Thursday, 31 March 2011 - 20:00

 

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True Inflation?

If you speak to any housewife (or person who’s in charge of household spending) about the cost of living they will inform you, in no uncertain terms, that the inflation rate that the government publishes on a monthly basis is not the same as the inflation that they experience day to day. They will argue that real inflation is far in excess of reported inflation.

For people who aren’t ‘at the coal face’ in shopping malls on a regular basis (but who possibly fund the expenditure) these accounts can be explained away using a few sound arguments:
• Improving standards of living (i.e. buying the same amount of, but more expensive, goods and services) – therefore expenditure grows quicker than inflation.
• Growing households (i.e. buying more of the same priced goods and services as the family unit grows) – therefore expenditure grows quicker than inflation.
• Different inflation rates for different income brackets / different regions. It is true that different baskets of goods grow at different rates.
• Anchoring of prices and not realising the impact of compounding inflation over long periods (a loaf of bread bought for R1.00, 25 years ago, would now cost R7.69 using the reported inflation rate of 8.5% pa).

While all of these are sound arguments, and will more than likely explain at least a portion of the story, The Economist has produced their own (light hearted) inflation index for a range of countries. Similar to the Big Mac Index – which looks at the relative strength of a variety of currencies against the US dollar based on the price of a Big Mac – The Economist has produced a Big McFlation Index!

In this light-hearted review they calculate the annual percentage increase in the price of a Big Mac across a variety of countries. The logic behind the argument is that a Big Mac is a fairly standard product across the world, that hasn’t changed over time, and includes a wide variety of inputs (agricultural commodities (beef, bread, lettuce, cheese), labour (blue and white collar), advertising, rent and real estate costs, transportation, etc).

The Economist then compares the inflation rate of a Big Mac with that of the official inflation rate in these countries. The results are shown in the image below:

As you can see, most countries have been underestimating their inflation rate on this measure (i.e. price of a Big Mac has been increasing faster than official inflation). In some countries the difference is particularly high, and in some the official rate is higher than the Big McFlation rate.

You can see that on this measure South Africa has been underestimating inflation by just over 2% per annum (just over 40% on a cumulative basis). Countries with a higher nominal inflation will typically have a greater error in this type of analysis.

If The Economist’s index is a true reflection of reality then it is even more important for investors to invest in growth assets that are able to grow at a rate faster than true inflation as opposed to cash which, on an after tax basis compared to the Big McFlation Index, is guaranteed to lose you purchasing power over the long term.

For a link to the full article, and to be kept up to date with investment and economic news click through to our Facebook Fan Page and click ‘Like’ at the top.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Thu, 31 Mar 2011

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