A Different Way to Measure Inflation and the Value of Time
A rapid increase in the rate of inflation, to levels not seen in decades, has dominated the news this summer. There are many consequences of rising prices, including significant effects that will last far into the future with higher interest rates both for long-term savings and long-term mortgages.
Inflation is like a shockwave. It is triggered by something specific and its effects balloon wider and further in time, burdening future years with increasing costs for lenders, borrowers, and consumers. The latest inflation shock began with the combination of vast quantities of money printed during the pandemic colliding with supply chain bottlenecks and fear of war both active (in Ukraine) and threatened (in the far east). The shock spread itself out, so that the very thought of inflation is now sufficient to drive up prices – when, for example, a company increases both its employee wages and its client prices by 8% thinking that inflation will continue at that rate indefinitely.
Inflation is not a decrease in the value of money itself. Money has, of course, no intrinsic value. Money is just bits of paper bills, metal coins, or electronic signals. Both the cause and effect of the value attached to money is the belief of the buyer and seller who use money as a medium of their exchange. The money itself has zero value in the trade because its quantity always remains fixed: a $100 bill can always be exchanged for a good or service priced at one hundred units of currency.
The value that the $100 bill represents, however, is the future worth of the good or service as buyer and seller believed it to be at the moment of exchange. The value of the good or service will be realized over time, sometimes very rapidly (say, a piece of bread in the hands of someone who is hungry) and sometimes very slowly (say, a vehicle that will serve its driver for ten years). Needless to say, $100 acquired a far greater value one hundred years in the past than it does now. The Bank of Canada’s inflation calculator indicates that the same goods that $100 bought in 1922 would now cost $1,682.42 – an increase of 1,682.42% That represents an annual compounding rate of inflation of around 2.9% for the past century. Inflation has been ingrained in our beliefs for a long time, and in each passing year we value the future that much less than the present.
So now our belief in the value of time is becoming strained and the future seems to be worth still less than the present. The rate of inflation is increasing and its effects are expanding in a shockwave. Once they start, shockwaves are difficult to stop. Since it is based on belief, the only way to quiet an inflation shockwave is to confront our beliefs about the future.
Does the current method of measuring inflation truly represent our beliefs about the value of the future? What would happen if we stopped measuring inflation only by the present prices of goods and services based on their past values, like the price of gas today compared to last month? Consider an alternative: measuring the future value of goods and services based on their present trends in value.
Here’s an example. As inflation is now measured, the price of fuel required for the majority of vehicles is a major contributor. The future of gas-powered vehicles, however, is very limited because the major manufacturers have pledged to stop making them by 2035. This means that, practically speaking, their value will decrease significantly by 2030 or even earlier – because buying a gas-powered car in 2030 will provide zero resale value and the cost of operating it will increase as drilling for oil and gas becomes uneconomic and gas stations begin to disappear. Already in the past year electric vehicles (EVs) account for 5.6% of vehicle sales in the United States, double the year before and nearly half the rate in Europe. Gas-fuelled vehicle sales have, of course, not doubled in the past year. Although the rate of increase in EV sales will slow over time, EVs are poised to become the mass-market standard.
An argument can then be made that the cost of gasoline, while volatile and now significantly higher than last year, should carry less weight in the calculation of future values. If the future is infinite (let’s assume, because we have no way to prove otherwise) then gasoline vehicles will have a value that disappears in an infinitely small fraction of time, in 13 years. The ratio of thirteen years to infinite years is tiny – there aren’t enough zeroes in the universe to place after the decimal when thirteen is divided by infinity. So shouldn’t the increasing demand and decreasing cost of EV’s factor into the calculation of future value as inflation is measured?
When I invest money today, or if I obtain a mortgage, why should my rate of return or interest cost twenty years into the future be based on an inflation measurement that includes a spike in the cost of gasoline in 2022 that few drivers will use after 2035 (and hopefully much sooner)? It doesn’t seem logical.
What would the inflation rate look like, if we factored in the rate of change in current market trends – whether it’s the increase in EV sales, or plant-based foods that are becoming standard fare on menus, or rapidly expanding demand for and availability of solar power – and considered their rapid decrease in cost and increase in quality?
These factors would reduce measured inflation, and tame the spreading inflationary shockwave. We just need to look at the expression of belief in our future – in the expanding cash flows of the EV industry, plant-based food suppliers, and solar energy producers – to see our future taking shape. It seems to be a brighter future than the current rate of inflation measures.