Monday, July 21, 2014

You'll get no edge with Zero Hedge



(This post originally appeared at Bloomberg View.)


I can’t tell you that gold is a bad investment. Even after the recent plunge, if you bought gold in 2004, your investment would have earned you an annualized rate of about 10.4 percent, after accounting for inflation. That is darned impressive. If you bought in 1994, it would have earned about 3.9 percent per year -- not too shabby. Even if you bought all the way back in 1984, you would have earned 1.8 percent in real terms. (Of course, this assumes that shadowstats.com is wrong, and that inflation hasn’t been massively understated.)
In addition to delivering decent long-term returns, gold has been a way to spread or offset investment risk. As my co-blogger Yichuan Wang showed last year, gold’s return is somewhat negatively correlated with interest rates, so that a bet on gold is to some degree a bet on lower rates. This is actually the prediction of some old economic models, which also indicate that gold should have a positive rate of return over the long term. But a lot of the variance in the price of gold isn't explained by such factors, meaning that some small amount of gold is a valuable addition to any well-diversified portfolio.
But there are two big words of caution with respect to gold. The first is that you shouldn’t believe the standard story for why gold will go up. The second is that you should be very wary of websites and media outlets that constantly push you to buy gold.
The standard story for why you should buy gold is that it’s a hedge against the inherent weakness of the fiat money system. Unfortunately, it isn’t. For example, gold is a poor hedge against inflation. The correlation is very weak. Remember that gold had its huge bull run in the 2000s and a long slide in the '80s…but inflation was higher in the '80s than in the 2000s!
A more speculative and extreme version of the story is that the whole fiat money system is destined for collapse, and that after this happens we’ll go back to using gold as money. If that did happen, you’d want to own a lot of gold at that moment. Unfortunately, there are some big problems with this story, too. Technology has advanced to the point where we can use things like Bitcoin instead of heavy, easy-to-steal physical commodities like gold. And if civilization collapsed to the point where we couldn’t even use computers anymore, I’d advise you to invest in guns, ammunition, seeds and antibiotics instead of gold.
A bigger problem with the gold story is the question of why you should expect it to earn a good return. For gold’s price to keep rising steadily due to the failure of the fiat money system, it has to be the case that more and more people will steadily realize that the story is true. So a bet on this gold story is a bet that your macro perspective is way, way ahead of the macro perspectives of most other investors. That’s a highly speculative, risky bet.
So you should beware of media outlets that constantly push this story on you. The most important such website is probably Zero Hedge. If you read Zero Hedge, you’ll see this story about gold and fiat money being promoted again and again and again, often mixed with a healthy dose of political ideology and references to “Austrian economics.”
If you actually take Zero Hedge’s constant gold-flogging to heart, you could lose a lot of money. Since gold hit a peak in 2011, it has lost about 33 percent of its value in real terms. Zero Hedge kept touting gold all the way down. For example, in November 2011, Zero Hedge ran an article saying that gold could be “on its way to infinity.” In March 2012, Zero Hedge urged its readers to “stay long gold.” An October 2012 article made the same recommendation. As the price fell, Zero Hedge assured us that the collapse was only in “paper” gold, not the physical commodity. Needless to say, if you took Zero Hedge’s advice at any of these points, you would have lost a lot of money.
Now, if the gold crash is only temporary, and someday gold heads toward infinity, then losing money on paper is no problem…unless, of course, you have to sell to cover retirement expenses or pay some medical bills.
A lot of finance people seem to treat macro stories, like the one Zero Hedge pushes, as entertainment rather than actionable information. That’s a healthy attitude. And it’s true that Zero Hedge occasionally does some excellent reporting, or publishes other good information. So maybe you can read the site just for those tidbits, and either ignore or just smile indulgently at the huge volume of gold-flogging politics-tinged macro-propaganda that the site hurls at you day after day. But then you’re like one of those rare people who really does read Playboy magazine for the articles.
Zero Hedge is still pushing gold. It’s still pushing Austrian economics. But should you be listening? Only if you’re very good at separating bedtime stories from reality.

50 comments:

  1. Do Austrians tend to support the Efficient Markets Hypothesis? Surely if Gold really was such an amazing investment, it would very quickly cease to be one once investors started buying it up to take advantage.

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  2. Shadow_Nirvana6:45 AM

    "And if civilization collapsed to the point where we couldn’t even use computers anymore, I’d advise you to invest in guns, ammunition, seeds and antibiotics instead of gold."

    Yes, let's give preppers more advice on the topic.

    Also that Zero Hedge article title: Austrian Economics vs. Clueless Trolls.
    Oh the irony.

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    Replies
    1. if civilization collapses, there will be no market for any kind of investment.

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  3. But a lot of the variance in the price of gold isn't explained by such factors, meaning that some small amount of gold is a valuable addition to any well-diversified portfolio.

    Above quote is really the point and was more the case in the past than now.

    I remember being on a plane before the crash sitting next to a financial adviser. He was in economy class which should have made me cautious about listening to his advice. It is summed up as the world is going belly up buy gold. I was a bit shocked because everything seemed tickety boo. But it was true enough. Glad I met him. After I bought it the bank called me in wanting to sell me some financial products. On asking if they sold gold the salesman gave a wry grin and answered no. The money men pretend it doesn't exist. The ero hedgers will say fiat is finished. Occasionally you will meet someone who will advise you to buy a bit of each. The financial advice is too unbalanced and all about maximise, maximise, maximise. An Indian gives his daughter some gold when she gets married. It is for the rainy day and if it never happens so what.

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  4. When you buy gold, do you have gold? That is, do you hand over your fiat money and stagger out of the gold store with an impossibly heavy slab of metal?

    A friend owns some gold and she tells me it is in storage, and that if she took physical possession of it then it would lose value, due to having to be re-certified if she tried to do anything else with it. I am hazy on the details, but it sounds more like fiat gold than a valuable substance. If I bought gold it wouldn't be for its profit potential, but only to admire and handle the stuff. The amount of gold I could afford seems to be hedged about with controls that reduce its value as a medium of exchange or a deposit of value. Like you said ... seeds, tools, and skills look more useful if there's a social collapse.

    Noni Mausa

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    1. Ah, here we go. Hardly sounds worth the trouble:

      "...Fact: Banks will hold your gold for you in registered, insured vaults at a cost of about 1.5 per cent of the gold's value per year. Or you can hold your gold yourself - a safety deposit box at a bank is advisable, and you can get one for under $100 a year.

      Whether you keep your gold in a safe deposit box or at home, you'll want to be sure it's covered under your home insurance. If the amount of gold is large, it will mean additional insurance premiums, though insurers charge a lot less if they know you keep it in a safety deposit box.

      If you hold larger bars yourself, you've removed them from the world's registered storage system, which means their purity can no longer be guaranteed. You'll have to pay to have them melted down by an authorized refiner, re-poured and audited for quality before you can sell them.

      Flaw: Cost. Both bars and coins sell for about a 5-per-cent premium over the price of the gold they contain, plus sales taxes and dealer commissions. Then there's the cost of storage and insurance. Government minted coins such as the Canadian Maple Leaf and South African Krugerrand are readily recognized by coin dealers around the world - but reputable dealers are going to want to see detailed ownership documentation before buying them from you..."

      http://www.theglobeandmail.com/globe-investor/investment-ideas/the-fears-facts-and-flaws-of-buying-gold/article1369834/

      That's in Canada, don't know about the rest of the world. But as a hedge agains inflation, doesn't sound too useful

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    2. yawn, you can think of gold as insurance. Why do you pay money to buy home insurance, car insurance, life insurance? Isn't it better to just save the money and invest in stocks? Are you not loosing money buying any kind of insurance?

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    3. Duh, most people who buy insurance do not possess enough wealth to cover the cost of a catastrophic event, nor does their income allow them to accumulate wealth so quickly by saving. This is why buying gold, which is a form of saving, is not a substitute for insurance. In addition, in a catastrophic event the insurance pay-off is guaranteed. With gold it is not, since the price of gold is very volatile. Comparing gold with insurance is silly to say the least.

      Gold simply helps you reduce the volatility of your portfolio through diversification, but only to the extent that its return is not positively correlated with other assets. However, this benefit should be compared to the costs, which include storage and a potentially lower Sharpe ratio. Better stop yawning and start thinking!

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    4. Is gold price really volatile? i think you can only say gold-USD exchange rate is volatile.

      stock have no storage fee, it has management fee.

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    5. Anonymous8:13 AM

      Oh please. The very definition of something's price being volatile is it having a volatile exchange rate against money. This is just pitiful; gold cannot fail, it can only be failed!

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  5. Anonymous8:30 AM

    Zero hedge = Zero Edge

    Anybody who have watched the Discovery gold reality shows knows gold is tied to the price of oil: if gold price rises then more and more gold mines will be opened and subsequently the price will drop again, as long as the biggest component fuel costs stay down. Thus gold price all comes from oil price. Unless you expect 20 $ a gallon its nonsense to think gold will go to $10.000 an ounce. Then why hoard gold if fuel is infinitely more useful anyway in such a world. It makes no sense.

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    1. yawn, the difference between gold and oil is oil is consumed, gold lasts forever. By your logic, we should all save our wealth in food, not USD.

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    2. Noah smith will give the usual stupid advise: insurance is money-loosing investment, insurance doesnt pay dividends, therefore invest in insurance is stupid. Something is a bad investment when price is low, something is good investment when price keep rising.

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    3. gold is a bad investment because it has been falling for 3 years, stock is good investment because it has been rising for 6 years, never mind that it crashed 50% from 2007-2008, that was an anomaly and will never ever happen again

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  6. Zero Hedge stopped being relevant years ago. There is occasionally some interesting quant research on there, but mostly just the same ol' doom and gloom circlejerk . Nothing they have predicted has come true . How many times do we need to be warned hyperinflation is eminent?

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    1. You're right. If I want to feel like the world's ending, I just click on the Zero Hedge home page and scroll down. It takes the optimism right out of me!

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    2. Some say it's "bear porn" ... I recommend doing a Bing image search on that for more information. :D

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  7. "A more speculative and extreme version of the story is that the whole fiat money system is destined for collapse...if civilization collapsed to the point where we couldn’t even use computers anymore, I’d advise you to invest in guns, ammunition, seeds and antibiotics instead of gold."

    Any ideas for a transaction/investment mechanism? Austrians, gold and Santa Claus...

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  8. Anonymous3:50 PM

    I read ZH each day to see what the crazies are thinking (They be loving them some Putin these days). They do occasionally get something before others do. Last week they had the Malasia Air crash ten minutes before CNN or BBC did. I know because I saw it there, and went to CNN and BBC to find out more. The CYNK scam a couple of weeks ago, too. Just don't get caught up in the libertarian racist crazy talk.

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  9. Warren Buffet had the best explanation on why not to buy gold in his 2011 letter to shareholders: http://www.berkshirehathaway.com/letters/2011ltr.pdf It's at page 18

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  10. Anonymous4:50 PM

    Zerohedge represents the Rothschilds "libertarian" pursuits. If you follow the money trail, it all ends there.

    The 'collapse' itself is impossible without some reorganization, because private property would be abolished as well and the rule of law would collapse. The "tribals" would start collectivizing and creating a "new" America, one Zerohedge readers may not like so much.

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  11. So many people with strong opinions about gold prices. So few people who know anything about the gold market.

    Gold is above all a long-term safe asset and hedge against inflation. It's much more popular in emerging markets and especially Asia than in advanced economies, partly because they have had more problems with inflation and they don't trust their banks or even their states.

    So what we've been seeing in the 21st century is a huge movement of gold from the US and Europe to Asia, driven by the catch-up of Asian incomes. The main reason gold prices in dollar terms are much higher today than they were a dozen years ago is that Asian incomes are much higher in dollar terms.

    The big spike and drop in recent years was western financial investors getting ahead of the rise of Asian demand. This was mostly hedge funds and high net worth Americans and Europeans who either got carried away by gold's success or thought it was a good hedge. There were a lot of sensible people flogging the 5% to gold hedge. The western buying was mainly through the GLD ETF. It had nothing to do with Zero Hedgers who buy mostly silver and in puny quantities and are too paranoid to trust ETFs.

    Since that bubble popped we've returned to the Asian demand story. China is still fairly strong, India and Turkey not so much. But I suspect overall Asian incomes will continue to rise in dollar terms and gold will bring a reasonable but not stellar return over the next decade.

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  12. In a situation where governments and banks are creating a lot of currency it only makes sense to own some hard assets, including gold.

    Gold costs a lot more now than it did 10 or 15 years ago, which is a sign that investors are still nervous about the direction of the global economy. In fact if you measure the price of the Dow in terms of gold, instead of the U.S. dollar, you find that the stock market has been in a recession since gold started its ascent, likewise if you measure the DOW with many other hard assets.

    In addition to the price of gold and several other hard assets rising over the past 10 to 15 years, the stock market is at an all-time high measured in U.S. dollars. These are signs of inflation, which give all the more reason to own some gold as a physical form of money in case currencies collapse. There hasn't been a currency in global history that has survived, they all go to zero eventually, but gold has been used as money for thousands of years and even if it goes down in nominal terms, it never goes to zero.

    I've never read Zero Hedge, but if they are warning people about the devaluation of currencies and advising people to own some gold then I would say they are on the right track.

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    1. Dan, the stock market costs a lot more than it did 10 or 15 years ago (i.e., its value has risen) -- so what?

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    2. duh, the stock market index has risen, but doesn't mean every stock has risen. You can buy an index, but then you are buying a derivative of stock, managed by some intermediary, not stock. Common sense say individual stock cannot be a long term storage of value because company issuing a stock has the possibility of bankruptcy. The lifespan of a company issuing stock is usually no longer than 50 years.

      Can you use say oil as currency? No, new oil dug out of the ground is quickly consumed, the total world oil supply is fixed or declining, so you would have a deflationary currency, that encourages of hording and speculation. Gold, because it is not consumed, is an inflationary currency, the total gold supply increases approximately 1%-2% every year, which is the rate of global gold mining and production.

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    3. If you bought a thousand shares of Lehman Bros 50 years ago, and put it in a vault, today you would have a bunch of paper worth nothing because the company no longer exist. For stock to be a long term storage of wealth, you would need to pay a wall street middleman to manage it for you.

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    4. David, no it's value has not risen, the cost in terms of dollars has risen. The cost of most things has risen at a higher rate than the stock market. You measure the value of a stock by how much REAL STUFF you can acquire with it if you were to sell it. The average stock will now buy you less than it would 15 years ago, and yet stocks measured in dollars are at an all-time high! That is a sign of currency debasement.

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    5. Dan, what you just said is incorrect. Here is the value of gold vs stocks, both adjusted for inflation.

      https://twitter.com/dandolfa/status/454978977749147649/photo/1

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    6. This comment has been removed by the author.

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    7. and what is that comparison supposed to show? stock can outperform gold because it is more risky and more volatile.

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    8. by your logic, an index of penny stocks will be the best inflation hedge

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    9. David, don't adjust it for inflation. It is the inflation, you are missing the point.

      Here is another chart http://pricedingold.com/dow-jones-industrials/

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    10. Unknown,

      I can't respond to your comment(s) because I don't know if they are all coming from the same person or several different people. Put up a real name and maybe I can answer your questions.

      Delete
    11. see, the best inflation hedge is an index of penny stocks

      "The less liquid a stock is, the better it will perform in the long run, compared with more liquid stocks."

      http://www.ft.com/intl/cms/s/0/3c62469c-11af-11e4-b356-00144feabdc0.html?siteedition=intl#axzz38DeETTz2

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    12. "They then ranked 3,500 US stocks by their turnover and ranked them into four quartiles. This showed that the least liquid quartile, from 1972 to 2011, returned an average of 16.38 per cent, compared to 11.04 per cent for the most heavily traded stocks, and 14.46 per cent for the universe of stocks under control."

      "over the full 1972-2011 period, illiquid stocks fared better than small stocks and high-momentum stocks."

      "As illiquid stocks should be harder and more expensive to trade, it becomes harder for share prices to readjust smoothly, creating volatility. But in practice, the experience of the 2008 crisis was exactly the opposite. Daniel Kim, one of the co-authors and research director for Zebra Capital Management in Connecticut, reports that illiquid stocks suffered far lower drawdowns during the most dramatic days of heavy selling. That was because, in an emergency, people sold whatever they could, so liquid stocks were sold first."

      this is proof that you all should keep your retirement saving in penny stocks.

      Delete
    13. and this explains why stock market is outperforming, because liquidity is evaporating

      http://www.bloombergview.com/articles/2014-06-26/where-have-all-the-traders-gone-ritholtz-chart

      Delete
  13. Noah,

    If shadowstats is correct, then you should have deflated the gold price by a far larger extent, no?

    In any case, I've posted on this before too. Here's a nice little graph depicting the price of gold against the price of U.S. equity.

    https://twitter.com/dandolfa/status/454978977749147649/photo/1

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    1. Hahaha exactly. Wait, didn't I point that out? :-)

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  14. Wow. I always thought that John Williams went back and calculated the CPI with the original 1980 formula. At least that's what is implied on his site. Does anyone do this? Actually recalculate the CPI with the 1980 formula?

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    1. That's what he claims to do, but it's unclear what he really does.

      "Formula" isn't really the right word. What is meant is the rules for estimating inflation as they existed in 1980. But the rules then as now don't give precise answers to every question. Statisticians must make judgement calls on all sorts of questions. And so far as I saw, granted I didn't spend much time there, Williams doesn't really explain in detail how he arrives at his revisions.

      The one value to Williams' efforts is in pointing out to what extent the inflation rate is a social construct, not an objective observable fact. It's hard to prove that he's wrong. For example, take a 1970s Cadillac versus a 2010s Cadillac. The BEA will tell you the 2010s Cadillac has far more real value than a new 1970s Cadillac had in the 1970s, because of all the technological advances. Williams takes the position that the 1970s Cadillac was roughly just as good as a 2010s Cadillac. If you agree with Williams on that and a whole lot of other similar points, then inflation since the 1970s has been massively under-reported. Ultimately value is in the eye of the beholder, so you can't prove it wrong.

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  15. This article did not address multiple issues that influence investing in gold. 1. $17 trillion in US debt, currently running a Ponze Scheme. 2. 40% or $6.8 Trillion in US debt matures in the next 3 years, the US government already can't pay its debts with historically low interest rates, so how can they pay it when rates rise? 3. $85 billion dollar per month trade deficit 4. The dollar has lost 98% of its purchasing power since the FED was originated in 1913. 5. The bubbles that have been created due to FED policy. http://tinyurl.com/o4fwaef check out this article on Business Cycles/Fed Cycles. Also, it doesn't mean the world will end when the government defaults, things will be different and the market will be able to operate on its own without manipulation.

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    1. It is impossible to tell whether the US Dollar as currency satisfies the no-ponzi condition required of a currency a priori.

      It is an article of faith on either side that they know the real growth rate of the economy compared to credit expansion.

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    2. Actually we know for a fact that credit expansion has far outpaced the real growth rate of the economy.

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    3. Anonymous2:22 AM

      Tyler,
      First, absolute debt is not important, debt/GDP and movement in debt/GDP is.
      Second, US has all its debt in its own currency, so anything like Greece, Argentina or Asia in 90's is impossible. Interest rates are determined by FED rate plus small premium.
      Loss of purchasing power is mainly intended, that's how capitalism works and how US progress in the last century came about: if there is inflation (moderate), than pure saving is costing you value, so you need to invest (btw. that's one of the problems today - inflation is so low that saving is often preferable to investing risks; that's why you can pump any amount of money into zero-bound economy without increasing inflation).
      When things are going well in gold-based economy, you won't find many noticeable differences from fiat-based economy. But recessions in gold-based economies are extremely brutal. It's no accident that many countries moved from gold during the great depression.
      I don't know why so many people believe that markets operating without government supervision would be ideal markets. If there is any benefit of size, and in most cases there is, markets will move towards oligopoly/monopoly, and monopoly is highly efficient for the monopolist and highly inefficient for everybody else. Think late 19th century, when workers were paid pittance and had no rights, and many were paid in company chips instead of money. Government regulation must prevent that.

      As for the quality of the article you linked, the writer actually states well his grasp of science and math. If fourth paragraph he says that FED greatly increased money supply, 400% in the last few years. In the sixth paragraph he says "When the money supply increases, prices increase." So, where is 400% cumulative inflation in the last 5 years?
      What the author is doing is giving some unconnected facts without looking for context (yes, increasing money supply increases inflation, except if economy is in recession; did you see US economy being at its maximum potential since 2008, so that FED has to worry about the inflation?), trying to push his political theory. For example, eighth paragraph explained his view why what once were middle class families are now losing ground. But, there was interesting statistic in France several years ago: in some 30-40 years, working compensation (workers' pay) increased in real terms by a few percent, and almost full profit from better productivity and all the advances went to owners and upper management. The trend is the same in all western countries. If that was equally divided, today's workers could again be middle class and upper middle class. But, of course, you won't find talk about inequity in such articles.

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    4. Its more accurate to say worker compensation has lagged the rate of inflation, while owner and upper management salary has kept up with rate of inflation. CPI massively understates true inflation, thus workers do not notice that their salary is being stolen by inflation. Take china for example, government policy of financial repression transfer wealth from the household sector to the state owned enterprises, then flow into the pockets of elites. If a totalitarian country like china cannot control asset bubble, then its unlikely a country like US can prevent asset bubble with regulation.

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    5. Anonymous3:40 AM

      I hear a lot that official indexes understate true inflation, but I never see itemized description, what is left out, how much have those prices risen, and why they are not in CPI. Can you give me that information?
      Real question, not sarcasm or trolling.

      Oh, and as long as people will speculate, there will be bubbles. Government job is not to stop bubbles, but to ensure, as much as possible, that bubbles don't hurt the economy, and that those responsible for speculation suffer most consequences, and also to ensure that those whose standard of living has fallen below set level get help, to survive, and, possibly, come back.

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    6. no inflation for manufactured goods because their production has been offshored to third-world countries.
      inflation show up in goods that cannot be offshored: medicare, education and housing

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    7. Anonymous2:41 PM

      This shows your ignorance. The CPI assigns the biggest weight (41%) to the cost of housing (the cost of renting the dwelling you live in). The second biggest item is transportation (16%) followed by food and beverages (15%).

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    8. Anonymous2:43 PM

      Education and medical care are also included but combined they only account for 15%. This is how much the AVERAGE household spends on both.

      Delete
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