The Sordid Truth About Inflation

With PPI out today, and CPI out tomorrow, inflation will be on Trader’s minds. Now is as good a time as any to update our thinking on Inflation.

Its been quite a while since we last railed against the absurdity of inflation ex-inflation — the reporting of only items that don’t go up in price to determine price increases. Given the Bank of England’s surprise rate hike last week, we thought today was as good a day as any to update this issue.

For those of you relatively new to the Big Picture, here’s our story so far: When the Fed slashed rates to half century lows, they jump started a flatlined economy. First, we reflated, then we inflated. With the cost of capital (i.e., borrowing money) so cheap, demand for anything dollar denominated lifted off. This sent prices for oil, gold, real estate, industrial metals, etc. skyrocketing. 

Politicians hate to make it appear that growth is merely price increases, so the US government has an inherent bias in its data reporting — Inflation is understated and Growth is overstated. Nothing so corrupt as the data being fudged; rather, the tilt of BLS and Commerce Dept is to be "growth friendly and inflation hostile." Given how massive the COLA payments based on BLS CPI are, its almost understandable.

All economic models in their attempt to depict reality have a slant, and our official models massage the data: They seasonally adjust them, account for hedonic improvements, create new modifications. The problem with this is that as time goes by, the cumulative impact of this is to create a disconnect between the model and reality. Like a small error in the initial trajectory of a rocket launch, a few million miles later and you are way off course.

The long term impact of this bias is to make the official inflation data more and more fictionalized. This forces economists to put themselves thru circus-worthy contortions to rationalize the disconnect. A classic example: Rising oil prices are not considered inflationary, but falling oil prices are somehow disinflationary. The lack of symmetry is at best annoying, and at worst intellectually dishonest.

Back to the BoE: They have matched the Federla Reserve’s Rate of 5.25% — yet somehow, inflation in the UK is admitted as rising, yet inflation in the US is declining. As Bill King astutely points out, this is simply false: "It’s comparing apples to oranges. The UK doesn’t engage in the plethora of ‘hedonic’ adjustments that pervert US CPI, and the UK uses real home prices plus mortgage rates to determine housing inflation.”  In other words, inflation is rising in both locales, only its reported differently.

Now here’s where things get interesting: This past Monday, the Financial Times reported that the Office for National Statistics (ONS) — the British Equivalent of the BLS — published a web calculator to let consumers determine their own inflation rates, as people have accused them of doctoring the sata:

“The nation’s top statistical office is fighting back against accusations, fuelled by newspaper campaigns, that its inflation index is inaccurate and underestimates the rate of inflation experienced by most people.

The Office for National Statistics today launches a personal inflation calculator on its website so people can see for themselves how their spending pattern is likely to deviate from the average for the retail price index, the most comprehensive measure covering goods and -services bought by most households.

Jim O’Donoghue, ONS inflation statistician, said: "It is clear from correspondence received and reports in the media that many people think inflation is higher than that shown by the official figures and that this has gone some way in under-mining confidence in them."

It getsw even better: Bill King delves into the details, and finds that, despite being vastly more accurate than our own system, the Brits still underreport their inflation rate:

"One of the findings of the ONS research is that people’s perception of inflation has been skewed by higher price rises of goods they buy regularly.  [No kidding, Sherlock!]  Big ticket electrical items and  clothes have fallen in price, but since they are bought relatively rarely, the ONS believes consumers have  a false perception of rapidly rising prices…

But the ONS has recognized that some people, particularly those spending a high proportion of their incomes on services, would have a higher inflation rate in recent years.”  To quote Guinness,  Brilliant!!!…Western governments are ‘fooling’ with economic data to obfuscate lower living standards  due to the enormous transfer of wealth to Asia.  But fin traders/investors heed the data."

A classic example of how inflation is underreported showed up in (of all places) Parade magazine. They noted that the US spend smore on healthcare in both percent of GDP and absolute dollar amount than any other country on the planet.

This massive expenditure didn’t happen overnight, but has steadily built up over time. And, BLS continues to dramatically understate it: King notes that "For 12 years, the BLS has been reducing double-digit real healthcare inflation to about 4.2% per annum via hedonic adjustments. If they were honest, they should increase healthcare costs more than the actual gains due to negative hedonic adjustments for the deteriorating healthcare results."

We noted a few weks ago in Wage Surge? that the actual annual increase in health care costs has been well north of 10%. Indeed, Tuesday’s WSJ had an article that detailed

"Increasing numbers of Americans are encountering similar choices as employers ask them to buy their own benefits, including disability and life-insurance policies, medical and dental coverage, and even benefits not normally found in the workplace like homeowner insurance and identity-theft coverage. Few businesses are actually replacing employer-paid benefits with these so-called voluntary benefits — "voluntary" because you pay for them yourself. But some experts predict that eventually, American workers will have to buy many of the benefits they now get free at work, much the way most of the burden of funding retirement savings has shifted from employers to employees in recent years."

Paying for something that was previously part of your compensation package? Pick your poison: Either that’s wage and income deflation, or price inflation.

Our curmudgeonly bottom line: Though decellerating somewhat, Inflation remains a genuine issue, and it is still considerably higher than reported. Wage gains, on the other hand, are actually worse than reported. 

Or to quote the eminent Judge Smails on the current state of data reporting: You’ll get nothing, and like it.


Calculating Inflation Rates
Personal inflation calculator & related information

Personal calculator for your own inflation rate
Scheherazade Daneshkhu,
FT, January 15 2007 02:00 | Last updated: January 15 2007 02:00

ONS to launch personal inflation calculator
Rebecca O’Connor
Times Online, January 04, 2007,,16849-2531286,00.html

Is America Still No. 1?
David Wallechinsky
Parade, January 14, 2007

The Shifting Calculus Of Workplace Benefits
Amid Rising Health Costs, Employers Offer Growing Menu of Insurance Products That You Pay for Yourself
WSJ, January 16, 2007; Page D1

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These are not intended to be predictions, but rather "events that have a
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