Inflation: why it seems understated

[CuppaJoe]

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Originally Posted by ladelfina joe, how 'bout "all of the above"? My bet is on 3/4/5 mostly....

My favorite is No. 1 (the numbers are wrong).

[ladelfina]

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one important point implicit in E Warren's work is that many people spend their money poorly

Michael I can only imagine you didn't watch the presentation if that is what you took away from it. You could have just stuck with the common media meme and saved yourself the hour. Sorry to be blunt. You may care to re-visit the presentation because it posits exactly the opposite, in large part.

People are not somehow wildly smarter or wildly more stupid from generation to generation. If they make certain choices there are reasons behind it, even if in the moment they can't always predict the political and economic changes ahead that may compromise their current standing. We are talking about the vast majority, not the lowest end of the bell curve.


Joe, do you care to share (even in veiled way) how you arrive at #1? Are the prince/princess figures that you review self-reported? How exactly do you come to see them?

[DJRR]

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Originally Posted by ladelfina Basically, the twist is that inflation for the country as a whole is 'correctly' measured, but the alarming growth in income disparity is responsible for figures that may seem to come from a fairy-tale. It's because they DO come from a fairy-tale; the spending of the princes and princesses is so much larger, and so much unlike, the spending of the average American, that the average figures no longer reflect the average reality as closely as they may have in the '50s/'60s/'70s. As this disconnect grows, CPI figures will continue to be more and more inaccurate for the practical purposes of mere mortals.

I somewhat relate to this. On a macro level I received a 4% pay raise this year and perceive no change in my standard of living, so I think that inflation is probably 3-4% overall. Some of my bills went up, but I got a smokin deal on Verizon Fios, etc. If "true" inflation were running more than double my paycheck I would notice a marked decrease in my standard of living.

On the other side, I use about 750 gallons of gas a year. If gas goes up $1 a gallon from $3-$4, that is not even 1% of my income. A 33% increase in gas barely registers to my budget. If I had a lower income and was using 2x the gas then I would be really hurting. Same with food costs. I shop at Costco in bulk, grocery stores on sale, restaurants with coupons, and bring my lunch to work. I pay 3.29 a gallon for milk at Costco, but others pay 3.99 at the grocery store or 4.50 at 7-11. Why? It is the same exact product. Meat costs were down, so I substituted more meat. I don't eat rice so I could care less what it costs, etc. The whole discussion is highly individualized based on your habits and preferences.

[CuppaJoe]

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Originally Posted by ladelfina .... Joe, do you care to share (even in veiled way) how you arrive at #1? Are the prince/princess figures that you review self-reported? How exactly do you come to see them?

I'm possibly wrong to even think of no. 1 (the numbers are wrong). But early on I did help people fill out the forms (I'm happy not to do that anymore), and that was my take, I would hold back from asking if they were sure about the food numbers. The rest of their numbers always looked ok.

Let's just say that I give the breakdowns some credence because they are signed "under penalty of perjury." We don't get that in surveys.

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My number 1 is sort of a joke because IMO so are the CPI numbers possibly wrong or understated.

[Abreutime]

Very good article about our biases in observing the inflation numbers

Seeing Inflation Only in the Prices That Go Up - New York Times

[ladelfina]

thanks for the link, Abreutime.. Another question.. since so much mention is made of hedonic adjustments in better computers and so forth, I wonder if they ever make hedonic adjustments in the opposite direction. For instance, airline flights got somewhat cheaper up until lately, but they also got far worse in terms of seating and horrific security hassles and waiting times, delays, no food, smaller bags allowed, missed flights, etc. Or is a flight just a flight?

[RockOn]

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Originally Posted by ladelfina thanks for the link, Abreutime.. Another question.. since so much mention is made of hedonic adjustments in better computers and so forth, I wonder if they ever make hedonic adjustments in the opposite direction. For instance, airline flights got somewhat cheaper up until lately, but they also got far worse in terms of seating and horrific security hassles and waiting times, delays, no food, smaller bags allowed, missed flights, etc. Or is a flight just a flight?

Fat chance of that

That link is hinting at counting falling house prices now, I knew it wouldn't be long. It's all a sad joke.

[MichaelB]

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Michael I can only imagine you didn't watch the presentation if that is what you took away from it. You could have just stuck with the common media meme and saved yourself the hour. Sorry to be blunt. You may care to re-visit the presentation because it posits exactly the opposite, in large part.

Ladalfina, you presume. I also apologize for my bluntness, but you read into my posts what you want, not what I write. If it is my poor communication, then I beg your pardon. Still, I get the feeling you are debating with yourself, putting your meanings into my words. That is a debate you are bound to win...

What I said was

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one important point implicit in E Warren's work is that many people spend their money poorly

What you responded was

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I can only imagine you didn't watch the presentation if that is what you took away from it

An important part of her thesis in "The Two Income Trap" is the waste from overspending in housing. Note - I'm not ignoring the insidious and reprehensible behaviour of the finance industry, just highlighting one aspect of her presentation - the core. Her lecture is more about the finance business but the book is overspending on housing and subsequent associated costs.

I am also not arguing that inflation does not exist, or it is not high, or it is not bad, or it is not a problem. For the record, it does exist, it is growing, it is a problem. Most gravely for those on fixed income or CPI-dependent incomes. Worst for those just beginning their retirements with life expectancies of 30+ years on CPI only.

I also said

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nor am I siding with Ayn Rand.

. To be a bit more blunt, I feel a strong social fabric is a key component of advanced and enlightened society.

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People are not somehow wildly smarter or wildly more stupid from generation to generation. If they make certain choices there are reasons behind it, even if in the moment they can't always predict the political and economic changes ahead that may compromise their current standing. We are talking about the vast majority, not the lowest end of the bell curve.

Here we part ways. The US stands alone in some choices made - spending over savings, credit, consumption and consumer spending in the face of impending recession. Federal, State, Local government and individually. From generation to generation. People are not stupid, but certainly willing. And it continues today - this year. This month. Who thinks this "rebate" is a gift? It is an advance to be repaid with future taxes, after the house takes their cut.

The budget debate in Illinois and the property tax change in Florida are just two examples of government behaving poorly and voters following their lead.

My point was, and is, the "problem" is not CPI mis-calculation, deliberate or not. Nor is it God's vengeance for sinful living, nor cosmic rays. It is the result of choices made.

Michael

[MichaelB]

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Originally Posted by RockOn Are you feeling a little defensive? Just wondering......

Not at all - but thanks for asking.

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Does one have to be a certified card carrying member of the the plunge protection team to have the imagination to claim the reported CPI is representative of an average American? Just wondering........

No problem. When you get that CPI conspiracy feeling, just reach for the tin foil.

Michael

[RockOn]

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Originally Posted by MichaelB NWhen you get that CPI conspiracy feeling, just reach for the tin foil. Michael

I'll keep it mind. I'm trying to break that habit but the new numbers will be out soon and I might lose it again. It's an affliction of mine.

[SkisALot]

The CPI is based mostly on "Owner's Equivalent Rent," which is the price you would get if you rented out your own home. It doesn't make any sense, but then, if the government admitted the real CPI they would have to give more accurate cost of living adjustments to people getting social security and government pensions (and so would the corporations that are giving the parties campaign money). The government has mismanaged money so badly that the money for these adjustments is no longer there and therefore, they not only skew the CPI to a more managable, nee fictitious number, they continue to deny the inflation we are being blindsided by. It will catch up and it will be very nasty.

[RockOn]

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Originally Posted by SkisALot The CPI is based mostly on "Owner's Equivalent Rent," which is the price you would get if you rented out your own home. It doesn't make any sense, but then, if the government admitted the real CPI they would have to give more accurate cost of living adjustments to people getting social security and government pensions (and so would the corporations that are giving the parties campaign money). The government has mismanaged money so badly that the money for these adjustments is no longer there and therefore, they not only skew the CPI to a more managable, nee fictitious number, they continue to deny the inflation we are being blindsided by. It will catch up and it will be very nasty.

Such tinfoil nonsense but I agree with you almost completely. I'm not sure about the nasty part, if inflation continues the fudging will just continue, if we go into deflation they will just change the way it's calculated to show inflation. Plus 4% to -2% forever, it doesn't get any better than that....the plunge protection crew approves of this message.

Welcome but beware, I'm going to be about your only foot soldier in this war.

[Leonidas]

I admit that I did dis Fleckenstein. But I was already familiar with the man and his track record - CXOAG Guru Grades – Bill Fleckenstein: Apocalypse Soon - which may have colored my appraisal of the material.

Putting Fleck's record aside for a moment, I found Ritholz's blog post lacking in accuracy because he merely copied what Fleck copied from Faber and then posted a link to the NYT's recent interactive CPI chart that shows food expenditures at 15%.

Where Faber got the 20% figure from is anyone's guess. His website is by subscription and all Fleckenstein indicates is that Faber says:

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food and health care are underweighted in the CPI. In fact, the U.S. counts food as only 8% of the index. Whereas, it counts for about 10% in the United Kingdom, about 15% in the rest of Europe and more than 18% in Japan. Interestingly, if you look at the proportion of U.S. household spending on food, by income quintile, all but the top 20% of earners spend at least 20% of their paychecks on food. Thus the CPI weightings understate what is already an understated rate.

Other sources show that Faber has been saying a lot of different things.

Here FSO Transcription - "What's Ahead in 2008" by Marc Faber 01/12/2008 he says

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You just can’t exclude food and energy prices and healthcare costs from the CPI, from the cost-of-living increases.

But that's wrong, because the CPI-U includes food and energy costs. In the same work there is an indication from whence Faber's got his ideas.

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In his report dated September 28, 2007, Larry Hatheway said that, "rising food prices will tend to have a disproportionate impact on real purchasing power of lower income groups. This is because lower income groups spend a higher proportion of their income on food. Furthermore, lower income groups spend proportionally more on food items that have a lower fraction of labour and a higher fraction of commodity inputs in the final price.

I couldn't find Hatheway's report, but I did find a UBS PowerPoint presentation, and numerous references to Hatheway's report (What's Up With Food Prices?) that indicate its focus was globaly, not U.S.

Here Dr. Doom Speaks - An Interview with Mark Faber -- GuruFocus.com in a speech to the Chartered Financial Analyst Society in Los Angeles Faber said that food is underweighted in the CPI

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Food only makes up about 10% of the CPI, yet most households spend closer to 20% of their income on food. This means that the true value of inflation is understated. The whole concept of Consumer Price Index (CPI), has been constructed deceptively, and does not reflect how people have to spend their money in the U. S.

Well, again Faber is just wrong. The CPI weights food expenses at 15%.

So, Ritholz copied from Fleckenstein and his own link proved the numbers wrong. Fleckenstein copied Faber, and Faber says he got 8% from Faber somehow, but Faber contradicts that by saying it's 10%, or it's 0. But it should really be 20%.

Where does Faber get his numbers? Perhaps the same place he comes up with the Dollar will soon be absolutely worthless, gold will be selling for $3,000 an ounce, and the US stock market will be at half its current valuation.

They don't call the man "Dr. Gloom" for nothing. Although, I will give him his due - his prediction track record is twice as good as Fleckstein's - he gets it right slightly more than 50% of the time. CXOAG Guru Grades – Marc Faber: Nabob of Negativism?

[RockOn]

Leonidas, great reporting, those guys are a little suspect. Faber has been predicting doom for years, Fleckenstein the same. Faber is on CNBC all the time, Fleckenstein on MSN. I wish I could make their money without a track record.

[nepo]

Faber says "food" is 20% of income. You say "food" is 15% weight of CPI, which I presume is 15% of total expenses measured in CPI. Those are 2 different metrics and can't be compared at first glance.

An income model is needed that will reveal that 20% of income for "food" equals 15% of all expenses used in the CPI. So you need to ask Faber if he's using median income to start with.

Finally, Faber is talking about the real impact of inflation in food costs on consumers, not the mechanics of measuring CPI. He measures impact by using percent of income as a pain indicator. So something that has large inflation AND is large percent of income hurts more.

[DJRR]

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Originally Posted by RockOn Such tinfoil nonsense but I agree with you almost completely. I'm not sure about the nasty part, if inflation continues the fudging will just continue, if we go into deflation they will just change the way it's calculated to show inflation. Plus 4% to -2% forever, it doesn't get any better than that....the plunge protection crew approves of this message.

Unfortunately, if the gubbmint was competent enough to pull off a CPI conspiracy then we wouldn't need one Takes the private sector to pull off a good Enron, Worldcom, or subprime mess

[RockOn]

ALERT, ALERT, New numbers coming in......ALERT, ALERT,-Massive Govenment Bailout.....Affects all those that were 30x leverged to the upside on "Other Linens" in April.

[RonBoyd]

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Originally Posted by ladelfina I came across this post today: The Big Picture | Inflation Ex-Inflation Ex-Inflation

I know it is wrong but... I can never get past the many grammatical errors (for instance, "the CPI weightings are dramatically understates what the average American is experiencing...") to lend much credence to this kind of reporting.

For some reason, however, I am very tolerant when they occur in other communication methods, i.e., e-mail, forums, and such. Much to my detriment I suppose.

[Leonidas]

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Originally Posted by nepo Faber says "food" is 20% of income. You say "food" is 15% weight of CPI, which I presume is 15% of total expenses measured in CPI. Those are 2 different metrics and can't be compared at first glance.

You have a valid point. Faber does talk about income, and the CEX measures expenditures which are ultimately translated into weighting in the CPI. Which made me go back and look at the CEX figures and now I am confused. Looking at 2005 CEX I see that the figures people reported for all expenditures in the two lowest quintiles exceeds their income before taxes:

Lowest 20 percent income before taxes: $9,676
Lowest 20 percent average annual expenditures: $19,120

Second 20 percent income before taxes: $25,546
Second 20 percent average annual expenditures: $28,921

If you look at Table 2 from the same 2005 report, you find it gets even more out of whack.

Consumer units with income before taxes of less than $5,000 show an income of $796, but total average annual expenditures of $19,684. :confused: That same type of discrepancy continues for several categories up to the group labeled "$20,000 - $29,999".

The numbers do not compute.

But, back to your other points.

Faber is not claiming anything about pain, he is claiming that the CPI is bogus and does not show true inflation. If you compare what people spend to what they make then there is a measurement of pain they experience when something goes up in price. But measurements of inflation are based on what people spend. Someone else will have to explain how a household with indicated income of $796 is spending 24 times that amount each year, but since inflation is a measurement of the increase in prices for the things they buy, all that matters is the accuracy of the expenses.

If I make $500 a month, and you make $5,000 a month, a 50 cent increase in the cost of a gallon of milk hurts me a lot more than it would you (provided either of us even buys milk). But the measurement of inflation is still based on that same 50 cent increase.

[brewer12345]

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Originally Posted by MichaelB No problem. When you get that CPI conspiracy feeling, just reach for the tin foil. Michael

Ladelfina, Rock, et al. don't have to - they have one on under their skin.