In 1963, the average price of a new home in America was $18,000. Last year, an average home sold for $212,000.
What does this tell us? Almost nothing useful.
Yes, it shows that there has been inflation. But inflation measured against what? The average worker earned just more than $2 an hour in 1963. Last year, the average wage was nearly $20 an hour. And the average home in 1963 was 1,450 square feet, versus 2,169 square feet last year. Adjust for both, and an average American could buy more property per hour of labor last year than he or she could in 1963.
This is the practical way to think about inflation -- how it has affected not just the prices you pay, but the prices you pay in the context of how you live.
For more than a century, the Bureau of Labor Statistics has published a list of how an average American consumer spends his or her annual budget. Rather than the raw numbers of inflation we tend to obsess over, it highlights the impact certain goods have on people's budgets in relation to their incomes.
What it shows is often astonishing.
Take, for example, how much of an average consumer's annual budget is devoted to food:
There has been rapid food inflation over the last century. But as a percentage of an average consumer's budget, food's importance has dropped like a rock. An upswing in agriculture technology meant food prices grew more slowly than wages. We became richer not because of inflation, of course, but despite it.
Look through the Consumer Expenditure Survey, and you see this again and again. Compared with a quarter-century prior, a smaller percentage of our budget today goes to transportation, appliances, postage, furniture, cleaning supplies, insurance, and many others. One of the biggest slides is in apparel:
In 1960, typical consumers devoted 36.3% of their budget to food and apparel (combined). Today, 16.5% of an average budget goes to those two categories. That's a difference of 20 percentage points. And since we aren't eating less or wandering around less clothed; it truly does mean that one-fifth of an average consumer's budget was freed up within with 50 years. And that's just looking at food and apparel alone.
What happened to that 20% of our budget? That's where things get interesting. Spending 20 percentage points less on food and apparel means we get to spend more on other categories. And a lot of those other categories include products and services that have made our lives demonstrably better.
For example, the percentage of our budgets devoted to health care has more than doubled since 1901.
Some will say that's a bad thing. Healthcare, after all, has seen inflation well beyond the rate of wage growth in recent decades. But there's another, deeply positive side to it. The quality of the medical care grew exponentially in the last century. And we can afford to spend more on health care today in part because large parts of our budgets have been freed up thanks to the relative decline in expenses like food and apparel. We've traded expensive pants for penicillin. That's a wonderful thing. And it has helped push average life expectancy up from 48 years in 1901 to 78 years today.
What else are we spending more of our budgets on today? Education:
Here, too, there has been inflation beyond wage growth in recent decades. But there's more to it than that. A far greater percentage of the population attends college today than in previous years -- a trend owing in part to the rise in discretionary incomes driven by the relative decline in other categories like food and apparel. We've traded expensive pants for an expensive bachelor's degree. And for most, it's well worth it. As David Leonhardt of The New York Times points out, "Relative to everyone else, college graduates have never done better than they are doing right now."
There are many other gains. On Wednesday, The Wall Street Journal studied the latest Consumer Expenditure Survey and lamented that cell phone bills now eat up a larger portion of consumer spending compared with years past. But of course they are. Ten years ago a cell phone could (sometimes) make a phone call, had a crude calendar function, and included a game called Snake. Today, Apple's (NASDAQ:AAPL) iPhone can play high-definition videos, store all your music, file your taxes, and help you find a job. We're paying more because we're getting so much more. And part of the reason we can afford to pay more for things like cell phones is because less of our budget is devoted to necessities like apparel.
Real middle-class income has stagnated (at best) in recent years, but we're still a powerfully productive country. New innovations and more efficient methods of production will reduce the relative cost of certain goods over the next 50 years, just as they did over the previous 50 years. That will free up part of average consumers' budgets, allowing them to spend more of their income on...what, exactly?
No one knows. A hundred years ago we couldn't imagine that we'd be spending as much of our budgets on health care as we are today. Thirty years ago we couldn't fathom we'd be spending as much on cell phones as we are today. Yet both have made our lives better. What new services will we be lucky enough to spend money on 30 years from now as more of our budgets are freed up? I don't know. But it's sure fun to think about.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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