Each month, the U.S. Bureau of Labor and Statistics updates inflation numbers by publishing data for the Consumer Price Index, or CPI. This number represents the cost of a range of goods and services commonly purchased by households in the U.S.
This CPI number, which has been tracked for over a century, was 10 in 1913, 100 in 1983, and as tabulated for March of 2022, stands at 287.5 today.
In the past year, the number is up 8.5%, meaning that a weighted average of the cost of commonly purchased goods and services has risen 8.5% in 12 short months. If this pace keeps up, cash we have today will only buy half as much in 8 or 9 years as it does today.
That fact is easily estimated using the Rule of 72.
The Rule of 72
I learned the Rule of 72 from my father sometime in the 1980s when the stock market was taking off and inflation was beginning to temper after a three-year run of double-digit inflation at the turn of the decade.
It’s a rule of thumb that lets you easily calculate how long it will take your money to double at a given rate of return. Take the number 72, divide by the rate of return, and that’s how many years it will take for your money to double.
The number 70 is actually a bit more accurate for monthly compounding, but 70 doesn’t have as many common denominators as 72, but you can basically use them interchangeably.
You can also use the Rule of 72 to predict how long your purchasing power will be cut in half at a given rate of inflation. It’s the same calculation, essentially.
Earn 2% on your money, and it will double in about 36 years.
With 2% inflation, your purchasing power is halved in about 36 years.
Earn 6% on your money, and it will double in about 12 years.
With 6% inflation, your purchasing power is halved in about 12 years.
Earn 14% on your money, and it will double in about 5 years.
With 14% inflation, your purchasing power is halved in about 5 years.
The Benefit of Inflation
A little bit of inflation is good for a healthy economy. If consumers can expect prices to rise, they will be more inclined to spend money now rather than waiting for better prices later on.
That expectation helps keep the economy rolling, and the Federal Reserve Bank (the Fed) would like to see long-term inflation of about 2%. That should be enough to keep consumers buying while only eroding purchasing power by 50% in about 36 years.
Deflation, when things are getting cheaper to buy, has the opposite effect. Why buy now when you can wait and see how low prices can go? That can bring an economy to a halt.
This “benefit” stops being beneficial when inflation heats up too fast and prices outpace people’s ability to pay for them. The cure for high prices is high prices, as they say.
Inflation should be somewhat self-limited in a capitalist society, but as long as enough people are willing to pay increasing prices, there’s little reason for vendors to reduce them.
The Reality of Inflation
The CPI increased 8.5% from March 2021 to March 2022. This is an average of the cost of many things, though.
Medical care, for example, is up less than 3% year over year. Physician care specifically is only up 0.7%, which might explain why your wages aren’t keeping up with inflation if you’re a doctor.
Airfare, on the other hand, is up 23.6%. Some of that increase is due to demand as pandemic restrictions are lessened or lifted. The rising cost of energy is another major factor; motor fuel, such as gasoline, is up 48.2% from one year prior.
Vehicles are much more expensive to operate, and similarly more costly to acquire. The price of used vehicles is up 35.3% and the price of new vehicles increased 12.5%.
Other double-digit price increases include electricity (11.1%) and “Food at home,” groceries basically, which are up 10%. Within that category, you’ll see an increase in “Meats, poultry, fish, and eggs” at a 13.4% increase. You can see all of the data at the BLS website.
The CPI and its variants (the above numbers are from the CPI-U for Urban consumers = 93% of the U.S. population as defined) may not be a perfect measurement. Shelter is reportedly up only 5% when the cost of new homes has increased closer to 20% and anecdotally, I’ve heard of rent increases from 20% to 40%.
Everyone will have their own unique rate of personal inflation based on what you tend to spend your money on and how your tastes and needs change with time. If you’re a vegan homeowner with a fairly new car that spends most of its time in the garage, inflation isn’t hitting you as hard as the rent-paying carnivore commuting two hours a day in an aging SUV.
What makes the CPI most useful, even if it doesn’t perfectly match any individual’s personal rate of inflation, is the ability to look at a standardized index with data going back for many decades.
Inflation Over the Decades
The CPI stands at 287.5. It was half that in April of 1993 at 144.0. It took 29 years for a dollar to lose half its purchasing power since I was earning $4.50 an hour at a grocery store as a 17-year old. That’d be like earning $9 an hour today to do the same job.
We only have to go back 13 years to January of 1980 to cut the dollar in half again. The CPI was 77.8 then, about a quarter of what it is today. In the summer of 1970, it was 39; the dollar lost half its value between 1970 and 1980. We have to go all the way back to a post-war 1946 to find another halving, when the CPI was under 20.
I can remember paying as little as 87 cents for a gallon of gas. A can of soda from a vending machine was 50 cents when I grew up. Candy bars on sale were 3 for a dollar. I may sound like your Grandpa talking about how everything under the sun once cost a nickel, but I have now lived long enough to see the true effects of inflation.
Thanks to inflation and the volatility of gas prices, gas costs 5x what it did when I was younger, and a single soda or candy bar usually goes for at least a dollar these days.
Over the nearly 11 decades it’s been tracked, the CPI has increased by 3.2% on average with a median of 2.7%. The mean of 3.2% represents an average doubling in prices about every 22 years.
Assuming that trend continues, the buying power of money will be halved four times in an 88-year lifespan. What you could get for $1 in your birth year would cost $2 at 22, $4 at 44, $8 at 66, and $16 at 88. Live to 110 and that one-dollar item will cost the equivalent of $32 in whatever cryptocurrency we’re exchanging via the chips in our brains at the time.
If the Fed could somehow maintain a 2% average inflation target over an entire lifetime, the cost of things would only double every 36 years. That $1 item you bought as a newborn would only cost about $8 at 108 years of age.
The current situation seems a bit out of control, and it is more than 4x the Fed’s target of 2%, but we’ve seen this before. Inflation has averaged 8.5% or more in 12 different years since 1913. Most of those high-inflation years came in that first decade during World War I and again in a stretch from 1974 to 1980. From 1992 to 2020, though, inflation never exceeded 3.4% and the mean over that timeframe of nearly two decades was 2.2%.
I personally have not seen inflation like we have now in my adult life, but from 1979 to 1981, in my early childhood, inflation ran 11.3%, 13.5%, and 10.3% in back-to-back-to-back years. Those were great times to lock in long-term bond rates, and it appears that the $40,000 in I Bonds I recently bought will be bumped from the current interest rate of 7.1% to 9.6% in May.
Here’s what inflation has averaged over the decades, with the 1910s starting from 1913 which is where CPI data starts. Note that the index was actually created several years later, but they were able to backfill accurate data to that year.
The worst decade for inflation in the last 100 years were the 1970s. Using the Rule of 72 / 70, we can see that spending power was cut in half from 1970 to 1980, and the CPI index we looked at above showed precisely that.
Could the 2020s be as bad or worse? Time will tell, but I believe that a lot of the price increases we’re seeing are at least peripherally related to the ongoing and hopefully waning pandemic.
As part of the pandemic response, the money supply was grown at a faster rate than usual to put more money in the hands of the population at a time when far more than usual were unemployed. Also, we’re now seeing pent-up demand met with limited supply as shut-down industries created long-lasting supply chain issues.
The Russian aggression against Ukraine and the world’s economic response to it is obviously decimating the economies of both countries, vastly reducing energy and agricultural exports from those resource-rich nations. The Shanghai lockdown hasn’t helped the supply chain issues at all, either.
So much for “transitory” inflation.
What to Do About Inflation
In terms of personal inflation, it may be time to try implementing some of the money-saving strategies that I’ve championed in the past. Make value-conscious purchases, learn to DIY where it makes sense, and consider putting any big planned purchases off until there’s a better value proposition.
Do what you can to ensure your earnings keep up with inflation. Negotiate a cost-of-living adjustment in addition to any performance-based bump when it comes to your salary.
When it comes to investing, much of what I have done with my own money and recommended to you is fairly inflation-resistant.
Consider stocks. When the costs of goods and services rise, those companies collect more money and become more valuable. Stocks, which comprise nearly 80% of my portfolio, tend to perform well in times of above-average inflation.
Similarly, the cost of housing is a component of inflation, and if you own real estate, it becomes more valuable. When rents rise, the active or passive real estate investments you own will generate more revenue.
Holding a long-term mortgage is actually a nice inflation hedge. Your monthly payment remains the same regardless of what inflation does. 30 years later, even with a low inflation rate averaging 2.4%, your payment is effectively half of what it was at the beginning, adjusted for inflation.
With any luck, your investments and finances are already set up to do well in times like these. A portfolio heavy in stocks and/or real estate should do the trick. If you locked in a low mortgage rate before they started their rapid ascent, more power to you.
For a look at additional asset classes and how they historically fare in inflationary times, see How to Protect Against Inflation.
What are you doing to keep your personal inflation rate reasonable?
Political comments will be deleted. I won’t let the comments section devolve into a left versus right debate, as it somehow did in a recent post about golf, of all things! There are places to have these discussions, but this is not the place.