Inflation Distortions

INFLATION DISTORTIONS

A bit of financial trivia that received a lot of attention in November was the increased cost of Thanksgiving dinner this year. According to the American Farm Bureau Federations’ survey, a turkey dinner for five with all the fixings cost about $49.20 this year, a 13% increase over last year. This price jump seems significant until it’s compared with the cost of the same meal during the Great Depression.

In a November 26, 2011, article for the Salt Lake City History Examiner, Rachel Quist did some research and calculated the cost of a similar turkey dinner in 1934. The amount: a mere $4.38 – until you adjust for inflation. In today’s dollars, the 1934 meal cost $72.73 – a difference of $23.53. Put another way, a 2011 Thanksgiving dinner cost 32% less than it did in 1934. Who would have expected that?

We all know inflation exists. In fact, we expect it and accept it as part of our financial lives. Some of us can remember when gas was $1.00/gallon and hamburgers were 50 cents, and recognize it’s unlikely we will see those prices again. But over time, inflation makes it hard to determine where we stand. Here’s another example:

According to the Internal Revenue Service, Americans filing a joint tax return in 1953 paid a top marginal tax rate of 92% on taxable income in excess of $400,000. A 92% tax rate is steep in any time period, but it’s the $400,000 threshold that might be worrisome to many people – until you adjust for inflation. According to Department of Labor statistics, $400,000 of taxable income is equivalent to $3.4 million in today’s dollars. So while the top-end tax rates were obviously high in 1953, a very small percentage of Americans reached that level of taxable income.

Inflation’s greatest distortions of perceived value occur when longer time periods are involved. This is one of the reasons calculating a “retirement number” is a dicey proposition. Suppose you are age 45, and want to retire at age 65, with an accumulation that can provide 75% of your annual pre-retirement income. What’s the inflation factor for 20 years? In short order, you find that if inflation averages 3%, $1 million in today’s dollars must increase to almost $2 million to maintain purchasing power. Suddenly, it occurs to you that $1 million is no longer a big number. And the task of reaching your financial goals may suddenly seem overwhelming. But don’t despair. It’s helpful to remember that inflation also tends to bump up incomes as well as costs – although not always to the same degree.

Given the capricious history of inflation, you can’t really “plan” for it, even though you are aware of its financial impact.

The only psychologically healthy and rational strategy is to guard against risks, consistently maximize your present transactions, and adjust as you are able. Meanwhile, enjoy the things that are less expensive today, even if inflation makes the price higher.

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One Response to Inflation Distortions

  1. Erik says:

    Kim,

    Enjoyed this article. You highlighted a point not understood by a vast majority of people.

    Erik

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