Price Inflation

The Happening

Riding high on top of the world, it happened.

Suddenly it just happened,

I saw my dreams torn apart

Something happened to prices during my lifetime. Rather than just being a cranky old man and complain about it, can examining the data suggest what happened?

Can you imagine a 5 cent candy bar? If you were born in 1951 like I was, you probably not only can imagine it, you can remember it. Before I entered college in 1969, prices were fairly stable. My first new car cost only $3,000. Something has happened to prices since that time. Looking at the data might help understand when, and why, something happened to prices.

The U.S. Bureau of Labor Statistics reports the Consumer Price Index (CPI) , which is often used to track inflation, from 1913 to the present. It is often indexed to a specific year. When the annual CPIs (with an index of 100.0 in 1984) are plotted, they take on a distinctive shape as shown below.

Doing a non-linear regression on that data, produces an equation whose values have a correlation of 0.9926 with the reported CPIs. The non-linear equation is essentially two straight lines with a transition between those lines somewhere between 1969 and 1975. Looking for a historical event that happened during that time period, that might have affected the CPI, and has remained in place since that time, suggests the Nixon Shock. In 1971, President Nixon ordered that the US Dollar, which was then the international reserve currency, no longer be convertible into gold. It had been not been convertible into gold for US Citizens since the 1930s, and this action seemed to primarily affect foreign governments, but that action remains in effect today.

If this was indeed the cause of the transition, this suggests that perhaps there are probably two transitions. One at the time of Bretton Woods Conference in 1944 when the US dollar (convertible into gold) was first made the international reserve currency. And then in 1971 when the US dollar remained as the international reserve currency, as it is today, but was no longer convertible into gold.

Fitting straight lines to the CPIs in each time period produces:

• A period before Bretton Woods, with virtually no CPI inflation
(an increase of 0.072 1984 CPI basis points per year. )

• A period between Bretton Woods and the Nixon Shock, where CPI inflation was modest
(an increase of 0.645 1984 CPI basis points per year) and

• A period after the Nixon shock, where CPI inflation was large
(an increase of 4.597 1984 CPI basis points year).

Using these three straight lines, you can compute values that have a correlation to the reported CPIs of 0.99931.

If you only look only at year to year inflation, which dropped from 11.0% in 1974 to 2.1% in 2017, you miss this underlying long term impact. The impact on inflation when a domestic currency is also used as the international reserve currency is known as the Triffin dilemma. https://en.wikipedia.org/wiki/Triffin_dilemma. An analysis of the reported CPIs, suggests that the dollar being the international reserve currency, especially when the dollar was no longer convertible into gold, has had a measurable effect, not just on the international economy, but on our daily lives.