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Inflation: The Real Deal Not Uncle Sam’s Charade

Posted by Larry Doyle on October 11, 2013 7:14 AM |

One of the main arguments made by the Federal Reserve for continuing to run the printing press via its quantitative easing program is the fact that the reported rate of inflation is running below its long term target of 2%.

Based on that reality (real or perceived?),  Ben Bernanke has been very comfortable opening the Fed’s QE-hydrant and letting the dollars flow despite the fact that the Fed’s liquidity does not appear to be gaining meaningful traction in the system and actually stimulating true economic growth.

Some might say that things would be far worse without Ben’s liquidity, but first let’s take a harder look at that reported rate of inflation and focus on that qualifier “reported.”  To do so, I welcome navigating into a report recently produced by Deutsche Asset & Wealth Management entitled Is The Inflation Threat Hype — or Real? (I thank the regular reader who highlighted this report.) 

Concerns have been raised that the U.S. government’s attempts to stimulate the economy could unleash a wave of runaway inflation. Is inflation in the future—and if it is, is your portfolio prepared for one of the greatest risks to personal wealth?

Many economists will tell you not to worry about inflation. The consumer price index (CPI), a widely used gauge of consumer spending, increased 0.5% in June of 2013 and so-called core inflation (which eliminates volatile food and energy costs) rose 0.2%. For the one-year period ending 6/30/13, the CPI rose 1.8% and core inflation rose only 1.6%.

That places core inflation near the U.S. Federal Reserve Board’s (Fed’s) target of 2%—and within the 2% to 2.5% annualized rates prevailing before the Great Recession of 2008 and 2009. Many inflation watchers argue that the downtrend does not seem to have ended. They point out that with the unemployment rate at 7.6% as of June 2013, wages are going to stay low for a long time, which will help rein in inflation. If anything, these economists say, slack in the labor markets suggests that core inflation might continue to fall for awhile.

Rethinking inflation: Three reasons we call inflation the phantom menace.

Official inflation data may be understated. Over the past 30 years, the government has made many changes to the way it calculates inflation. Because of these changes, inflation today may not be the same thing as inflation the last time we saw it.

According to economist John Williams at Shadow Government Statistics, if we still calculated inflation the way we did under the Carter presidency, today’s CPI would be closer to 9% than 2%. Jim Grant, the host and editor of the newsletter Grant’s Interest Rate Observer, has said that the Fed arguing that the inflation rate is too low is “like the New York Police Department complaining about the lack of crimes.”

How can this be the case? The way inflation is calculated today . . . CPI calculations have not remained constant since the index started.

In 1983, the index stopped using housing prices, switching instead to owners’ equivalent rent, which is the amount of rent that could be paid to substitute a currently owned house for an equivalent rental property. It is now the largest part of the CPI.

In 1998, the index broadened the use of product quality enhancements . . . for example, the quality of televisions has increased over time, with many improved features, such as plasma screens and HDMI connections. If you buy a more expensive television today, then, is that the result of inflation? The government says no . . .

In 1999, the CPI began using product substitutions (assuming, for example, that if the price of steak rises, consumers will buy hamburger instead). These changes may have led the CPI to significantly understate inflation. Below we show what the CPI would be today using older methods of calculating CPI.

Have CPI changes led to understated inflation? (Is the Pope Catholic?) 

Current One Year CPI: 1.8%
Pre-1990 CPI method estimate: 5.2%
Pre-1980 CPI method estimate: 9.4%

While core consumer inflation rose just 0.5% in June 2013, suggesting that inflation is tame, that number belies what many consumers feel in their wallets: Raw material prices are climbing, and as a result, across America, companies are raising the prices of their goods and services. The reason inflation isn’t obvious, perhaps, is that not all prices are rising. We’re currently seeing inflation in the prices of goods we need, and deflation in the prices of goods we want.

Needs (basic goods) : Have increased in price, 10 largest category increases in price the last 12 months
Inflation rate
Peanut butter +27.26%
Health insurance +12.71%
Gasoline +9.14%
Parking fees and tolls +8.28%
College textbooks +7.78%
Womens’ outerwear +7.10%
Girls’ apparel +6.64%
Water and sewerage maintenance +6.62%
Men’s footwear +6.62%
Uncooked ground beef +6.55%

Wants (luxury items): Have decreased in price, 10 largest category decreases in price the last 12 months.
Inflation rate
Televisions –18.18%
Propane, kerosene and firewood –12.22%
Lamb and mutton –11.42%
Potatoes –10.88%
Other video equipment –10.80%
Utility (piped) gas service –8.42%
Dishes and flatware –8.31%
Butter –8.08%
Video cassettes and discs –7.89%
PCs and equipment –7.77%

What is the ultimate outcome of this government manipulated charade? You are paying more for basic goods and services, wages remain largely stagnant, and you’re earning less on those fixed income investments traditionally utilized to generate some meaningful form of income.

In layman’s terms, you’re getting screwed up, down, and sideways . . . and Uncle Sam and his consiglieres at the Fed have every intention of continuing this manipulative and expensive — for you — game of charades.

Navigate accordingly.

Larry Doyle

Please pre-order a copy of my book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy, that will be published by Palgrave Macmillan on January 7, 2014.

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I have no business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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