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Is inflation really 3%, if not......
Old 02-15-2008, 09:35 AM   #1
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Is inflation really 3%, if not......

There are a many people who do not believe the PPI is 2.3% or the CPI 4.0%. Here is one:

Shadow Government Statistics Alternate Data Series

He does seem to be a reasonable thinker. He could be, and probably is wrong, he thinks inflation is around 12%. I have to admit, it does seem higher than 2.3% to me.

For conversation, let's say the real rate of inflation is really about double what the government is telling us, or around 6%.

What does this mean?

Here are a few thoughts:

1) It means the govenment is in much less debt than we think because they can pay off the national debt and SS/Medicare with delated dollars, that is the good news. (Would they fudge the numbers to make that happen? It seems to me that they would)

but, as investors doesn't it mean:

2) We have been in a recession for awhile. (GDP is growth minus inflation).
3) Tips are paying less than inflation and are very overvalued.
4) Bonds are paying less than inflation and are very overvalued
5) Stocks, since they are priced at a discount rate to future flows, are very overvalued. (Plug in a 6% discount rate instead of a 3% rate and the value would drop.)
6) Real assets such as houses and gold are not as overpriced as we think because our dollar is being devalued due to inflation much more than we think.

If we believe inflation is really being understated, how can we believe that a 60/40 buy and hold strategy of mostly stocks and bonds is a good investment? We really need to believe inflation is 3%, do we not? If we believe it is 6% do we need to be investing differently, i.e. possibly some stocks (they are an inflation hedge but are very overpriced now); but mostly in real assets?

Thoughts?
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Old 02-15-2008, 09:55 AM   #2
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> Thoughts?

CPI-U is useless. I follow CPI-P (Consumer Price Index - Personal). You need to know what your year-over-year price increases are and budget accordingly.

For instance, I'm cooking at home a lot more than I was last year. While fuel has gone up, food is our second-biggest budget item. Because I'm able to cook more and more cheaply, my CPI-P has actually gone down compared to last year. On the other hand, if someone lived in the frigid north and heated their house with fuel oil, their CPI-P might be up 10% against last year.

Likewise, one person's CPI-P may actually start to mimic CPI-U. If beef prices go up, they may cut down on the steak and start using chicken or hamburger more... sliding lifestyle to meet dynamics in pricing.

Your long-term plan should take that into account. My long-term plan for retiring when I'm 45 (pushing for 40 now) calls for a return of 2.5% over my CPI-P. My opinion is that it'd be foolish to plan without understanding one's personal budget needs and increases over time.
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Old 02-15-2008, 08:38 PM   #3
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If you have to alter your lifestyle to a less expensive approach, inflation has still occurred. You have simply found a way to deal with it. Substituting catfood for steak on the senior side of the aisle for instance.

Inflation is notoriously hard to pin down, but I'll bet that the cost of living an ordinary day-to-day existence has been rising for most of us at a faster rate than the government statistics indicate.

To the wealth readers of this blog, the consumer price rise will be immaterial.
For the rest of us.... more pain ahead.
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Old 02-15-2008, 08:44 PM   #4
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Wow, serious tinfoil hattery. And I love the methodology: if your predictive model doesn't work, it must be the data that is wrong. Yeah, that's the ticket...
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Old 02-15-2008, 09:19 PM   #5
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Inflation is notoriously hard to pin down, but I'll bet that the cost of living an ordinary day-to-day existence has been rising for most of us at a faster rate than the government statistics indicate.
And for some of us, it hasn't. Thus, the need to track your CPI-P. Do you know what your's is? If not, then you should. It's not that hard to pin down at a personal level.
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Old 02-15-2008, 10:33 PM   #6
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I'm somewhat surprised at the responses. I am not really sure what inflation is now, I'm not pressing that point. I do think it is at least somewhat under-reported.

My point is this: if the government is not being honest in calcuating inflation; which many, if not most people believe; doesn't that affect investment decisions. For instance if inflation is being underreported at 3% vs a true 6%, then the yeild on TIPS is low. I am actually giving away my asets by investing in them because they have a negative real rate of return.

Do we just accept that 3% is correct and move on as if it is a fact, or should we be adjusting our thinking? For instance, buying TIPS at a negative real return is crazy. Do we have our head in the sand to ignore this?

Brewer12345, I 'm sorry but I do not understand your response, I'm not talking about having an incorrect predictive model as I see it. I'm not trying to adjust data, I'm only questioning whether the data that we base our decisions on is believable. I guess it comes down to these questions: Do you believe the PPI is 2.3% and the CPI 4%? Do you believe that TIPS at todays yield provide a real rate of return?
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Old 02-15-2008, 11:22 PM   #7
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I'll say it again. 3% is irrelevant. Who cares if it's correct or not?

If your personal inflation rate is 10% then TIPS might be a bad deal for you if you're using them to stay ahead of your personal inflation rate.

If your personal inflation rate is 2% then TIPS might be good for you if you're using them to stay ahead of your personal inflation rate.
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Old 02-15-2008, 11:53 PM   #8
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Marquette, I do get that point. You are correct, if your CPI-P is that low you are doing well. For this discussion, let's assume that most peoples CPI-P is 6% in this country on average, as I think it might be. Why do I hear so many people talking up TIPS as one of the best low risk investments? They are not good investments if they are paying a negative real return. The same with bonds that do not pay a real rate of return. Stocks are more tricky but they could be very overvalued if the inflation rate for most of us is really 6%, I'm sure the market would tank on Monday morning if the public was told inflation is running 6% and has been for a few years.

If the government is fudging the inflation number it does make a difference to investors I do believe.

As far as my CPI-P, it is pretty high I know that. I do not track everything so I do not have a number for you but my health insurance has gone up at over 10% a year for about 10 years now, my property tax went up 20% this year, food is up, gas is up, utilities are up, other insurances are up, my sons college tuition/room and board went up 14% just this year, eating out costs more, the days of $5 lunches and $0.50 coffee are long gone. What it all adds up to I do not know, but I'd bet it is more than 3% per year. A few things go down, I only buy a computer every 5 years or so if that is cheaper, it doesn't make much difference. Have you shopped for a TV lately? I know they are better and I'm supposed to say I need to take that quality improvement into account, but as I leave the store I know they got a lot more of my cash than they used to.
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Old 02-16-2008, 12:17 AM   #9
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I bought an older model of this TV line 2 years ago for $2,400. List price was $3,200.

Samsung - 40" 1080p 120Hz Flat-Panel LCD HDTV - LN-T4069F

It's now $2,200 list. So, yes, I have shopped for a tv lately and prices fell. I'm sure the example isn't quite what you're thinking... but I can't think back far enough to know what I paid for my 25" tube tv 10 years ago, which is probably more in line with what you had in mind for a timeline.

I'm pretty sure I read a post from brewer yesterday that TIPS were a horrible investment at their current coupon / yield. If you're reading that they're good investments right now, it's probably from the same people who were telling us that there wouldn't be a housing downturn.

I like the hypothetical idea, though. What happens if Ben comes out tomorrow and says "sorry folks, we were wrong, inflation is 6% now and will be going forward". You said the market crashes... which one? I would imagine you'd see a run to commercial REITs, commodities, and gold. Those markets would do fine.

Personally, I don't, and never have seen fixed income as low risk. I suppose I view it differently, but in mind mind the two riskiest (not in terms of traditional risk) portfolios are 100% fixed and 100% equities. The two work together to dampen one's standard deviation, smooth out return, and generally let one sleep better at night.

If you're not interested in gold or commodities (or commodity futures) then, as you mentioned before, pick up some real estate. That 5.5% mortgage doesn't look so bad if you're financing it with such cheap future dollars.

I'm not so sure 6% would have such a huge long-term impact on the market. 6% is nowhere near hyperinflation (although I suppose it is twice as close as 3%).

edit: And, I'm entirely sure that some tomfoolery does happen with CPI. However, I'm not sold on the extent or ramifications. It's not exactly smooth, either, so it's possible that it balances slightly better over time. For instance, gas prices spiked and then leveled off. Your kids college tuition is going up rapidly but that's only for a short period (4-5 years I'd assume) and then the cost disappears altogether, making it a rather localized event when viewed over 100 years.

And, don't forget that you can't let wishful thinking cloud your memories of the past. we all tend to reminisce about how good the past was and how little things cost. Back to the TV example. If it was a bottom of the line, small screen TV that you're remembering from 15 years ago, then it's best to compare a similar set today to see if, in that case, inflation has exceeded the expected value.
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Old 02-16-2008, 12:39 AM   #10
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Thanks for the thoughful response. I wasn't sure anybody was saying TIPS were a poor investment, if Brewer did I think he's a God. As far as the tv, I did mean compared to the ones we got 10 years ago. I doubt you paid $2200 minus 3% inflation anualized.

By saying the market would tank if we knew inflation was really 6%, I really meant the SP500, not specific sectors like gold stocks, I'm sure they would soar. I have my doubts the SP500 would recover any time soon but that is just guessing, nothing is for sure. I think my guess might be correct because the discounted rate of future flows from stocks would be severely affected. If that is at least partially how stocks are valued it would matter.

My main wish is that the govenment should just play it straight and let the chips fall where they may. As Kudlow says "Free market capitalism". Isn't fudging the inflation rate tinkering with the economy similar to wage price controls? We likely both remember what happened after Nixon tried that. Is it the govenment's job to do whatever it takes to support capital market prices?
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Old 02-16-2008, 03:41 AM   #11
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our entire cpi is based pretty much on cheaper substitutions. its never based on apples to apples. while a new chevy malibu may be the equal or better in fit and form to an old caddy a caddy driver isnt driving a chevy malibu , he wants a caddy.

electronics in a relative term always get cheaper but in the same light the best of breed and newest technology of that time period does not. a top of the line best of breed sony xbr 20 years ago was about 900 bucks . today a best of breed xbr is 3x that. if you dont want to get the current equal in technology than yes older technology is cheaper.

dont forget color tv when it came out was a new technology. it cost 500 bucks way back then for a set. today that set may cost 99 bucks if that much.


while you can buy a plasma set at costco for 2000 bucks a best of breed panasonic or sony can still hit 5-6000 for up to the minute technology.
everything is relative to performance of that day. 20 years ago a best of the day computor was about 1200.00 bucks. today its still 1200 bucks, you just get more for your money.

comparing a crappy pair of walmart jeans in the index to a pair of gap jeans still show jeans rising in price not falling if i dont want an inferior substitution


the list goes on and on
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Old 02-16-2008, 06:07 AM   #12
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The quality of living doesn't matter in DC as long as the workforce can drag itself back to the chain-gang each year. The minimum required to achieve that goal is all that is important. Any more is inefficient and requires better management transformations.
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Old 02-16-2008, 11:15 AM   #13
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Originally Posted by RockOn View Post

If the government is fudging the inflation number it does make a difference to investors I do believe.

As far as my CPI-P, it is pretty high I know that. I do not track everything so I do not have a number for you but my health insurance has gone up at over 10% a year for about 10 years now, my property tax went up 20% this year, food is up, gas is up, utilities are up, other insurances are up, my sons college tuition/room and board went up 14% just this year, eating out costs more, the days of $5 lunches and $0.50 coffee are long gone. What it all adds up to I do not know, but I'd bet it is more than 3% per year. A few things go down, I only buy a computer every 5 years or so if that is cheaper, it doesn't make much difference. Have you shopped for a TV lately? I know they are better and I'm supposed to say I need to take that quality improvement into account, but as I leave the store I know they got a lot more of my cash than they used to.
It's one thing to say "The things I buy have gone up by more than the national CPI" and a different thing to say "The gov't is consistently understating price increases by 3% per year".

If you buy individual health insurance and have kids in college, I'll believe your total expenses are going up faster than the CPI because your weights for those things are higher than the national average weight.

(I think there may be an national issue with medical insurance. I don't know if/how the BLS adjusts for changes in the split of medical costs between employers and employees.)

But, looking around, I don't see Americans consuming a lot less than they did 10 years ago. Yes, I know some of that consumption is funded by borrowing.

The gov't numbers say we need 30% more income today just to consume as much as we did 10 years ago. That's pretty much in line with the increase in median earnings, so the median worker should be about staying even. You're thinking that the real increase in prices is 73%. That would mean the average worker is consuming 25% less now than 10 years ago (or borrowing 25% of his annual income every year to maintain his spending). I don't see that.
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Old 02-16-2008, 11:25 AM   #14
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I bought an older model of this TV line 2 years ago for $2,400. List price was $3,200.
This would be terrific if you had to buy a tv every week.

Quote:
And, don't forget that you can't let wishful thinking cloud your memories of the past. we all tend to reminisce about how good the past was and how little things cost. Back to the TV example. If it was a bottom of the line, small screen TV that you're remembering from 15 years ago, then it's best to compare a similar set today to see if, in that case, inflation has exceeded the expected value.
Indeed, 15 years ago a 55" big screen rear projection set generally ran between $1200 and 2000 for a good set. But the primo for quality was a 35" crt set that generally ran from about $895 to about $1500 for a good set.

Electronics probably dont have a lot of weight in most peoples budgets. I'm imagining many ER's have the balance of their nondiscretionary budget in food, energy, insurance, health care...you know, the stuff that goes up like crazy.
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Old 02-16-2008, 11:37 AM   #15
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Independent... So you think the PPI and CPI as reported are about right. Maybe, but I think if we took a poll around 80-90% of Americans would disagree with that. A poll is not scientific, I understand.

I think it was when the Clinton Admin was running things that the serious fudging began. I find it pretty hard to believe there is no fudging going on. If they are fudging, the government benefits while our purchasing power is being slowly eroded.

I want to Government to report the correct numbers. If they did and I am correct that what they are reporting is low (3% or even much more), we would be able to invest much more safely in my opinion. The economy would have to make some painful adjustments but in the long term that is a good thing in my mind. The real estate bubble might not have happened. We could be getting 7% on TIPS and bonds and buying the market at a lower level. In my opinion a big risk right now is that if we somehow come to conclusion as investors that we have been misguided about inflation, and it is really much higher, our TIPS/stock/bond investments are much more at risk than we think.

ps. One more thought, you don't think that people were spending more than their income when they were cashing in on the housing ATM during the real estate asset bubble? This could easily account for the some of the difference in your calcs.
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Old 02-16-2008, 02:23 PM   #16
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I was trying to differentiate between any of the CPIs, which are rather arbitrary "baskets of goods" and the personal on-the-ground cost of living that the majority of Americans are experiencing. I thing most of us have less money for discretionary purchases or more importantly, for saving, each year.

Some of the posters on this site are well-to-do, high-earners. A relatively small portion of their money gets spent each year. For instance, if the cost of the food they buy increases by $1000 every year, they hardly notice. $500 more a year in gas means nothing compared to their over all income.

They are a select group though. Even here, there are a few who are finding prices to be an onerous burden. In the greater world, The Great Heartland for example, one finds former industrial workers who are in dire straits. Many blue and white collar workers are faced with permanent decline in wages and are feeling the effects of expenses especially hard.

The CPI is not an accurate practical representation of the cost of living increase for the majority of people.
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Old 02-16-2008, 02:56 PM   #17
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We spent less last year than the year before. However our grocery bill went up by 20% . Told the DW we need to knock that off LOL . That was the biggest sticker shock for us.
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Old 02-16-2008, 03:32 PM   #18
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Independent... So you think the PPI and CPI as reported are about right. Maybe, but I think if we took a poll around 80-90% of Americans would disagree with that. A poll is not scientific, I understand.

I think it was when the Clinton Admin was running things that the serious fudging began. I find it pretty hard to believe there is no fudging going on. If they are fudging, the government benefits while our purchasing power is being slowly eroded.

I want to Government to report the correct numbers. If they did and I am correct that what they are reporting is low (3% or even much more), we would be able to invest much more safely in my opinion. The economy would have to make some painful adjustments but in the long term that is a good thing in my mind. The real estate bubble might not have happened. We could be getting 7% on TIPS and bonds and buying the market at a lower level. In my opinion a big risk right now is that if we somehow come to conclusion as investors that we have been misguided about inflation, and it is really much higher, our TIPS/stock/bond investments are much more at risk than we think.

ps. One more thought, you don't think that people were spending more than their income when they were cashing in on the housing ATM during the real estate asset bubble? This could easily account for the some of the difference in your calcs.
I'm not sure what to say except the obvious. You believe the "typical" family that has had raises equal to the CPI over the last 10 years, and that didn't have a change in family size, is actually buying 25% less stuff. That means they are buying 25% fewer gallons of gasoline, kwhs of electricty, pairs of jeans, loaves of bread, etc. I don't see that. Lots of people aren't getting ahead, but they aren't slipping behind that fast, either.

Sure, people complain about prices going up, but that doesn't mean that the average price is going up faster than the gov't numbers.

I'm not saying that nobody has slipped backwards. Some people lost jobs and had to trade down. But that doesn't mean that prices really went up a lot more than the CPI claims.

Some people have personal CPIs that have gone up faster than the average. In the last couple years, two things that carry more weight for lower-middle income people (food at home and gasoline) have gone up faster than other prices. So a CPI weighted for a lower-than-average income family probably went up faster than the standard CPI-U. But that doesn't mean the gov't is "fudging the numbers". The BLS is pretty open about how they do things.

Regarding "house as ATM", I'm sure there is some of that going on. I'm not sure that it's happening just so people can stand still, or so they can consume more. Either way, it can't be big enough to offset the kind of price increases that you're suggesting.
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Old 02-16-2008, 03:45 PM   #19
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But that doesn't mean the gov't is "fudging the numbers". The BLS is pretty open about how they do things.
Aha!!! They've already gotten to you!!!! Did they threaten your family?


I swear, we need a tinfoil helmet emoticon...
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Old 02-16-2008, 04:00 PM   #20
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