The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Frederick Sheehan is the co-author of Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.

His next book, Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession, was published by McGraw-Hill in November 2009.

Fred was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans. He wrote the monthly Market Outlook and Quarterly Market Review for clients from 1990 to 2001. He has written several guest articles in Marc Faber’s Gloom, Boom & Doom Report. He has more recently contributed to Whiskey & Gunpowder and the Prudent Bear website, among others.

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Some quotes to start:

“Moreover, inflation has been declining and is currently quite low, with measures of underlying inflation running close to 1 percent….In this environment, the Federal Open Market Committee (FOMC) judged that additional monetary policy accommodation was needed to support the economic recovery and help ensure that inflation, over time, is at desired levels.”

-Federal Reserve Chairman Ben S. Bernanke, Sixth European Central Bank, Central Banking Conference; Frankfurt, Germany; November 19, 2010

“CORE U.S. INFLATION SLOWEST ON RECORD: Core consumer prices in the U.S are at their lowest pace since records began, bolstering the case for the Federal Reserve to complete its planned $600 bn in asset purchases and extend the programme to buy more….Excluding volatile food and energy prices, the consumer price index rose by only 0.6% on a year ago….”

-Financial Times – headline and lead story on page one, November 19, 2010

“A key gauge of U.S. inflation has fallen to its lowest level since record keeping began in 1957, underscoring continued weakness in the economy and bolstering the Fed’s case that it should continue its bond-buying program.”

-Wall Street Journal, first sentence, top of page one, November 19, 2010

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A BRIEF REVIEW: The Federal Reserve launched QE2 (a.k.a.: printing money) on November 3, 2010. Chairman Bernanke justified this laboratory experiment as a measure to prevent deflation. He wrote in the November 4, 2010, Washington Post: “Most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth….” This “2 percent” hokum is an invention of Bernanke & Comrades, but the chairman pretends it is chiseled into the Federal Reserve charter. The contention is important since it is on this rock the Fed has built its justification for launching the $600 billion asset purchase, referred to in the Financial Times headline above.

The media, as represented by the newspapers above, not only accept the Consumer Price Index as released by the Bureau of Labor Statistics, but also: (1): accept the rationale that food and energy prices should not be included in the price index because of their excessive volatility, and, (2): notify readers that such low inflation “bolsters” the Fed’s case to continue pumping up asset prices. Note that both papers link the happy inflation news to the $600 billion purchase with the word “bolster.” This has the whiff of a press release delivered by the Fed to the media.

It went unnoticed how the Bureau of Labor Statistics (BLS) relieved the volatile food and energy prices of volatility. The BLS also relieved the CPI of “extreme values and/or sharp movements [of prices] which might distort the seasonal pattern [which] are estimated and [are] removed from the data.” So out went milk, cheese, oil, and cars from the CPI, if they did not meet the BLS volatility criteria. (The excisions also include non-edibles and non-combustibles, including cards, trucks and textbooks.)

Below are some monthly lists of items removed from the monthly Consumer Price Index Summary calculation and the excuses for doing so. (The lists were cut-and-pasted from the BLS website at the time. It looks as though the BLS only posts tables (no words) from the monthly CPI releases prior to May 2007.) There is nothing particular to the months shown. The reader may note the lists stop in 2006. This is because the BLS stopped releasing the list of items after December, 2006; possibly because the deception was so clear as to show the entire CPI calculation is a fraud. This is suggested without much conviction since there weren’t ten people outside of the BLS or Federal Reserve who knew it existed, possibly because critics of BLS methods had so many other fish to fry: hedonic adjustments, geometric averaging, substitution bias, owners’ equivalent rent, and on and on it goes.

To keep this short, the BLS methodology is not discussed. It is described in “Intervention Analysis Seasonal Adjustment,” a paper on the BLS website. The “procedure” referred to is the “X-12-ARIMA Seasonal Adjustment Method,” which may or may not apply to a particular item since (quoting the BLS) “components change their seasonal adjustment status from seasonally adjusted to not seasonally adjusted, not seasonally adjusted data will be used in the aggregation of the dependent series for the last 5 years, but the seasonally adjusted indexes will be used before that period.” Yeah, right.

This prescribed method of stupefying the public successfully deterred me from attempting to understand the changes to food and energy prices. And, as mentioned above, there are so many other distortions to the CPI that one is better off to assume the consumer price index is rising 5% to 10% a year and to adjust one’s life (and investments) accordingly. John Williams, author of the Shadow Government Statistics website, calculates that if the BLS used the same methodologies for compiling the CPI today that it employed in 1990, the government’s number would be 4.5%. If the BLS used the same methodologies as in 1980, the official CPI would be 8.5%.

Year-in and year-out, some items (e.g. motor fuels, new cars) are apparently a nuisance to stable prices, with the same stated rationale for not including them. How can the errant products forever be in need of adjustment (or banishment), since the selection is supposed to include temporary aberrant conditions? Of course, this whole procedure should not exist, if the CPI is a measure of the change in consumer prices. But that is not its purpose. Chairman Bernanke cannot stop reminding us that one of the Federal Reserve’s “mandates” from Congress is “stable inflation.” Thus, throw out prices that change. The wonder is after primping the inflation calculation he still has such difficulty keeping it stable.

June 2002 – BUREAU OF LABOR STATISTICS RELEASE: CONSUMER PRICE INDEX – A NOTE ON SEASONALLY ADJUSTED AND NONADJUSTED DATA

Extreme values and/or sharp movements which might distort the seasonal pattern are estimated and removed from the data prior to calculation of seasonal factors. Beginning with the calculation of seasonal factors for 1996, X-12-ARIMA software was used for Intervention Analysis Seasonal Adjustment. For the fuel oil, natural gas, motor fuels, and educational books and supplies indexes, this procedure was used to offset the effects that extreme price volatility would otherwise have had on the estimates ofseasonally adjusted data for those series. For the Nonalcoholic beverages index, the procedure was used to offset the effects of a large increase in coffee prices due to adverse weather. The procedure was usedto account for unusual butter fat supply reductions and decreases in milk supply affecting the Fats and oils series. For the Water and seweragemaintenance index, the procedure was used to account for a data collectionanomaly. It was used to offset an increase in summer demand in the Midwest and South for Electricity. For New vehicles, New cars, and New trucks, the procedure was used to offset the effects of a model changeover combined with financing incentives.

[My underlining. This preface introduced (until January 2007) each month's "Note on Seasonally Adjusted and Nonadjusted Data" in the BLS' Consumer Price Index. I left it out of the following examples.]

JUNE 2004 – BUREAU OF LABOR STATISTICS RELEASE: CONSUMER PRICE INDEX – A NOTE ON SEASONALLY ADJUSTED AND NONADJUSTED DATA

For the fuel oil, natural gas, motor fuels, and educational books and supplies indexes, this procedure was used to offset the effects that extreme price volatility would otherwise have had on the estimates of seasonally adjusted data for those series. For the Nonalcoholic beverages index, the procedure was used to offset the effects of labor and supply problems for coffee. The procedure was used to account for unusual butter fat supply reductions, decreases in milk supply, and large swings in soybean oil inventories affecting the Fats and oils series. For the Water and sewerage maintenance index, the procedure was used to account for a data collection anomaly and dry weather in California. For Dairy products, it mitigated the effects of significant changes in milk production levels and higher demand for cheese. For Electricity, it was used to offset an increase in demand due to warmer than expected weather, increased rates to conserve supplies, and declining natural gas inventories. For New vehicles, New cars, and New trucks, the procedure was used to offset the effects of a model changeover combined with financing incentives.

July 2005 – BUREAU OF LABOR STATISTICS RELEASE: CONSUMER PRICE INDEX – A NOTE ON SEASONALLY ADJUSTED AND NONADJUSTED DATA

For the Fuel oil, Utility (piped) gas, Motor fuels, and Educational books and supplies indexes, this procedure was used to offset the effects that extreme price volatility would otherwise have had on the estimates of seasonally adjusted data for those series. For the Nonalcoholic beverages index, the procedure was used to offset the effects of sharp rises in the price of coffee futures. The procedure was used to account for unusual butter fat supply reductions, changes in milk supply, and large swings in soybean oil inventories affecting the Fats and oils series. For Dairy products, it mitigated the effects of significant changes in milk, butter and cheese production levels. For Fresh vegetable series, the method was used to account for the effects of hurricane-related disruptions. For Electricity, it was used to offset an increase in demand due to warmer than expected weather, increased rates to conserve supplies, and declining natural gas inventories. For New vehicle series, the procedure was used to offset the effects of a model changeover combined with financing incentives.

December 2006 – BUREAU OF LABOR STATISTICS RELEASE: CONSUMER PRICE INDEX – A NOTE ON SEASONALLY ADJUSTED AND NONADJUSTED DATA

For the Fuel oil, Utility (piped) gas, Motor fuels, and Educational books and supplies indexes, this procedure was used to offset the effects that extreme price volatility would otherwise have had on the estimates of seasonally adjusted data for those series. For the Nonalcoholic beverages index, the procedure was used to offset the effects of sharp rises in the price of coffee futures. The procedure was used to account for unusual butter fat supply reductions, changes in milk supply, and large swings in soybean oil inventories affecting the Fats and oils series. For Dairy products, it mitigated the effects of significant changes in milk, butter and cheese production levels. For Fresh vegetable series, the method was used to account for the effects of hurricane- related disruptions. For Electricity, it was used to offset an increase in demand due to warmer than expected weather, increased rates to conserve supplies, and declining natural gas inventories. For New vehicle series, the procedure was used to offset the effects of a model changeover combined with financing incentives.