New York Federal Reserve President William Dudley Teaches About Inflation Using the iPad … And Makes People Angry
There was a firestorm of controversy this morning following remarks by New York Federal Reserve Chairman William Dudley.
In an attempt to explain how the Federal Reserve calculates inflation, the Fed President commented to a group of working class people that you can’t just look at the price of food – the price of everything has to be factored in to understand what is happening to the purchasing power of the dollar. His comments:
“Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful,” he said. “You have to look at the prices of all things.”
Of course, this resulted in outrage from the crowd including remarks that, “I can’t eat an iPad”. Yes, but that is like saying you can’t survive off arthritis medication or pianos or cars or furniture or clothing or light bulbs. Theoretically, we could live without those things but the idea that they aren’t an important part of civilized life that raises the standard of living is preposterous.
This is why I sometimes want to bang my head against a wall. People talk about inflation. Yes, inflation is real. Inflation is an invisible, hidden tax that transfers money from savers to debtors. But inflation doesn’t have to hinder you if you build in a reasonable inflation estimate into all of your return calculations. In fact, it is possible to profit from inflation if you structure your asset / liability match correctly.
But here is the truth: Inflation isn’t as bad as economic data alone would indicate because it doesn’t factor in human utility. Or rather, it didn’t until some recent changes that still don’t go far enough. An illustration may help.
Measuring Inflation in Coffee*
Let’s take Morris County, New Jersey. In 1900, a pound of coffee cost approximately 35¢. Today, similar coffee in that same location costs $3.99 for 11.5 ounces. That means we have to do a conversion since there are 16 ounces in a pound, so the equivalent cost of coffee today is $5.55.
That means that money, as measured in coffee, has lost 93.7% of its value over the past 110 years. That is, $1.00 in 1900 in coffee is worth only 6.3¢ today. Conversely, $1.00 in 1900 would require $15.86 today to buy the same equivalent goods.
Measuring Inflation in Flour*
A barrel of flour in the United States traditionally holds 196 pounds. In 1900, a barrel of flour cost $4.45 or around 2.27¢ per pound. In 2010, a 5 lbs. bag of Gold Medal flour cost $2.49 or just shy of 50¢ per pound. In barrel terms, that is $97.61 but that is misleading because people don’t bake consistently enough to require constant use of flour so they are sold in much smaller 5 pound bags, drastically increasing the packing cost per unit.
Still, let’s use that figure. In 110 years, to buy the same measure of flour would cost approximately 22x more because dollars, measured in flour, have lost 95.45% of their value.
Why New York Federal Reserve President William Dudley Is Right
But now, think about cell phones. And computers. And iPads.
As the New York Federal Reserve chairman pointed out this morning, today, on the launch date of the iPad 2, you can buy a tablet computer from Apple with twice the processing power and nine times the graphics processing capability for the same price. That is, measured in processing power, the dollar has doubled in value over the past year. Measured in graphics performance, the dollar has increased 900% in value over the past year.
Much is made about the stagnating wages of the middle class. However, a middle class person can now walk into Best Buy and purchase a high definition television for $1,500 that would have been $20,000 only a few years ago. Modern day XBox 360 and Playstation 3 systems have more computing power than the government had at its disposal for space missions back in the 1960s.
In fact, in one of my favorite Elizabeth Warren speeches, she pointed out that the cost of automobile ownership, despite all of these great improvements, has actually decreased but the reason families spend more on transportation is because they now have two cars instead of one.
Wages Have Increased Faster Than the Rate of Inflation for All But One Group
But here is something that people who want to complain about the dollar never seem to mention. Whether it is a lack of data or a purposeful oversight, real wages – that is, wages paid to workers in excess of the rate of inflation – have consistently risen throughout time when looked at over long periods such as decades.
For example, over the past few decades, real wages for those with a four year college degree have risen beyond inflation by 19%. So not only can you buy more coffee, flour, tea, sugar, and milk than you could doing the same job in the past, you can now by a car with far better gas mileage and safety features, a television that is 65″ with high definition display, a phone that is essentially a computer in your pocket with the ability to talk to almost anyone, anywhere, cars now have navigation systems and heated seats, oh, and Americans have more free time than any other productive group of people in the history of civilization according to historical research (five extra hours per week, to be exact. What do we do with that time? Watch television) and then you have to adjust the figures so that we are getting paid more per unit of time worked since we are earning higher salaries for fewer hours on the job.
The only catch? None of this is true for people who don’t have a college degree. For those people, real wages have dropped by 7% over the past few decades. That is, they can buy fewer groceries for doing the same job even though they have access to a higher standard of living in terms of material comfort. The President talked about this in his state of the union speech when he said:
Over the next ten years, nearly half of all new jobs will require education that goes beyond a high school degree. And yet, as many as a quarter of our students aren’t even finishing high school.
Non-skilled, non-specialized labor will have very little utility as society progresses. Instead, what will matter is the ability to create new chemical compounds, like inventing steel that is as strong as a spider web so that buildings can weigh less, or establishing technologies to help reverse the effects of aging. When automobiles rise, Rickshaw drivers have to find other work. That is now happening in more and more areas of the global economy.
*Update: This post was restored on 05/14/2019 as part of a project to release selected older articles from the private archives if I felt like they had at least some academic, educational, or entertainment value. Re-reading this post nine years later, I think it is worth pointing out that it is true the dollar has lost nearly all of its purchasing power when talking about commodities such as coffee and flour. However, what I should have pointed out (as a tangent to the central theme of this piece) was that gains in real GDP over time resulted in the average family spending an ever-shrinking fraction of their household income on basic needs such as coffee and flour compared to what they did generations ago. That is, their household purchasing power rose. This article is of particular importance right now because over the past decade, there has been what I see as a decoupling of various inflation rates. Technology costs continue to plummet, delivering more and more efficiency and productivity at ever-lower costs. Meanwhile, housing, education, and healthcare costs have risen far more quickly than base inflation. In some cases, these increase in price have perfectly reasonable explanations that reflect the values of local communities. In others, there are systematic problems, often caused by government intervention (e.g., the Federal government is largely responsible for the insanity that is happening in tuition prices). At the same time, Congress and the Executive Branch have begun screwing with inflation definitions in ways that will result in higher taxes and lower Social Security and Medicare benefits down the road, which the average American probably doesn’t realize. It’s coming. It’s absolutely coming. It may take awhile to arrive, but I’m not sure it can be avoided indefinitely.