a way to claim that housing prices cannot be subject to a speculative bubble. As we now know, all those people were wrong. The same goes for gold; whether or not it has been used as a speculative asset in the past, it can become one in the present day. Scroll down to the last graph on this web page, which charts gold prices over the last 35 years, and judge for yourself whether the current trend might represent an unprecedented, speculative break from gold's historic and fundamental value. (Does it remind you of these kinds of housing-price graphs before the crash?) With all the money the Fed has been pumping into the economy, I'd be surprised if there weren't a few bubbles being blown.

Note: much of this is directed at the thread in general; I realize the person I replied to agrees with the possibility of gold as a speculative bubble.

Edited by Dante
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Any product that hasn't changed significantly seems closer to 15%/year when you look at decade long changes.
I don't think this is true. For instance, home prices (other than the top few areas that grew rapidly) have gone up in low single digits. If I take the price at which my house was bought by its first buyer (in 1977), and the amount I paid for it in 2003 (near the peak) it was about 7% per year; since then it has dropped, giving a resulting rise of about 3-4% per year over the last 35 years. When I look at apartments in my area, the rents have hardly budged for over a decade. The price of oil (West texas crude) has risen about 15% per year since 2000, but see how flat it was for years before that. If one looks at wholesale beef and pork prices over the last 10 years, they're up by about 4% per year, but if one goes back another decade or so, the rise is smaller. A mid-range Toyota Camry sells for around $23K-$27K, which is not very different to what it sold at 15 years ago.

Yes, prices have been rising steadily over the decades, but the official numbers do not understate it by very much. I think sites like ShadowStats have this wrong. You also have it right that in a free-market, we ought to see a falling secular trend to prices. So, by that reckoning, a 4% price-rise might well be 7% more than it ought to be. Still, I think the OPs point is that we are not in for price rises that are significantly different from what we have seen in the past.

There are major deflationary forces working in the credit markets. While there may be more cash around, people are getting rid of a lot of their credit. In net, their buying power (cash plus credit) is not expanding at any spectacular rate. Consequently, there is little reason to think that prices will rise more than their historical norms.

Of course, the price of gold is a separate issue. It is definitely not the case that the price of gold only mirrors expectations of rising prices. Gold can do well in a deflationary scenario.

Edited by softwareNerd
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Also, the first graph I linked is a few months out of date. The current one can be found by going here and scrolling down to the 'MULTI YEAR GOLD: 1975-2011' option. The upper limit on the axes for the current chart is a full $300/oz higher than the outdated one from a few months ago.

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Inflation adjusted annual gold prices 1914-2010

If there is a gold bubble, it is still early and a good time to get in.

That graph ends last year, and today's price is much closer to the 1980 peak at $1786, although there's still a difference of a few hundred dollars.

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I certainly concede that gold is as susceptible to "bubble" conditions when compared to other asset classes. Anything that relies on human behaviour and perception is subject to distortion.

I disagree that the current price is a panic fueled bubble. It simply isn't held by widely enough by investors, simple or sophisticated, to justify the comparison to actual bubbles that have emerged over time. When Joe Blue Collar is flipping properties with artificially cheap credit for year after year... we have a housing bubble. What is the comparison for gold? Hardly anyone I know has more than 1% of their portfolio invested in it. Check out Norway's monster $600B portfolio - not much in the way of precious metals at all really. How can the "current" price of gold be even remotely considered a bubble? It just doesn't add up in my opinion.

Also, I don't believe goldbugs, or simple current gold enthusiasts hold the opinion that, like the housing myth before it, "it can't go down". That simply isn't part of the rationale the supports the acquisition of gold "right now".

If the US got there shit in gear, slowly pulled themselves out of the economy, acknowledged the illegitimacy of using deficits to fund entitlement programs of any kind and moved towards a more free economy and limited government... I think you'd find the same people clamoring to get into gold would suddenly be the first ones off the ship, acknowledging that the US had restored their faith in sound money.

Generally speaking - rational investors do not want to be invested in gold. They're forced to when economic conditions require it. I feel confident asserting that that concept holds true through most of modern history.

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(...)

When Joe Blue Collar is flipping properties with artificially cheap credit for year after year... we have a housing bubble. What is the comparison for gold? Hardly anyone I know has more than 1% of their portfolio invested in it.

(...)

You obviously don't watch the Glenn Beck Show (or every show on Fox News for that matter)--good for you :-). It's basically one giant infomercial for gold.

Check out Norway's monster $600B portfolio - not much in the way of precious metals at all really. How can the "current" price of gold be even remotely considered a bubble? It just doesn't add up in my opinion.

A 500% run-up in the last ten years doesn't scare you? Even a little?

Also, I don't believe goldbugs, or simple current gold enthusiasts hold the opinion that, like the housing myth before it, "it can't go down". That simply isn't part of the rationale the supports the acquisition of gold "right now".

If the US got there shit in gear, slowly pulled themselves out of the economy, acknowledged the illegitimacy of using deficits to fund entitlement programs of any kind and moved towards a more free economy and limited government... I think you'd find the same people clamoring to get into gold would suddenly be the first ones off the ship, acknowledging that the US had restored their faith in sound money.

Generally speaking - rational investors do not want to be invested in gold. They're forced to when economic conditions require it. I feel confident asserting that that concept holds true through most of modern history.

You keep making my case here, over and over. It's fear of default and/or massive inflation that is driving the price of gold. There is no possibility of default and there is no massive inflation anywhere on the horizon. US 10-year bonds are priced as if we're never going to have inflation ever again and other commodities like oil (or even platinum to some extent) are NOT following gold, which is what you'd expect if there was real inflation fears among the mainstream of investors.

Deficits might be immoral (I would never put it way but no matter), but they are current "not" causing inflation and by all accounts this is NOT a valid reason we should be against deficits. We should be against deficits because involuntary taxation is immoral, as is involuntary indebting of citizens. But ascribing specious additional downsides is misleading and counter-productive.

OP

Edited by OptimizedPrime
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I don't watch Fox News in general. Though, I used to have a guilty pleasure of turning on Bill O'Reilly before a soccer game so I could get angry. :P

Yes, a 500% over 10 year run up in gold does concern me. But not that it could be a bubble. I just don't see the pieces lining up to substantiate a bubble. The rise in price alone - in the absence of the other "bubble" conditions - speaks more of a hedge against inflation. When researching the "official" inflation figures - as we've discussed - I come to very different (much higher) rates than what has been reported. Perhaps its a self-serving conclusion. Perhaps not. I'm still researching. I still have no money to invest - so its entirely academic at the moment anyway. :)

You keep making my case here, over and over. It's fear of default and/or massive inflation that is driving the price of gold. There is no possibility of default and there is no massive inflation anywhere on the horizon. US 10-year bonds are priced as if we're never going to have inflation ever again and other commodities like oil (or even platinum to some extent) are NOT following gold, which is what you'd expect if there was real inflation fears among the mainstream of investors.

I disagreed that it was "panic and fear" driving gold - as I interpreted that statement to mean something on par with an irrational frenzy. A hedge, like any other, is used to preserve a position (depending on the nature of the hedge) against some perceived outcome. I agree that gold is being used to hedge against inflation, and the possibility of default in the US (or other!) currencies. Remember that gold is a global market - and Americans, in general - haven't even begun to acquire the physical product when compared to their Euro or Asian counterparts.

Further, while I to agree with you on the possibility for a US default being remote, the only way to avoid default given the current political climate is for the government, through the Fed, to debase the currency with substantial and continuous money printing. As see this as a high probability event and one that will kick start a much larger wave of price inflation than we've seen before.

I guess the next couple of years will be very informative. I for one, hope I'm wrong - if it matters.

Deficits might be immoral (I would never put it way but no matter), but they are current "not" causing inflation and by all accounts this is NOT a valid reason we should be against deficits. We should be against deficits because involuntary taxation is immoral, as is involuntary indebting of citizens. But ascribing specious additional downsides is misleading and counter-productive.

You're absolutely right, on all points. I should probably have used the word "unsustainable" instead of "illegitimate" as I wasn't looking to make a moral evaluation. I was only suggesting that, should things improve in the US - politically - like electing Ron Paul (not perfect, but better than the alternatives) - I would expect it to be the start of a significant movement out of gold.

I disagree with your comment about the 10 year rates though. Inflation adjusted - they're negative. There's a reason why the Federal Reserve has become one of the single largest buyers of US debt. Very recent 2 year and 5 year debt auctions while successful - experienced nothing close to the bid-cover ratios they've traditionally enjoyed.

Moreover, precious metals have all risen considerably. I'm not sure where you were reading - but I've linked a few sources:

Platinum

Silver

Palladium

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Aequalsa:

I referenced the changing nature of the CPI calculation in a response to OP - but realize I didn't link a follow up reference. As you've inquired, I've linked it here for you. It explains how the CPI is calculated these days incorporating hedonics (subjective quality evaluations) into all inputs to the CPI calculation.

Thanks for the information. I appreciate it!

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Yes, prices have been rising steadily over the decades, but the official numbers do not understate it by very much. I think sites like ShadowStats have this wrong. You also have it right that in a free-market, we ought to see a falling secular trend to prices. So, by that reckoning, a 4% price-rise might well be 7% more than it ought to be. Still, I think the OPs point is that we are not in for price rises that are significantly different from what we have seen in the past.

I understand what your saying, and by those numbers, I'd agree, but what I was trying to get at was that the true numbers are cumulative and also difficult to meaningfully measure. In the past 100 years of being robbed blind by the FED and US Govt, there has been more than a 2000%(so say 20%/year for 100 years) decrease in value. It is not apparent due to their measuring year by year, effectually hiding it's cumulative nature as well as technological advance and market manipulation which helps hide it even more in the short term. My thought is that this has allowed them to take the vast majority of the discretionary wealth produced by capitalistic advance. With a removal of regulation and subsidies, the cost of living should be rapidly approaching free, but instead the medium income in the US, after taxes(say24k/year) is barely enough to get by with a lifestyle not insignificantly, but not significantly enough different from what it was 100 years ago.

Obviously a number of other factors are at play in this morass, but I think inflation is a much larger one than most suspect, do in large part to this intentional blurring through redefinition and recalculation.

Edited by aequalsa
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I understand what your saying, and by those numbers, I'd agree, but what I was trying to get at was that the true numbers are cumulative and also difficult to meaningfully measure. In the past 100 years of being robbed blind by the FED and US Govt, there has been more than a 2000%(so say 20%/year for 100 years) decrease in value.

It doesn't quite work that way.

You get 2000 percent with a only a 3 percent per annum rate, not a 20 percent, because of the very fact you mention, that it is compounding. (100th root of 20 is approximately 1.03)

Edited by Steve D'Ippolito
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(...)

Obviously a number of other factors are at play in this morass, but I think inflation is a much larger one than most suspect, do in large part to this intentional blurring through redefinition and recalculation.

You bring up an interesting point (or at least you did for me :-)).

Before his fall, Greenspan talked about the advent of trade with emerging economies (e.g. China) being an incredibly deflationary event. It's as if our labor force doubled in size overnight (and the new labor was dirt cheap). A quick trip to Walmart will give anybody a lesson in this. And clearly advances in technology should also drive prices down drastically as well. Everything from food to manufactured goods benefit from IT, and there have been huge advances particularly in the past 20 years in that area. And then IT itself has obviously fallen through the floor in price for a wide range of goods.

So Greenspan basically took all of this as an indicator that the Fed and congress were free to "try" to inflate the living shit out of everything because the net effect on prices would be neutral. Besides inflating the money supply, covert deficit spending aka the housing bubble financing massively inflated things to the point of counteracting all of the inherent deflation. Greenspan's goal was ALWAYS price stability, and if that was the goal, then you must inflate as much as you can from a policy perspective.

All this, however, leads us right back to where we started. The driver of inflation will be policy in Washington, not the market (and this will be true as long as we are not on a gold standard).

Right now Washington looks to be in a deflationary mood. Nobody on either side of the aisle is talking about fiscal expansion, and Keynes, at least for now, is thoroughly discredited because the $700b stimulus didn't work and we're on our way to a double-dip. Meanwhile, the Fed is up against the "zero bound" in terms of lowering interest rates.

So maybe this clears things up a bit. Yes, the government is busy "inflating" these days, but from a price perspective all they are doing is canceling out natural deflation.

The question is, will they get it wrong, and in which direction? Right now everything policy-wise points to DEflation, not inflation.

OP

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It doesn't quite work that way.

You get 2000 percent with a only a 3 percent per annum rate, not a 20 percent, because of the very fact you mention, that it is compounding. (100th root of 20 is approximately 1.03)

Sorry, I wasn't clear...or maybe I don't understand. 3%/year compounding gets to 2000, which /100 is 20% of the original value per year, that is lost with the later ones being much, much higher.

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