Inflation: why it seems understated

[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]

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]

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

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

What you responded was

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

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.

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]

Are you feeling a little defensive? Just wondering......

Not at all - but thanks for asking.

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]

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]

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:

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

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.

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

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]

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]

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]

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. 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]

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.

 

[REWahoo]

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

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[ladelfina]

MichaelB, yes, no doubt I am debating with myself, but that's kind of my nature.. but then, and, if, how about?

Her lecture is more about the finance business but the book is overspending on housing and subsequent associated costs.

I was just going by the video lecture; I did not read her book or know of its contents. If you want to go into what the book claims, I'd be interested.

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. ...

In this we don't really 'part ways': people are just as likely now as ever to be led into poor apparent choices; that's what I was trying to say. Some of these affect them as individuals and some are collective. But the US is not special; the mortgage mess and property price disconnects are even more severe in Spain, the UK and Australia.

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.

Sure. I see the 'choices' in the CPI flap as being not really choices that we have any control over, though. Electing this or that politician from year to year doesn't have much hope of changing the long-term underlying structure and practices of Federal economists or the Federal Reserve. We certainly have little individual choice in how the media decides to frame the gov. figures. Some people brush off questions about how well reporting by these entities reflects reality (or better, how useful it is in its intended practical role) as "tin-hattism"; I just call it healthy skepticism.

In the realm of individual choices, on the face of it, are these choices really so 'poor' in context? If someone offers you a no-money-down mortgage with a super-low initial rate, that's appealing. If the mortgage broker gets paid by the number of mortgages he/she sells, that's an incentive to sell iffy mortgages. If the banks don't have to hold the mortgages and so don't feel the need to examine them closely, that's another incentive for disaster. Every choice was "wrong", yet "right"! I'm fascinated by those kind of dynamics.

Another interesting thing just coming out are distortions in the LIBOR
Bloomberg.com: Worldwide
Banks falsely reporting a lower rate have a material advantage.. another "wrong/right" choice that screws up the system for everyone.

My mild panic (or let's say 'perplexity') is due to the feeling that it's all a very creative fiction. No doubt I have been naive to think that companies, banks, and governments would face certain material facts with a certain responsibility and logic.

Thanks to Leonidas and nepo for their research on Faber & Fleckstein. Since I don't pay attention to CNBC or MSN I had no idea who they were.

--Thanks brewer, for your helpful comments.. now all I need is for Nords and Jarhead with their guaranteed pensions no doubt larger than my entire investment SWR to chime in and tell me not to worry my pretty head over yields vs. inflation. I have a tin hat because I don't happen to have a gold-plated one. All's I have is dollars in the bank that buy less and less every day.

 

[Independent]

Very good article about our biases in observing the inflation numbers

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

Excellent article.

 

[brewer12345]

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Heheh, mithril!

Either that or shiny Jesus Jammies.

 

[ziggy29]

Consumer prices rise in April, but less than expected - May. 14, 2008

Surprisingly, the Labor Department reported that seasonally adjusted energy prices did not rise from March's levels. Though unadjusted gasoline prices were up 5.6% in April from a month earlier, seasonal adjustments made to that estimate resulted in gasoline prices being down 2% on that basis.


That's despite the fact that gasoline prices posted a string of 16 straight daily record highs in April, according to the motorist group AAA. Other measures of national average gasoline prices, including the U.S. Department of Energy and AAA, showed gasoline prices and rose an average of 9% to 10% over the course of the month. Crude oil prices rose 11% in April.


Seasonal adjustments. How convenient.

 

[nepo]

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

Just a quick check on the CEX for 2006 show consistent results. Check here:

ftp://ftp.bls.gov/pub/special.requests/ce/standard/2006/quintile.txt

I believe part of the answer is consumers get in more debt every year. That's really troubling because the credit crunch is going to put a stop to that trend for the majority of consumers. If you look at this item in the report:

Net change in total assets and liabilities.......


All the columns show negative numbers (liabilities increasing more than assets are increasing).

 

[Independent]

"This is of course why a focus on prices, especially the CPI, is dead wrong. The CPI is not a valid measure of inflation. No measurement of prices is a valid measurement of inflation.

It doesn't matter what you call inflation. What matters is the cost of living, in other words cost of consumption, which CPI estimates, or would estimate if it were done properly.

By definition, nobody has to buy any assets, including houses, ever.
People have to buy consumables. Those are the prices that matter, whether you call consumer price increases inflation or not."


This is a quote of someone from another site. It represents rather well the practical concept that I would like to express. Whether or not the technical definition of inflation is met, the on-the-ground experience of most people is that they are rapidly losing financial ground.
That is a situation that effects even the most well to do visitors of this blog.

I don't get the quote.

My econ textbook defined "inflation" as "the overall increase in prices in the economy". Your quote says "No measurement of prices is a valid measurement of inflation."

I think it's useless to use any word unless we can agree on a definition.

Maybe the best approach is to drop the word "inflation", and clarify what you mean by the "on-the-ground experience of most people".

 

[MichaelB]

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[REWahoo]

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[brewer12345]

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