Chart of the Month (November 2023)

Chart Description

• The chart above shows the US consumer price index for the last 30 years (1994 – current).
• According to the US Bureau of Labor Statistics, the consumer price index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of goods and services. 
• For most non-economists, CPI represents a general measure of inflation in the economy.
• Per the chart, the CPI level was at 258.62 in December 2019.
• As of the last reading on Tuesday (11/14/23), the CPI basket had jumped 18.96% to 307.62.

Our Take

The chart clearly shows an acceleration in the growth of CPI over the last four years.  Despite all the debate in 2020 and 2021 about constrained supply chains and transitory effects, most people are willing to acknowledge at this point that the significant increase in the rate of change in prices has been largely influenced by an enormous increase in the amount of money created by the Federal Reserve during this period.
 
The tone of the inflation conversation has flipped in recent months, from concern to relief, as the YoY percentage change has fallen from a peak of 8.9% in June of 2022 to the most current reading of 3.2% on Tuesday, November 14th.  Some have argued, justly in our view, that the official inflation numbers have been intentionally manipulated downward.  An example from Tuesday’s report was a supposed 34% reduction in health insurance premiums from last year.  Still others claim that if we calculated inflation the same way today that we did 50 years ago, it would show that recent inflation has already surpassed the levels recorded during the 1970s.  While those are not unimportant discussions to be had, the key point is that the rate of change in prices has clearly slowed over the last 16 months.     

So, is it time to rejoice?  Not so fast in our view.  There are two important considerations that are often glossed over, if discussed at all, when the financial media is reporting on inflation.  The first is the perspective that inflation is a tax, and it is cumulative.  The second is that, while inflation is currently trending downward, there is a strong likelihood that it will reaccelerate and potentially eclipse the highs seen last summer at some point in the next 5 years.  The second point is anything but consensus, but we will explain our rationale.   

The late Purdue economics professor, Don Paarlberg, presented a detailed case in his 1993 book titled “An Analysis and History of Inflation” for why we should view inflation as a tax.  Early in the book’s introduction, he is quoted as saying, “deficit financing is a form of taxation and has been called the cruelest tax of all.  It transfers resources from the people to the government much as would taxation.”  Per the graph above, the cost of living is roughly 20% greater than it was in January 2020.  That creates a problem for many families as most individuals have not seen a 20% increase in salary over the last 4 years.  Even if the rate of change is slowing, the price increases are cumulative, and therefore the smaller increases in prices that have been recorded recently only add to the pressure on household budgets.  Paarlberg refers to inflation as the cruelest tax because it is regressive in the sense that all individuals must pay the same increase in food, clothing, shelter, etc. regardless have how much money they make.  Therefore, inflation always hits the lowest paid workers the most.   

After reading Professor Paarlberg’s book, it is difficult to argue with the root causes and consequences of high inflation.  Our second point, that inflation will reaccelerate at some point in the next five years, is much more controversial.  Almost all the experts, from Federal Reserve officials to Ivy League economists to Wall Street prognosticators agree that inflation will continue to fall and stay low for the foreseeable future.  Based on the pricing of financial instruments (TIPS/Treasury breakeven) the market itself is projecting an inflation rate of only 2.30% over the next 10 years.  As stated, we agree that inflation is coming down.  We believe that it is likely to continue to trend down into 2024 and may even turn negative for a brief period meaning that the overall price level will decrease.  However, the current fiscal position of the United States will create some uncomfortable decisions in the coming years.  The US Government’s fiscal 2023 ended September 30th.  If you remove the accounting impact of the student loan forgiveness plan that was never implemented, the government recorded a fiscal deficit of roughly $2 trillion.  That represents ~ 8% of GDP, which is a similar deficit level that the government was running in the depths of the Great Financial Crisis in 2007 – 2009.  The interest that the government pays on outstanding treasury debt is approaching $1 trillion and is now greater than the total amount budgeted for national defense.  The bottom line is that the current path is unsustainable.

There are only two choices.  The government can spend less money or tax more.  Spending less is unlikely to happen anytime soon.  Roughly 78% of all expenditures in FY 2023 were made up of Medicare/Medicaid, Social Security, defense spending and interest payments.  Some politicians are starting to say things like, “Warren Buffett doesn’t need his social security.”  That may be true and Buffett himself may even agree.  Unfortunately, taking social security from Buffett and other billionaires wouldn’t move the needle.  To have a meaningful impact, the government would have to reduce benefits for everyone across the board.  That does not seem like a viable political strategy in the current environment.

The other option is to raise taxes.  The typical proposal is to raise taxes on corporations.  Unfortunately, corporate tax only amounted to $420 billion last year.  That’s only 10% of total government revenue and 6.5% of 2023 expenditures.  Therefore, it would be almost impossible to raise corporate taxes enough to close the gap.

If we’re not going to spend less and we can’t raise explicit taxes enough to make a dent, what is the alternative?  We’re left with the “kick the can” approach that politicians of all stripes have resorted to for decades.  We’ll simply pretend that nothing is wrong and look to “print” our way out of it.  The likely result is a wave of freshly printed dollars all chasing the same basket of goods and services.  That is why we believe it is only a matter of time before inflation reaccelerates.  The taxes communicated in the internal revenue code are not likely to increase significantly, but don’t be fooled.  Taxes are definitely going up, just not the type that voters are aware of.      

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