Making sense of some graphs

Perhaps some of you are questioning the things that I say for lack of empirical evidence.

The reason for this is twofold.

Firstly, I wasn’t sure how to add pictures to the posts before. Stupid I know.

Secondly, following the misesian study of economics, I am a big believer in the praxeological method. Praxeology, does not rely on empirical evidence. In fact, empirical evidence is often unreliable. Like I’ve said before, the economy is a very big complicated machine, this makes it hard to back-up causal relationships with empirical evidence, since we have a great amount of uncontrollable variables.

That is why the Austrians method, relies on constructing economic theory from pure abstraction. This means, that economic theory should be achieved through a process of rational thinking, relating concepts and ideas which are undeniable laws of nature and human nature.

This doesn’t mean empirical evidence isn’t helpful, but we have to be VERY careful when we draw conclusions from them.

Having clarified that, lets have a look at gold and inflation.

Like I’ve argued before, following gold prices is the best way to measure inflation. Lets observe how gold and the CPI (the gov’s measure of inflation) behave over time.

This graph starts in 1970, roughly the time when the U.S., and consequently most of the world, abandoned the gold standard.

What we see here, is that gold and oil increase much more than the CPI. The CPI is vastly understating inflation. This is because the CPI is not a good measure of inflation. Taking aside the unreliability of the data itself, the fact is, that the CPI doesn’t account for changes in the quality of goods, for example, it only looks at the price, and therefore doesn’t account for the quality/price tradeoff which might happen during bad and good times.

Also, you will notice that gold and oil correlate. This is because changes in the price of oil during the 1980s, despite the fact that most economists simply called them “oil shocks”, were indeed caused by inflation. Money printing in the 70s led to abandoning the gold standard and high inflation, this made oil prices worldwide (since most currencies were linked to the dollar) rise. It was NOT an (apparently unexplainable to modern day economists) rise in oil which led to inflation, but rather inflation that caused oil prices to rise.

Again, this reflects the bias of historical analysis, which doesn’t acknowledge the blunders of Nixon administration in being responsible for the oil “shocks”. But just as people don’t question anything when they are told -inflation is an increase in the price level.- They also don’t bother to question things like this. Lack of critical thinking, that’s the problem today, I always say it.

Here’s a more comprehensive view. Can you see how gold prices in fact LEAD inflation. Interestingly, this relation breaks down completely in 2004, where they start going in different directions. What’s going on?

We can learn more of this disparity by looking at this graph.

 

This graph compares the CPI with the big mac index. The big mac index is another good way of measuring inflation, by looking at the changes in the price of Big Macs, which are available in almost every country.
As we see, the disparity is clear. Big Mac prices have increased much more than inflation, and the same goes for many other goods. So if the CPI was unreliable in the 1980s, it is even less reliable now.
Why is this important? Well, inflation also has a great effect in measuring real gdp. If the account of inflation is wrong, so is the account on GDP. Have a look at this.
Now do you see why I am always saying that the economy ISN’t really growing? That we are still in recession, and that perhaps, the worst is yet to come?

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