(Note: This is an unedited draft of an introductory chapter from a manuscript about inflation. Not giving detailed analysis, rather explains why I am interested in the relation between asset prices and inflation.)
My view follows the conventional economic opinion: asset prices are in a different category than the prices of consumer goods for current consumption, and since they behave quite differently, it does not make sense to lump them together. The Consumer Price Index in the United States no longer includes house prices, which is standard for developed countries now. This reflects a desire to have the CPI reflect the cost of current production. Meanwhile, I typically use “inflation” as a shorthand for consumer price inflation, following the convention generally held by market commentators and economists.
I see two main reasons for objecting to this view: the cost of living ought to incorporate house prices, and arguments that “inflationary policies” are seeping into asset prices.
Finally, there is a belief that house prices were removed from the CPI as a tactic to purposefully reduce the rate of measured inflation. I will return to this topic later, when I dig deeper into the discussion of house prices.
Cost of Living
Given the importance of homeownership to the middle-class world view, one can see that it might be perceived as a necessity. (Shelter is a necessity, and renting shelter is an option – and rent is included in the CPI.) Therefore, one could argue that the cost of buying a home ought to be included in the cost of living. And if one assumes that the CPI reflects the cost of living (ignoring what the economists and statistical agencies have to say), one ends up at the position that house prices ought to be in the CPI.
Most of this chapter will revolve around discussing housing. I will summarise my arguments in the following way: even if we want to consider a home purchase as part of the cost of living, we need to reflect the reality of how homes are purchased: with very considerable amounts of debt. Interest rates have collapsed since the early 1980s, and house prices have risen in consequence.
As for financial asset prices, linking them to the cost of living does not make too much sense (other than for someone setting up a trust fund).
Inflationary Policies Have Driven Asset Price Inflation!
Another common argument runs along the following lines: central banks have conducted inflationary policies (e.g., “printing money!”). What is happening is that the money allegedly goes to some shadowy group the speaker has an ideological complaint against, and they bid up asset prices first. Then, the “inflation” will seep into the prices of other goods, and thus eventually show up in the CPI.
This does match one old theory about the inflation process, which is popular among internet Austrians. I will discuss it in more detail in Section TK. The immediate problem with this theory is that it does not match the observed data: we have had a generational bull market in almost every asset since 1980 (with a few bear markets mixed in), yet inflation rates fell and were then quiescent since in the 1990s.
I am also somewhat cynical about this theory and its proponents. Many of the people making these arguments forecast inflation because of central bank policies – and were horribly wrong. In desperation, they seized on anything that rose in price, and want to pretend that this vindicates their forecast.
The reality is that there is a large sub-culture of people who sell books, newsletters, and curios, all premised on protecting buyers of their wares from the evils of inflation of fiat currency. As a writer, I know very well I could probably sell way more books if I waxed lyrically about the coming demise of the major currencies in a bout of hyperinflation. (Admittedly, I might be doing so under a pseudonym.) Since the general public is not that greatly perturbed by the roughly 2% inflation that has prevailed since the early 1990s, they need some kind of hook to excite readers.
(c) Brian Romanchuk 2021