No Inflation? HAH!

Congress keeps telling Social Security recipients that because inflation is low, there won’t be a cost of living increase. Congress does this because they don’t want to give Seniors a cost of living increase, and also, because they don’t actually shop for gas and food, they wouldn’t know if there was inflation or not.

The Bureau of Labor Statistics doesn’t include food or energy costs in their index, which makes absolutely no sense.

CBS News recently reported that the rate of inflation, as calculated by the American Institute for Economic Research (AIER), clocked in at a whopping 8% over the past year.

This number is in stark contrast to the relatively modest inflation rate of 3.1% being reported by the government’s Bureau of Labor Statistics.

The AIER calculates what they refer to as an Every Day Price Index (EPI). The EPI only looks at the cost of goods the average household buys every month, and factors in only those costs which are subject to price fluctuation. For example, mortgages are typically stable over the course of a year so those numbers are ignored. They wouldn’t change unless a person moves or refinances, so they don’t act as a good measure of inflation from month to month.

Another measure of inflation comes from John Williams’ Shadow Stats. Williams calculates the consumer price index (CPI) using the same model as the government did prior to 1990. Williams also calculates the CPI using the same model as the government did prior to 1980. In each case, the government changed the way it calculated inflation in order to give the appearance of less inflation.

If we calculate the inflation rate the same way the government did prior to 1990, the inflation rate averages around 6.5%, which is basically double the official rate. However, if we measure inflation the same way the government did back prior to 1980, the inflation rate clocks in at a mind-numbing 11%, which I am sure is closer to the actual truth.

In the current official model, the state makes widespread use of hedonics and substitution to hide real inflation rates. It must do so in order to keep the interest it pays on Treasury Inflation-Protected Securities (TIPS) and Social Security cost of living adjustments low. If the government used real consumer inflation rates, it would become readily apparent that the U.S. is completely insolvent in much the same way Greece is insolvent today.

If other nations should catch on to this, they would begin dumping U.S. treasuries in order to protect themselves from a U.S. default, the same situation Greece is facing today. People don’t want to hold Greek debt because they fear they will not be paid back with money that has any value. In other words, they fear that the Greek state will simply print money to make the interest payments.

It appears that this situation may already be taking place with some major U.S. creditors. The Chinese have dumped over $100 billion worth of U.S. treasuries in the month of December, which is a continuation of a trend that has been going on since April of 2011. Chinese holdings of U.S. treasuries are down $300 billion since April of 2011.

This creates a dangerous situation for the U.S.. If enough governments dump U.S. treasuries because they fear the U.S. is insolvent,  interest rates will skyrocket – unless the Fed prints the money to buy those bonds. However, if the Fed buys the bonds, domestic inflation rates will skyrocket.

If you’re like many Americans, you may find the recent economic news somewhat perplexing. Government reports show the economy improving and inflation under control. And yet, it may well feel as though your standard of living is eroding, and you may be shocked by prices when you go shopping. Well, there’s a reason for the disconnect between  reported statistics and your personal experience – and much of it has to do with the nature of inflation.

The fundamental problem is this:  – economists and laypeople talk about inflation as though it can be measured accurately and represented by a single number. In reality, though, inflation is a judgment call and varies enormously depending on what part of the economy is under consideration. Thus the discrepancy between what you see in print and what you experience at the grocery store.

These discrepancies have been highlighted in recent weeks as various authorities reported economic statistics for 2011. The Consumer Price Index rose a modest 2.9% over the past 12 months. On the other hand, a report on Thursday by an independent research organization calculated that prices of “everyday items” rose more than 8% last year.

The latter report on everyday prices, by the American Institute for Economic Research, an organization with free-market leanings that originated at MIT in the 1930s, was particularly interesting in its details. On the plus side, there were double-digit price declines for televisions and computers, while some other kinds of consumer electronics declined at single-digit rates. But those improvements in affordability were massively overshadowed by the big price increases in 2011:

Meat and milk rose more than 9%

Coffee was up 19%

Peanut butter, a staggering 27%.

Heating oil climbed 18%.

Children’s clothes were up 6% for boys, 9% for girls.

Gasoline rose almost 34%.

With Oil at $120 a barrel, the cost of everything will be impacted from packaging to transportation. No wonder food prices have skyrocketed.

And, even those figures are only averages. Inflation is higher for the affluent (who at least can afford it). Indexes of luxury goods climbed anywhere from 6% to 15% last year. More serious, inflation for people age 62 and older is typically as much as two percentage points higher than the overall CPI, in part because of medical expenses.

This enormous variability in the inflation rate filters through to other economic statistics, as well.  So-called real growth in the economy or household incomes is calculated by subtracting inflation from figures in today’s dollars. The smaller the inflation adjustment, the higher real growth will appear, and the larger the inflation adjustment, the weaker real growth will be.

Indeed, the reported economic upturn in the fourth quarter can be attributed almost entirely to an unusually low inflation adjustment. Most measures show consumer prices rising at close to a 3% annual rate, and the inflation adjustment for GDP growth was at least 2.6% in each of the first three quarters of 2011. But in the fourth quarter, the inflation adjustment used to calculate real GDP was less than 1%. If fourth quarter growth had been based on the same inflation rates used earlier in the year, there would have been no upturn, which is what I believe actually happened – already weak growth would have slowed further between the third and fourth quarters.

There may be valid reasons that inflation in the industrial economy measured very low for the fourth quarter. But that doesn’t necessarily reflect your own personal reality. For example, workers’ real incomes have risen slightly in the past few months, according to government inflation measures. But if those workers face continually rising prices at the grocery store and elsewhere, their own experience will be that the recession has not ended and that their standards of living are still falling.

Some commentators have tried to make current conditions sound rosier by pointing out that prices of a few key big-ticket items are falling, offsetting the price rises on everyday items. This argument is faulty for two reasons. First, big-ticket items such as housing and autos are highly cyclical. Their contribution to long-term inflation depends on their trend over time, not on temporary lows near an economic trough.

Second, people don’t buy cars and houses every day. Your monthly budget isn’t affected by what you might have paid for your home some years earlier. Indeed, this underlines the extent to which your own inflation rate depends on your personal circumstances. A renter might be affected by price trends in the real estate market, but someone with a long-term fixed-rate mortgage wouldn’t be.

There are, in fact, multiple difficulties in trying to account for cyclicals and highly volatile items such as oil when measuring inflation. But insofar as such things can be assessed, they suggest more inflation in the future, not less. Depressed home prices will likely rebound at some point if the economic recovery gains momentum. And current high oil prices will eventually factor into inflation as transportation costs get passed along for many goods. If Iran or Europe turn into the likely nightmares they will probably become, Oil could go to $400 barrel.

In the final analysis, what matters most to you is your own personal experience of the economy. And you’re probably feeling higher inflation and weaker growth than the economic statistics coming out of Washington would suggest. If you really want to know what’s happening to your own standard of living, go shopping for groceries.


About Steve King

iPeopleFINANCE™ Chief Operating Officer. Former CEO of Endymion Systems, Inc. a $36m Information Systems Services company. Co-founder of the Cambridge Systems Group, the creator of ACF2, the leading IBM Mainframe Data Center Security product; acquired by Computer Associates. IBM, seeCommerce, marchFIRST, Connectandsell alumni. UC Berkeley alumni. View all posts by Steve King

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