Wage Increases vs. CPI Increases

In discussions of social security, I've been hearing that wage increases are generally greater than CPI increases. That is, wages increase faster than the costs of goods and services.

So that means that over time people have more and more disposable income? I'd expect that things would generally even out. Am I missing something?

[laurence]

You got me, T-Al! It's my understanding that disposable income has increased over the last century, a.k.a. our standard of living continues to go up. But I didn't think the difference between disposable income and CPI would be enough for the kind of savings they are counting on. But yeah, it makes sense there is a difference, for our real GDP to go up, there has to be, otherwise it's a recession, yadda yadda.

[cute fuzzy bunny]

Part of the problem is that cpi does not reflect actual inflation in a lot of areas of the country.

[unclemick]

I think the Brits(Thatcher??) figured that out a while back so their govt went to calculated inflation not wage data.

Guess who makes the calculation?

heh, heh, heh.

[uncledrz]

Originally Posted by unclemick2

I think the Brits(Thatcher??) figured that out a while back so their govt went to calculated inflation not wage data.

Guess who makes the calculation?

heh, heh, heh.

That's exactly the reason I think there is more risk in the I bond or TIP than we are told by the issuer. The government/issuer decides the rate at which, at least, a part (the inflation factor) is paid. That rate is likely to change when budget pressure increases.
Uncledrz

[cute fuzzy bunny]

Ding ding ding...we have a winner!

[wabmester]

Originally Posted by uncledrz

That's exactly the reason I think there is more risk in the I bond or TIP than we are told by the issuer.* The government/issuer decides the rate at which, at least, a part (the inflation factor) is paid.* That rate is likely to change when budget pressure increases.

I'm not sure that I'd call that "risk." First, an inflation premium is supposed to be built into all bonds (not just inflation indexed bonds), so if the market believes that the fed is under-reporting inflation, that should be reflected in how the market prices the bond. Second, you can always sell the bonds if you feel you're being undercompensated and invest elsewhere, so this "risk" doesn't seem to affect your returns.

Bottom line: bond yields are a function of market forces, not government fiat.

[Michael]

I'd expect that things would generally even out.

With respect to SS, things would even out if the number of workers supporting one retiree remained constant. *The problem is that there will be fewer workers, and more retirees. *The politicians want to cut benefits as the solution. *Changing to inflation indexing instead of wage indexing will cut benefits in a sufficiently complicated way that many voters will not know what has happened.

[charlie]

Wab, nice to hear from you again. I think you are right on
the money with your CPI comment. The feds can't do much
to control long rates and CPI is the only game in town, even
if it is wrong.

Cheers,

Charlie

[uncledrz]

Originally Posted by wabmester

I'm not sure that I'd call that "risk."* *First, an inflation premium is supposed to be built into all bonds (not just inflation indexed bonds), so if the market believes that the fed is under-reporting inflation, that should be reflected in how the market prices the bond.* *Second, you can always sell the bonds if you feel you're being undercompensated and invest elsewhere, so this "risk" doesn't seem to affect your returns.

Bottom line: bond yields are a function of market forces, not government fiat.

Wabmester
I agree with you that at the point the return or projected return on any bond does not fairly compensate, the instrument can be sold.
I also agree that any bond does have an inflation premium built in. Thus, a 6% bond may have a 3% inflation premium and 3% real return.
I do not agree that government inflation adjusted bonds (I and TIPS) are structured so that yield is a function of market forces. The bonds are sold at par with a fixed rate and an inflation adjustment. The inflation adjustment is based on CPI. CPI is a government generated figure that is subject adjustment in the actual figure, but more importantly to adjustment in the method of computation.

As the upcomig budget crunch becomes more severe, the potential to adjust to benefit the government, IMHO, will increase. Its not just the bonds that are subject to this adjustment, but other government payments as well. I believe that the potential to "adjust" the numbers is present.
Don't believe me, look no further that the figures presented to Congress regarding the cost of Medicare prescription drugs. True figures were held back.

BTW, I'm still holding the I bonds, bought some time ago. Think they are a good investment at this time. I do, however, recognize the potential for the government to play games with the return.
Uncledrz

[charlie]

uncledrz,

I am not very sophisticated about bond pricing, but it seems to me
that the market does influence the issue price of new I-bonds and
TIPS even if indirectly. After all, if the gov wants to sell them they
have to compete with prices in the secondary market. Yes, I
agree that CPI as calculated by the gov could be manipulated
but it seems to me that the calculated CPI and the perceived
inflation component assigned by the market could not differ
by much due to arbitrage ..... I totally agree with Wab even if
he is more articulate in expressing this view.

Cheers

Charlie

[wabmester]

Originally Posted by uncledrz

I do not agree that government inflation adjusted bonds (I and TIPS) are structured so that yield is a function of market forces.* The bonds are sold at par with a fixed rate and an inflation adjustment.

Sorry, that's not quite right.* * TIPS are sold at auction just like any other treasury.* *The govt says "here is the CPI, here is the real rate, now what do you bid?"* *The bonds can sell for above or below par, depending on what the market feels those coupons are worth.

And i-bonds are a bit strange, but basically the govt takes an average market-based 5-year real yield and sets the real yield of the i-bonds slightly below that average to reflect the fact that you can cash them in after only one year.* *Personally, I think i-bonds at 4.8% are a no-brainer.* * You simply can't find short-term treasury debt at that yield anywhere else.

As Charlie says, the treasury has to sell govt debt in a very competitive market.* *That competition with other bonds severely limits the games they can play with the numbers.

[cute fuzzy bunny]

Granted the initial sale is competitive, but the after-the-fact adjustments to the largest piece of return is not.

They stop becoming a no-brainer when some more basket substitutions and hedonic adjustments are dialed in to bring "inflation" back below 3%.

Greenspan already said he believes CPI overstates inflation by more than a percent. People who I actually listen to say its understating it by more than a percent.

I'd rather play with assets that arent directly manipulated by the same people who have to pay out on them.

[wabmester]

Originally Posted by th

I'd rather play with assets that arent directly manipulated by the same people who have to pay out on them.

You mean like those 3.5% munis you love? 3.5% means a negative real yield according to the current CPI, which you believe understates inflation, so how do you translate your lack of faith in the CPI into a money-making plan?

[cute fuzzy bunny]

Uhh..gee mr. threadcrapper

I have about 3.5% of my total investments in munis.

Principally because I like a little dribble of money into the checking account every month that doesnt affect our tax profile.* With the new working wife I've had to throttle back on ordinary income taxable inflows.

Given our particular situation, the 800 bucks a month I have coming in from munis and tax-free money funds keeps us in boxed wine and lobster tails.* And its worth about 4.5% if I took it and the rest of my tax frees as taxable.

Or I could slap it into ibonds, not get any current income, watch it grow by 1.2% plus whatever the gods of CPI decide is the premium over the next 5 years, and regularly wonder whether to take the interest hit between now and then to dump them or ride it through.

Man am I going through some major portfolio rearrangement with this new wife that wont quit working thing...from a high current income plus enough capital gains to offset inflation to medium to long term growth with a little current income and a substantially lowered tax profile...jeesh...

By the way, I love Ren and Stimpy...

[wabmester]

Originally Posted by TromboneAl

In discussions of social security, I've been hearing that wage increases are generally greater than CPI increases.* *That is, wages increase faster than the costs of goods and services.

So that means that over time people have more and more disposable income?* I'd expect that things would generally even out.* Am I missing something?

Alright, back to the original question: CPI only tracks the cost of a "typical" basket of goods.* *It is not a gauge of consumer spending, personal savings rate, or income taxes, so it doesn't necessarily track wages.

And as for those evil hedonic adjustments TH is always ranting about, if you bought a 386-based computer in 1990 for $1000, the cost of an equivalent computer today would be about $20.* * *That deflation is factored into the CPI indirectly through hedonic adjustments -- the BLS basically says "OK, you still spent $1000 for a computer, but you got a much more powerful machine, so we'll treat that as the deflation it really is."* * That's just one example of how consumer spending can increase without the CPI increasing in tandem: improved quality of life.

It would be interesting to find a long-term chart of spending vs wages vs CPI, taxes, savings, debt, other income, etc., but I didn't find one with a quick google.

[cute fuzzy bunny]

I think you're still mad because I got that baby monitor to work and yours is a lawn ornament.

I still dont like hedonic adjustments. What is "improved quality of life" for one person is of no additiional value or a detraction to another.

For example, I saw a very good study done that conclusively showed that a high speed internet connection and a faster computer were detrimental to performance and 'quality of life'. With a low speed connection and slow computer, people tended to be very picky and choosy about what they did and often thought things through more thoroughly. With the faster connection and computer, they spent more time online, looked at and participated in far less "wholesome" or "beneficial" activities than they did with the slower setup, and often reacted and responded to things with less thinking in manners that caused them to have to do damage control later.

I've seen some really good calculations where a common basket of goods and services were put together and tracked for a 20 year period. No attempt was made to substitute goods, determine 'quality' or 'life improvement' of the goods and I had no argument at all with their methodology.

That you will be 'happier' with a product or that it will make your life 'better' is irrelevant to this calculation - its simply supposed to show how more expensive a product has become. A car still just gets you where you're going. A steak still gets eaten. A computer still wastes 4 hours of your time every day.

Steeeempy you idddddiottt!

[wabmester]

Originally Posted by th

I've seen some really good calculations where a common basket of goods and services were put together and tracked for a 20 year period.* No attempt was made to substitute goods, determine 'quality' or 'life improvement' of the goods and I had no argument at all with their methodology.

That would be interesting to see -- can you point me to that one?* * Let's see, 20 years ago I would have had an 8088-based desktop with a 10MB hard drive and 1200 baud modem, and my new car would be a fantabulous Chevy Vega or equivalent.* * I wonder how they followed the prices of equivalent goods over 20 years.*

[cute fuzzy bunny]

Easy, a dell 2400 computer and a compact chevy sedan.

Both samples of a standard product of its category that performs the function it was purchased for.

As far as the chart I referenced, I'll see if I can find it later. It was pretty simple though. Guy took a pound of ground beef, a gallon of milk, a gallon of gas, a midsized chevy sedan, etc, standardized them for a families consumption level vs the other items, then plugged in the prices for those over that 20 year period.

Honestly, I think its probably more a function of smart people without enough to do trying to get too fancy for their own pants than someone trying to deceive.