Inflation adjustment is often misleading

Inflation adjustment is often misleading

Inflation is a tool for the Fed or your local central bank. And it’s also often used by laypeople to contextualize the value of money in the past. For example, about Warren Buffet, Wikipedia says:
By the time he finished college, Buffett had amassed $9,800 in savings (about $121,000 today)
This mode of adjusting for inflation is misleading, encouraging one to think “$9,800 in 1949 is equivalent to $121,000 today” instead of the more accurate: “$9,800 in 1949 could buy as much stuff as $121,000 can today”.
This might seem like a silly hill to die on - isn’t adjusting for the value of money what you actually care about? It seems fine to say that Warren could spend as I spend today, and he’d feel like I’d feel if I had $121k in savings.
But this isn’t the question we care about. Inflation adjustment is handling changes in the value of currency, but we want to adjust for more than that!

Consider another case of John Doe who was a lawyer in the past, making an amount equivalent to $100k/y today.
That $100k/y figure smushes together answers to multiple questions:
  • a) How much did people consume back then, compared to now? How much richer are we now?
  • b) How much did lawyers make back then? Was this more or less of a high socioeconomic status occupation?
  • c) Was John Doe an exceptionally well paid or poorly paid lawyer?
Sure, we get to know that John could afford to consume as much as an entry-level engineer does these days, but usually we’re more interested in understanding John’s relative socioeconomic status for his time - questions b) and c).
Average personal spending, when adjusting for inflation, has increased about 5x from 1940 → 2022. This fact alone means that inflation adjusted numbers are unhelpful for understanding anything about people’s finances relative to their contemporaries.
Adjusting for GDP per capita, median income, or per capita consumption will very often give you a better understanding - in fact if I had to choose a general default, I’d rather pick one of them. This is often roughly equivalent to removing question a) from the equation, getting you a number that’s only answering mix of b) and c). You can use this calculator to see what it looks like to adjust for them instead of inflation.
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But, the best bet is to actually get several different estimates, depending on the specific case being estimated. Here are some examples of that.

Case 1: Warren Buffet’s College Savings

Warren Buffet had $9,800 in 1949, and inflation adjusting it tells us it’s worth $121k.
Adjusting for the 1949 income per capita of $1400 instead though, we learn that it was worth $450k in 2022. This is the right number to keep in mind if the question we’re trying to answer is “How many years would an average American have had to work to save that much money?”
If we’re trying to ballpark how much business capital Buffet had access to right out of college - it’s probably more accurate to think of it as ~$500k instead of $100k.

Case 2: Bribes in the Black Sox Incident

In 1919, eight members of the Chicago White Sox were accused of throwing the 1919 baseball World Series. From Wikipedia:
Besides Weaver, the players involved in the scandal received $5,000 each or more (equivalent to $84,000 in 2022), with Gandil taking $35,000 (equivalent to $591,000 in 2022).
It’s unimaginable that a modern MLB player would throw a game for $84k. What’s going on here? To what extent is this due to baseball players getting paid more over time, vs other factors?
  • Adjusting for US average individual income instead: $500k
In the context of modern MLB, it’s probably most effective to think about the decision as being offered a $10m bribe.
So, if we try to answer the question: “Why were MLB players willing to risk their careers for just $5k in 1919?”, it breaks down into:
  • Money was more valuable then, adjusting for inflation takes us 17x from $5k → $85k
  • Everyone just made less money then, adjusting for individual income takes us 6x from $85k → $500k
  • MLB players made less money then, adjusting for their pay takes us 19x from $500k to $9.5m

Case 3: Rockefeller’s Net Worth

According to the Wikipedia article on him:
His personal wealth was estimated in 1913 at $900 million, which was almost 3% of the US gross domestic product (GDP) of $39.1 billion that year. That was his peak net worth, and amounts to US$26.6 billion (in 2022 dollars; inflation-adjusted).
But, here Wikipedia recants, and on another page, List of richest Americans in history, is willing to adjust for GDP instead:
Most sources agree that adjusting for inflation, John D. Rockefeller (1839-1937) was the richest American in history in terms of wealth vs. contemporary GDP. He amassed a fortune of more than $410 billion, adjusted to 2022.
The $410 billion figure puts him at ~2 Elon Musks in terms of proportion of US GDP. This is a useful measure when evaluating wealth in the context of: “How big of a deal is this individual’s wealth relative to the economy they’re situated in?”
We might also choose to adjust for something else - income to wonder about how large of an army of workers they could assemble, or cost of construction to look at how much they could build.
Again, adjusting for CPI alone feels rather weird - as it’s rather unclear why being invariant to the cost of a basket of goods is actually helpful at all.

In closing: most often we’re trying to understand the value of a sum of money relative to its time. Inflation adjusted numbers include the deflationary effect of us getting richer as a society, and hence are often misleading. Adjusting for per capita income is often a better default.