It’s Your Money: Interest rates can’t match inflation
by Mark Rosenberg
Aug 21, 2014 | 2334 views | 0 0 comments | 3 3 recommendations | email to a friend | print
There’s a joke about the milk bottle game at Coney Island: A terrible storm swept through and flattened the entire amusement park; nothing was left standing — except those milk bottles.

It’s not really that hard to knock over the milk bottles. The Santa Cruz Beach Boardwalk has the same game, and I threw many a ball at those bottles as a kid, winning Mexican jumping beans, Chinese finger traps and other useful prizes.

On a recent night, I was at the Boardwalk and noticed the milk bottle game is still there. You get three throws for $2. When I was a kid, three throws cost 10 cents.

That’s a 1,900 percent price increase in 45 years. Assuming semiannual compounding, that works out to 6.76 percent inflation per year.

Apparently, Federal Reserve Chair Janet Yellen doesn’t play the milk bottle game. In an effort to justify the Fed’s easy-money stimulus policies, Yellen says inflation is running below the Fed’s target rate of 2 percent per year.

Apparently she doesn’t go to the grocery store, either. Last week, I was at a local supermarket and stopped to chat with an employee. I asked if he thinks the cost of food is rising by less than 2 percent per year.

“No way,” he said. “Bananas were 3 pounds for 99 cents 10 years ago. Now they’re 67 cents a pound. Apples were 99 cents a pound a few years ago. Now they’re $2.49. Lettuce, onions, they’re all going up by much more than 2 percent a year.”

Nearly everywhere I look, I see inflation: at the gas pump, insurance costs, airline tickets, college tuition, government services, and on and on.

Inflation is caused by too much money being spent on too few goods. The Fed’s easy-money policies — intended to boost the economy and create jobs — are stoking inflation.

Why would the government understate inflation? To save money. Cost-of-living adjustments for Social Security and federal pensions are linked to inflation, as measured by the Consumer Price Index (CPI).  

In 1996, the U.S. changed the way it calculates the CPI. It added “hedonic adjustments” that work like this: Last year’s model of a computer cost $500. This year’s model also costs $500 but has added features (which most of us won’t use). Under the hedonic adjustment formula, the price of that computer dropped, and that supposedly lowers our cost of living.

Another change was “substitution,” which says that if the price of oranges goes up, but the price of grapefruit does not, then I can buy grapefruit instead of oranges — therefore my cost of living didn’t rise.

I don’t know how much the cost of living is going up, but I believe it’s substantially more than the official rate of 2 percent. Some experts say it’s going up by more than 5 percent a year.

That means if all of your savings is in bank accounts paying you 1 percent interest, you are losing buying power. If the price of oranges goes up by 5 percent a year, and your savings grow only 1 percent a year, then you can buy fewer oranges every year.

This leads to another effect of artificially low interest rates: They force investors to move money out of low-yield bank accounts and into stocks and real estate, which aren’t guaranteed like a bank account, but give investors a chance to stay ahead of inflation.

Does this mean you should run out and put all of your money into the stock market or real estate? No. But it does mean that when devising a financial plan, remember that the cost of living is going up by much more than what the government would have you believe. 

- Mark Rosenberg is a financial adviser with Financial West Group in Scotts Valley, a member of FINRA and SIPC. He can be reached at 831-439-9910 or mrosenberg@fwg.com.

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