Wednesday, February 27, 2008

Flawed WSJ Editorial: Wages Are a Price, Too

From today's WSJ editorial "Inflation May Be Worse Than We Think" by David Ranson:

The graph above shows how rapidly the purchasing power of income declines from an ongoing inflation of 4%. After nine years, an income of $100,000 is worth only $70,000. After 17 years its purchasing power has been cut in half, and after 30 years by about 70%. The cumulative loss of purchasing power if inflation persists above 4% is an awesome prospect that is surely going to be unacceptable.

Comment: David Ranson is way off-base on his inflation analysis and has made a serious and fundamental error: he has assumed that income remains constant for 30 years and all other prices increase annually by 4%. That's pure nonsense and nitwitery.

Reason? Wages are just another price, the price of labor. And inflation affects all prices, including wages, see chart below:

From 1964 to 2008, average hourly earnings have increased at almost the same rate as the Consumer Price Index, suggesting that Mr. Ranson's graph, adjusted for wage increases at the rate of inflation, would look like this:

Inflation may or may not be a problem, but to assume that prices go up but wages don't IS a real problem for this WSJ editorial.


30 Comments:

At 2/27/2008 9:52 AM, Anonymous Anonymous said...

What multiple of median household income was required to purchase the median house in 1957, 1972 and 2007?

The St. Louis Fed. says the average hourly earnings is just under $18.00 or less than $36,000 per year.

$36,000 per year.

 
At 2/27/2008 10:16 AM, Blogger geewhy said...

Great blog! I'm wondering if you could comment on two things related to this issue:

1. These are averages, so the growing disparity in income in the U.S. seems to be a real issue that needs to be reckoned with in these calculations. The average income figures don't mean much if you're in the bottom half, right?

2. Along these same lines, I grew up in Flint and now live in San Francisco, so things like the average cost of housing don't really mean much to me in either place — Flint's housing is incredibly low and SF's is incredibly high.

I'm not an economist, but experience and common sense has shown me that things are getting worse for pockets of people around the country, so the average figures showing things aren't so bad aren't that reassuring.

It's like Bush using the average tax cuts all Americans got...we know the bulk of the cuts benefited a select few at the top, but when you average it out, it deceptively looks like all citizens got a decent tax cut, which is not true.

If you have time, can you address these aspects?

And again, I'm really enjoying your posts! When I have some more time, I plan a post about you on my blog, which doesn't quite match your's in economic rigor:

www.flintexpats.blogspot.com

 
At 2/27/2008 10:34 AM, Blogger Walt G. said...

This article might not reflect wages that are annually increasing, but it's highly accurate for workers contemplating a fixed-income retirement. People tend to underestimate the effects of inflation on their pension, and that their personal inflation rate can be much higher than the stated CPI rate. The only thing more difficult than turning down a $62,500 GM buyout offer is figuring out how to live comfortably 35 years from now on a 2008 fixed-income pension.

 
At 2/27/2008 10:47 AM, Anonymous Anonymous said...

I still have massive (over 100k) student debit. Inflation is my friend, as demonstrated by this chart.

Of course it hurts my savings too - guess it is time to use my savings to pay off my student debt :)

 
At 2/27/2008 11:02 AM, Blogger Walt G. said...

Your education will be your friend in earning power over your lifetime. Most research shows education is a great investment.

 
At 2/27/2008 11:10 AM, Blogger happyjuggler0 said...

walt g. @10:34,

It is precisely that type of situation, combined with seniors putting most of their personal investments in either bonds or CD's, that shows the folly of those who think that inflation hurts the rich and helps the poor.

What inflation does is hurt the poor who have virtually all of their assets in cash, and also hurts retired people. The people helped are middle class home owners with mortgages, as well as the wealthy who borrow money against their wealth to get even wealthier.

Thus inflation hurts those who can least afford to be hurt, and helps those who least need government help.

 
At 2/27/2008 11:21 AM, Anonymous Anonymous said...

There is an answer to the problem of fixed income. Move to a destination where purchasing power is higher.

Increasingly, retirees are looking offshore to places like Nicaragua and Mexico.

There are also many seniors who continue to work past the age of 65. Statistically, those who remain active live longer and have higher mental acuity than those who retire and sit at home.

 
At 2/27/2008 11:21 AM, Anonymous Anonymous said...

You one ignorant dude.

http://quotes.ino.com/chart/?s=NYBOT_DX&v=d6

Dollar falling like a stone.

http://quotes.ino.com/chart/?s=NYBOT_CI

commodities all time highs.

This is currency devaluation at it's finest. Americans have been getting inflation broke off in their butts since 2002.

Hope you have some gold because you my friend are going to need it.

 
At 2/27/2008 11:31 AM, Anonymous Anonymous said...

"nitwitery" love that word! You present a compelling argument that all things do not remain equal.

Anon. 11:21
You forgot to mention the 'S' word, stagflation in your incantation of doom to come. On these occasions, Dickens' words spring to mind"

"Men's courses will foreshadow certain ends, to which, if persevered in, they must lead," said Scrooge. "But if the courses be departed from, the ends will change. Say it is thus with what you show me!"

By the way, "it's" is a contraction meaning "it is", the possessive is "its".

 
At 2/27/2008 11:41 AM, Anonymous Anonymous said...

http://mwhodges.home.att.net/inflation.htm

He's right and you are a very interesting fellow. They could use a someone like you at the FED to spoon feed the BS.

 
At 2/27/2008 11:44 AM, Blogger Frank said...

Don't forget that the cpi tends to overstate inflation. Conversely, wages may be understated b/c they don't include non-wage compensation. Taken together these factors indicate people's earnings have considerably outpaced inflation.

 
At 2/27/2008 12:09 PM, Blogger Walt G. said...

Frank, your wages might have outpaced inflation lately; mine has not.

Individual’s inflation rates do not track with the CPI, so that data is ambiguous for personal use.

My inflation rate is between +8% - +12% changed from last year, but my "market basket" is heavy on fuel and food. For example, my diesel fuel went from $2.62 to $3.69 since last year (that's a 40.8% change).

Track your expenditures and income for a few months or years and find out your personal inflation rate. You might be surprised. Don’t let someone else tell you about your own business.

 
At 2/27/2008 12:28 PM, Blogger Walt G. said...

Frank,

I realize that I did not address your non-wage compensation statement in my post above. I used a standard-of-living methodology; increases in my employer-paid health insurance did not increase my standard of living whatsoever. After all, I had health insurance last year and the same this year; there’s no personal difference. On the other hand, my pay increased about 3% while my expenses increased around 10%. I consider that a 7% loss in my standard of living. I’m not an economist, but I know that I was financially better off last year than this year.

 
At 2/27/2008 12:34 PM, Anonymous Machiavelli999 said...

I am really tired of people completelly dismissing actual numbers and FACTS and instead relying on random anecdotes. As if, at no other time in history was anyone ever poor and today we are at an incredibly, horrible situation because there are actually poor people out there.

This is the liberal way of thinking. They FEEL that something is wrong so it must be so. They FEEL that something is wrong with healthcare and gas prices and their candidate will do 'something' about it.

What is causing high healthcare and oil prices and what exactly that 'something' their canidate will do is doesn't really matter. As long as they FEEL that 'something' is being done about it, its OK by them.

The NAFTA debate I saw last night is by far the dumbest thing I have ever seen.

HARD FACTS: Day NAFTA enacted unemployment = 6.3%

Today (in a 'recession') unemployment = 4.9%

Yes, we really have lost a lot of jobs because of NAFTA.

 
At 2/27/2008 12:47 PM, Anonymous iamnorth@gmail.com said...

Feelings are often the result of people utilizing heuristics to establish that qualitative "fact" they sense. Heuristics should not be dismissed, though they are certainly not as "factual" as... FACTS -- as Machiavelli999 so eloquently states.

The individual perspective, certainly, is contingent upon each independent situation. For some, the economy may appear dismal while, for others, is incredibly fruitful.

Evidence of a thriving economy for (some) individuals:

CardTrack.com says "the percentage of people delinquent on their credit cards is the highest it's been in three years," according to CNN. Over the past year, U.S. consumers have charged "more than $2.2 trillion in purchases and cash advances.

http://consumerist.com/361301/late-payments-on-credit-cards-highest-in-three-years



Evidence of a thriving economy for (some) corporate entities:

NEW YORK (CNNMoney.com) - Exxon Mobil Corp. set U.S. records for annual and quarterly profits Monday as it easily topped fourth-quarter earnings forecasts.

The nation's largest oil company reported net income in the fourth quarter of $10.7 billion, or $1.71 a share, compared to $8.4 billion, or $1.30 a share, a year earlier.

http://money.cnn.com/2006/01/30/news/companies/exxon_earns/

If I am an executive at Mobil, it is unlikely that I will be late on my debt service payments and my near-term outlook for the economy is favorable.

If I am a line employee of KMart or Home Depot, my near-term outlook may be quite negative.

 
At 2/27/2008 1:16 PM, Anonymous Anonymous said...

Nowhere in the piece did Ransom talk about wages. He referred to the declining purchasing power of a fixed annual sum of income, e.g. a fixed annuity, a cola-free pension. Ransom is, of course, right. Perry overreacted and is setting up a straw man.

 
At 2/27/2008 1:22 PM, Anonymous Fred said...

"Don't forget that the cpi tends to overstate inflation."

Really? Show your work.

 
At 2/27/2008 1:27 PM, Blogger Walt G. said...

Machiavelli999,

If you are laid off, you have a personal 100% unemployment rate. Isn't that an actual number or fact?

 
At 2/27/2008 1:28 PM, Anonymous Anonymous said...

Really? Show your work

I'm not John Williams buy you could sink your teeth into Shadow Government Statistics.

 
At 2/27/2008 1:33 PM, Blogger OBloodyHell said...

Bad Economical Reasoning? No!! No one ever has that!!

Me, I'm waiting for the WSJ editorial on how the thug breaking the shopkeepers' window stimulates the economy...

> These are averages, so the growing disparity in income in the U.S. seems to be a real issue that needs to be reckoned with in these calculations.

1) See first paras above.
2) Why? Other than simple ENVY, why does how much Jones down the street makes of ANY RELEVANCE TO YOU? Do you have food? Your kids' college paid for? Your house in good repair? You have a flat-panel TV, a cell phone, TWO CARS? Becasue THESE are what are relevant. The first part of that because THOSE are necessities. The latter because they are present for MOST people in America (far more than at any time in US history) and thus, despite this "all-important" disparity in income, the "average" US citizen is richer now, in both adjusted income and "comfort assets" than at any time in US history. But somehow, "we're worse off than ever"? Gimme a break!

"Income disparity" is nothing but an appeal to greed. You know, one of the "seven deadly sins". You don't like the disparity? Tough. Get another job. Work harder and get ahead at the one you have. The one thing I've noticed that is a consistent factor in people who make more than US$ 50k? Working MORE than 40 hours per week. Lots more. Typically, 60+ hours per week. Often more than that during the time (i.e., college, or early work history for non-college skills) when they were getting themselves the skills which would pay notably better than minimum wage.

" ... I recall one candidate's promise that I heard during the presidential campaign of 1976, a campaign promise that seems to me to illustrate how far American rationality had skidded:
'We shall drive ever forward along this line until all our citizens have above-average incomes!'
Nobody laughed."
- Robert A. Heinlein, 'To Sail Beyond the Sunset' -

> It's like Bush using the average tax cuts all Americans got...we know the bulk of the cuts benefited a select few at the top, but when you average it out, it deceptively looks like all citizens got a decent tax cut, which is not true.

Well, it's kinda hard to actually cut taxes you don't pay.

Go hunt up a breakdown of who actually pays taxes in the USA -- what percentage of the US tax burden is paid each year, by income bracket (I could find one easily, but you won't listen to me, I'm quite sure). What you will find is that the ones who actually pay taxes are generally not even *IN* those lower brackets. Thanks to any number of income redistro schemes, the breakpoint is about that of the "average" household income -- of $56k a year. I grant, that's not a lot in SF, but in most parts of the country, that's a damned good income.

You're right. You aren't an economist (neither am I, BTW). Trust me when I say, there are a lot of things about economics which defy "experience and common sense" reasoning. Once you start learning of them, you can begin to guess where your experience and common sense don't work, but until you actually take the time to learn, you aren't going to figure things out correctly.

1) Economics is one of the most complex topics currently being investigated by man. It ain't easy by any measure. Half of what you think you understand about it is flat-out wrong. The rest is just complete bullsh**. I don't mean that insultingly -- it's actually the truth. I've got friends who have studied the subject. Discussions have led me to grasp that of my own earlier, uninformed opinions, and I'm a mathmatician by training, so it's not like sloppy reasoning or lack of sense is a weakness. This leads to...

2) Much of economics is inherently counter-intuitive and not subject to "common sense". The "broken window fallacy", for example, is a common misunderstanding. The notion that the Fed can actually "save" money is another. They can buy assets which can go up in value, but they cannot actually just "set it aside" for later use" as a person or business can. Those are a couple of such counter-intuitive notes, but there are a LOT of them.

Some good starting points would be to look up old columns by both Thomas Sowell and Walter Williams -- both readily available on the net (Townhall is just one place). They often revisit topics as current events allow, so skip around, there is a wealth of subtle economics understanding to be gleaned just from those columns.

For some alternative views, www.Mises.org has a regular daily article they send out (they tend to be very dreary about the long-term economy) -- as long as Mises.org sticks to economics, they can be quite enlightening (Rockwell, the editor, is an isolationist nutjob among other things, on general political topics -- but Mises does a good job on making basic economics approachable).

These are two good articles, too:
The Nation That Lost Its Jobs, But Got Them Back

The Broken Window Fallacy Reapplied


I also recommend P.J. O'Rourke, esp. "Eat the Rich", wherein he looks at a dozen nations using different "systems" from almost total anarchy to rigid socialism for what makes them wealthy.

 
At 2/27/2008 1:40 PM, Blogger OBloodyHell said...

> The only thing more difficult than turning down a $62,500 GM buyout offer is figuring out how to live comfortably 35 years from now on a 2008 fixed-income pension.

Boy, talk about "nitwitery".

a) "35 years from now"? If you're young enough that you plan to be *alive* 35 years from now then you really need to be looking at investing that money and finding a new career -- not retiring. Assuming one plans to live to age 90 (which is notably above the average LE), "35 years from now" means you're 55 or younger. That's not retirement age.

b) If you plan to utterly retire -- that is, stop working entirely for the rest of your life -- then you need to have invested a decent percentage of your money into assets, at least some of which will go up in value over the long term. If you did not start this by about 15 years before you retired (preferably 30), then forget about it. You never had enough of a clue to retire like that in the first place.

 
At 2/27/2008 1:54 PM, Blogger Walt G. said...

obloodyhell,

a) I'll soon be 53, I've built a pretty good skill set, and I've worked at least two jobs most of my life.

b) I've invested well, but I'm still cautious and tend to over plan things.

c) No need for name calling. It does not help your post's credibilty.

 
At 2/27/2008 2:01 PM, Blogger OBloodyHell said...

> My inflation rate is between +8% - +12% changed from last year, but my "market basket" is heavy on fuel and food. For example, my diesel fuel went from $2.62 to $3.69 since last year (that's a 40.8% change).

Using a single unusual year with a particularly egregious spike in fuel costs (which ripples into everything else, as should be ridiculously obvious) to argue about something that is generally time-averaged is blatantly specious reasoning.

Furthermore, depending on your job and situation, fuel costs+food are an all-important but minor portion of one's yearly expenditures, probably much less than 25%, typically like 10%.

The increase in RE property values in many areas is far more relevant, as it drives up housing costs (including rental, for those who rent), as it raises taxes significantly for no benefit to the owner. In the last 15 years the cost of a rental where I live (not Cali) has literally almost doubled -- something that was ca. $450 in 1992 is now about $850. A "starter house" has gone from ca. $75k to $200k. *That* is a much bigger hit. Great for anyone who bought back then but not for anyone who is buying now or renting.


OTOH, if you invest well with your savings, over the decades, it's not hard to keep well ahead of inflation. A net return on assets, over the course of 30 years, of 5% is adequate to keep one fairly well heeled in one's old age. If you weren't smart enough to put in small amounts early on, well, you can blame two things:
a) the lame-ass educational system which taught you "self esteem" instead of basic financial strategy for living a long life.
b) your own lack of foresight in learning these things on your own.

The interest curve on a slow, steady 30 year investment averaging 5% is.... interesting. It should be required teaching to all kids and teens to the point where they all know it even if they could care less about such things, as kids are wont to do. That way, when they get responsibility for their own future they will know how to apply it.

 
At 2/27/2008 2:12 PM, Blogger Walt G. said...

Although some metric is needed, my point was that the CPI does not measure anyone's cost of living.

Yes, compound interest is great. It should be required reading for all.

 
At 2/27/2008 5:17 PM, Blogger Frank said...

Regarding the CPI overstating inflation:

http://en.wikipedia.org/wiki/Boskin_Commission

http://www.ssa.gov/history/reports/boskinrpt.html

 
At 2/27/2008 7:47 PM, Blogger juandos said...

anon @ 11:21 am rants in typical libtard fashion: "You one ignorant dude"...

I love the links pal... Funny how absolutely ridiculous they are...

It couldn't be that the dollar is dropping like a stone because of the massive, nanny state socialism we are dealing with, could it?

Imagine the money we could save if we used sure fire methods of deportation...

 
At 2/27/2008 8:10 PM, Anonymous Anonymous said...

Well, is the whole point of the exercise that Perry has no goldilocks data to bring to the table? He was ranting and raving in the recent past about how great the banks weren't.

Today the Fed Chair hauls his posterior up to Congress and unequivocally states in Fedspeak that the federal funds rate is going to drop at the next meeting on March 18 and the S&P500 yawns to a flat close.

Wall Street is going to tank the market and force Bernanke's hand again. It's ZIRP and you better get used to it. And then all the goddamn economists should resign from their perches of incompetence.

 
At 2/27/2008 8:51 PM, Blogger juandos said...

You know anon @ 8:10 pm it would've been interesting if the FDIC would've also shown just how much was extorted from the banks in the form of taxes...

Meanwhile are people listening to David Walker?

 
At 2/28/2008 9:56 AM, Anonymous Anonymous said...

Anon. 2:01,

"The interest curve on a slow, steady 30 year investment averaging 5% is.... interesting"

Aren't you forgetting a little thing called taxation? Agree that the financial and economic literacy is abysmal reflecting not only inadequate education but also widely disparate parenting skills.

Juandos,

David Walker is absolutely correct. Unfortunately, both parties are keep concocting new spending plans.

Interesting article in the WSJ Obama's Patriot Act offers a further twist:

http://online.wsj.com/article/SB120407121574294919.html?mod=googlenews_wsj

Good news, in Canada, we have a prime minister who is an economist. Finally, we have a government who is committed to paying down the debt and maintaining a balanced budget. In the face of a high dollar, the Canadian government is lowering taxes including bring corporate taxes in line with Europe. In 2008, businesses in Ont. will be able to file a combined Federal/Provincial corp. tax return rather than 2 separate returns.

Don't think the average Canadian gets it but it makes a nice change from the "fiddling while Rome burns" approach taken by the Liberals. Always thought the bumper sticker said it best:

"Support organized crime. Vote Liberal."

 
At 2/28/2008 1:48 PM, Anonymous Anonymous said...

Prof. Perry,

You have not touched on Mr. Ranson's use of the price of gold to predict inflation. Would be interested to hear your take on that aspect of his argument.

 

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