Around May 6, 2005, Time Magazine published an article about the current state of inflation. I won't review every detail of the article for lack of time and energy, but there are a few things I think warrant a mention. First, he notes that inflation is growing at 3%, which is "about par for a growing economy." So far so good. But then, he quickly drops off the deep end and says that inflation is "actually worse than it appears. That isn't widely understood by the millionaires on Wall Street, who were shocked -- Shocked! -- to learn that life is getting more expensive and sent stocks into a brief tailspin."

Yes, according to Daniel, those "millionaires" (which are actually mostly comprised of institutional investors like pension funds and money market accounts, the owners or beneficiaries of which include regular people who are themselves far from being millionaires) just don't understand economics like he does, whoever he is.

Here's the biggest goof:

"One underappreciated development: folks have gone so much deeper into hock that even the lowest interest rates in a generation haven't cut their average monthly household debt payments, which are at an all-time high and increasing. As rates rise, that will get worse."

Daniel doesn't refer to the data source which supports this notion, so there's a chance there's something he's uncovered that I don't know about, but here are the facts: household debt includes mortgage payments. Home ownership is at an all time high. The reason consumers have more debt is because they bought houses when interest rates were low. In fact, because of this, debt often increases as the economy improves (as does the trade deficit, but I'll save that for another time).

He then laments that real estate prices have gone through the roof (see the previous paragraph). That, of course, means that the net worth of home owners is through the roof, too. He makes the startlingly insightful observation that floating-rate loans "all but guarantee that they [the borrowers] will pay more over the life of their loans." Well, yes, the interest rate floats, so there will likely be periods in which they are paying higher interest on the loan than they are paying now. But this does not mean that they will pay more money in interest over the course of their loan when compared to a fixed rate mortgage.

There are also a lot of economists who believe that the CPI, as a rule of thumb, overstates inflation anyway (this is alluded to when Patrick Jackman is quoted describing an adjustment to the cost of automobiles that was made when calculating the CPI because of "an effort to measure 'constant quality'."

The problem with the CPI is that a $20,000 car today is a different car than a $20,000 car purchased 5 years ago. Quality has improved, and this often isn't reflected in the CPI. Daniel says that "out-of-pocket costs" have not gone down, therefore the consumer isn't really benefiting from this quality improvement, but that's just not true. One of the ways that cars have improved in recent years is that they last longer. Since they last longer, you do not need to buy a new one as often as you used to. This means that over time, you do save money. Since most automobiles are purchased with debt, the longer lifespan of autos means that you can spread out the repayment period over a longer period of time. Instead of a three-year loan, a new car buyer can take out a five year loan, which means the quality improvement directly translates into a reduction in "out-of-pocket costs", regardless of what the sticker price says.

The driver of inflation is gas prices. Gas prices are high because demand is up. According to the law of supply and demand, this means that the only way to get lower gas prices (and therefore end inflation) is to increase the supply of gasoline, or reduce the demand. As a consequence, some people may opt to buy more fuel-efficient cars (I'm sure Daniel doesn't think that the money they save at the gas pump should be reflected in the CPI, since it might make the out-of-pocket expense for a new car seem understated).

Demand is up because the economy is good. We really do need to invest more in finding alternatives to gasoline because the supply problem will only get worse in the future as China and India and countries like them lift themselves out of poverty. Bear in mind that the reason that interest rates are increasing is because the Federal Reserve seeks to limit the money supply, and thereby slow the growth in the economy in an effort to fend off inflation.

It's not worse than you think. Everything is happening as it is expected to happen.