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On inflation, the rate of inflation, and the erosion of the dollar



The rate of inflation is a statistic that is supposed to indicate how much the dollar drops in value in a year as determined by the increase in the cost of living over that year (i.e. if your cost of living has doubled in a year, the value of the dollar has dropped to 1/2 of its initial value). The yearly change in cost of living is computed by taking some weighted average of the price changes of some selected set of items over the specified year. It is important to understand that each separate item moves on its own schedule with regard to price change and the difference from item to item can be extreme. For example, between 1960 and the present time (Oct 2016) the cost of a house has probably gone up by about 20 times its 1960 price (the exact amount depending on its location, etc.). Rent costs between 1960 and the present have probably gone up in the same period by about the same amount. The price of motor vehicles has probably gone up in that period by about 20 times. The price of gasoline has probably increased by 15 to 20 times in that period. On the other hand, a Sthil chain saw that currently costs $370 probably cost about the same amount in 1960. I would guess the same is true for washing machines, clothes dryers, stoves, refrigerators, sewing machines, rifles, fishing rods, and many other items. Their price hasn’t changed much over the last 56 years. In regard to food, each food item has its own schedule in regard to price change. Candy bars have probably increased in price by about 15 times their 1960 price over that period. Bread has probably increased in price by about 4 times its 1960 price. In 1960 a meal in an inexpensive restaurant (a diner) cost around $1.50 and one in a nice restaurant cost around $4.50. Today the cost in an inexpensive restaurant is about $5.00 and the cost in a nice restaurant is around $15.00. The costs have gone up by about three times. Because the cost of housing represents by far the largest part of one’s cost of living, the cost of living for most people has probably increased by about 20 times since 1960. This means that today’s dollar is worth about 1/20 of a 1960 dollar i.e. that today’s dollar is worth only about 5% of a 1960 dollar (which shows what inflation can do to money over time). Thus $100 today is equivalent to about five 1960 dollars and the cost of today’s Stihl saw is only about 370 /20 = 18.5 1960 dollars. A computer that today costs $200 can be had for only 200/20 = 10 1960 dollars.


 A million dollars today is only worth about 50,000 1960 dollars. A hundred million dollars today is only worth about five million 1960 dollars.


Holding dollars is like carrying a pail filled with a volatile liquid. Starting out the pail is full. You check it a while later and it is only three quarters full. Then after a while you check it again and it is only half full. And then later it is only a quarter full. The liquid just keeps disappearing on you!


The phenomenon of inflation works for the person who borrows money because when he pays back the money it is with easy money of reduced value. It works against a person who lends money because he gets paid back with money of reduced value. Buying a house with a 30 year mortgage is usually a great investment because you pay off the house with money that is constantly decreasing in value and on top of that houses usually increase in value in step with inflation.


The rate of inflation is a concept that can be misleading, can lead to erroneous conclusions. For example, the fact that the dollar has dropped in value by 50% over a particular period of time doesn’t mean that the cost of everything doubles over that period as is illustrated by the examples above.


I wonder why the costs of housing and some other things increase so much with time and the costs of many other things increase little or not at all.



Oct 2016



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