Inflation and Income

Fundamentals of Market Investing by Adam J. McKee

If you are reading an investment book, you most likely want to invest and see the value in doing so.  The goal of investing is simply to build (and protect) wealth.  Building wealth requires great luck (inheritances, lottery wins, extraordinary athletic ability, etc.) or savings.  For most of us, it is savings that will determine whether we ever become wealthy.  In order to save, your basic needs have to be met with enough left over to save something every payday (I strongly suggest 15%).

For many of us, the choice not to save is more of a matter of hedonism than it is a matter of income.  We have formed a habit of spending what we earn plus a small percentage over that amount which increases our ever-growing credit card debt.  For many others, there simply is not enough income to manage a household with a decent standard of living, and savings must be put aside so that food, clothing, shelter, education, and healthcare can but provided.  Many Americans live in poverty, which is astonishing considering the economic might of the United States.

A proximate cause of this social injustice is the influence of inflation on real wages.  Since most people don’t understand inflation, they do not notice that their buying power and thus their necessary income to meet living expenses is diminished every day.  If we examine the historical trend in real minimum wages, we see that Americans have been suffering from a decline in buying power since the late 1960s.  We marvel at a minimum wage of less than $2.00 an hour, and most of us fail to realize that this represented much more buying power (by a factor of nearly two) than the minimum wage of today.

If we consider this fact along with the fact that the real cost of basic necessities tends to track inflation (which is why commodity baskets are a poor investment), a larger and larger percentage of the wage earner’s money is taken up with bread, eggs, and milk.  There is less for savings.  Of course, everyone knows that nominal minimum wages have gone up over time, but that increase has been erratic and has not kept up with inflation.

For those that earn the minimum wage, the government should legislate a final minimum wage law that establishes a baseline of a living wage (which the current minimum wage does not establish) and from there on tracks the rate of inflation.  Computing the increase would be very easy since the folks at the Treasury already have to do so when valuing TIPS.  For those of us who make above the minimum wage, there is no law dictating that our salary should be kept at constant (which still does not compensate for experience as it should).  The result is that many of us lose buying power every year that we don’t receive a raise that is on part with or beats inflation.

Over the past decade, inflation has been at historic lows, so we haven’t noticed our deteriorating standard of living.  The decline of collective bargaining and unions is a potential explanation for why this unacceptable state of affairs is allowed to continue unabated.  It can also be explained in part by the shift from a blue-collar industrial economy to a white-collar service economy.  White-collar jobs have never enjoyed the benefits of collective bargaining to the same degree as their blue-collar counterparts.  The result is that union welders, pipefitters, and heavy equipment operators earn a larger income each year than many of us who wear a tie to work every day.

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