Have you bought any food lately? How about gas? Have you filled up your tank? Of course you have. And, it’s getting a bit more expensive, isn’t
it?
Take a look at this chart of inflation over the last 70
years.
So, why do we keep hearing that inflation is under
control?
Listen carefully the next time you hear it. They’ll say, “Core inflation excluding
volatile food and fuel prices” is under control or something like that.
If you can’t score a touchdown, move the goal post.
There’s more. The
chart above shows the Consumer Price Index (CPI) which is the measure of inflation we have all grown up with. However, the boys and girls over at
the Federal Reserve have decided to use Personal Consumption Expenditures (PCE)as a measure of inflation (starting in 2000). Here’s how
the two compare.
So, what’s the difference?
In simple terms, the CPI measures the change in prices of a fixed set of
goods and services – bread, clothing, gasoline, etc. The PCE fiddles with that calculation a
bit. For example, if you bought a new
computer a few years ago for $800, you got a certain amount of processing
power, memory, ports to plug stuff into and so on. If you spend $800 today for a new computer,
you would get more of all that stuff. Or,
to put it another way, buying the same processing power etc. today as you did a
few years ago costs less. PCE averages
that lower cost of the same features into its index holding down this
particular measure of inflation.
The Full
Employment and Balanced Growth Act of 1978 established two goals for the
Federal Reserve: reducing unemployment
and reducing inflation.
If your goals included holding down inflation like the Fed
Chairman, wouldn’t you prefer to use PCE?
If you can’t score a touchdown, move the goal post.
In fairness, a lot of economists think PCE is a better
measure inflation. But, out here in the
real world where the cost of gasoline and food has been moving up steadily over
the past five years or so, I don’t really care what they think.
So, what should we make of all this?
Perhaps the best perspective is provided Dylan Grice, author
of the Edelweiss Journal. He tells us
“inflation is not measurable”. He tells
policy makers that “trying to control a variable you can’t measure (inflation)
with a tool you don’t fully understand (money) in a complex system with hidden,
unobservable and non-linear interrelationships (the economy) is a guaranteed
way to ensure that most things which happen weren’t supposed to happen”.
And, when was the last time the government’s forecast for
economic growth came true?
WHO WILL LEAD?
Great post. I predict there will be no useful course change for the United States until there is an overhaul of the Federal Reserve, and the IRS. I'm also confident that such isn't going to occur without significant stress.
ReplyDeleteBy Christopher Smith
Jim Fay
ReplyDeleteAccount Manager at Compressor Systems, Inc.
Yes. Then repaint the field and modify the definition of a yard as 18 inches, so you still get 100 yards to the field.
Curt Lindsay
ReplyDeleteEngineer, NAVAIR
Don't companies do the same thing? Comes back to "numbers don't lie and liars use numbers". So when do we trust numbers?
@Curt. When companies do it, they harm no one but their shareholders who have the option to divest. Not so when it's the Fed.
ReplyDeleteJim Fay
ReplyDeleteAccount Manager at Compressor Systems, Inc.
Everyone puts on their best face when selling. Individuals put only the things they want an employer to see on a resume, companies always try to make their results look good, and politicians spin results and information to make themselves look as successful as possible. I belive relatively few companies out and out lie, but they don't give bad news if not absolutely necessary and negative results are hidden within other numbers as much as possible. Politicians have evolved to where obfuscation is an art form.
It is incumbant upon the listner, investor, or voter to understand this and study the numbers to their maximum ability in order to make a judgement as to whether the person, company or politician is trustworth. Yes children, inspite of what you have been told, it is necessary to judge people and organizations - not condemn, but evaluate what level of trust to bestow - at all levels of life.
Ralph Michalske, MBA
ReplyDeleteSemiconductor Product Marketing Professional
John, your graphs indicate that recent inflation, since the Jimmy Carter years, has had a fairly linear trend, around 2% on average. This indicates stability in our economy, at least from a monetary standpoint. I think you could say the Federal Reserve Board has done a good job controlling inflation over the past 40 years. It's really a minor factor in the loss of wealth in our nation now. Moreover, our central bank now has the secret sauce to contain inflation at its current level, or even reduce it. Also, your graphs don't support any conclusions or relationships to our National Debt which has grown recently. When our National Debt topped $1T during the Reagan years, economists warned that growing debt would cause increased inflation. Lucky for us, those economists were wrong.
I think it's only politicians and political agendas that try to move goal posts or have economists do it for them to support their agendas. Frankly, economics has become highly politicized in our society today. It has caused us to lose compassion for those in our society who need help. It diminishes our courage to help our neighbors, the rest of humanity, advance and make life worthwhile for themselves. If our politicians and corporate leaders focused more on moving the goal posts in these areas, we would truly be proud to be Americans.
@Ralph, I admit I had a hard time writing this one. It's difficult to write a short piece on economics. What has occurred since Nixon closed the gold window is a dramatic expansion of the money supply aided by the Fed whose low (or zero) interest policies have made borrowing too cheap. The impact has been a reduction in the multiplier effect of investment capital. Here's a graph that shows the effect:
ReplyDeletehttp://research.stlouisfed.org/fred2/graph/?s%5B1%5D%5Bid%5D=MULT
Once interest rates hit zero, the Fed doubled down by introducing QE which further expands the supply of money. Many economists believe that we are heading for a collapse. Too much public sector debt will eventually catch up with us. The Fed contributes to this potential calamity by keeping interest rates artificially low.
Because investment capital does not yield a reasonable return, investors turned to leverage to expand the available pool of cash and increase return on equity. And so, the seeds of the financial crisis were sown. When Congress and others called for the regulation of hedge funds and credit default swaps, the Fed (in the person of Alan Greenspan) convinced them it was unnecessary. And so, a potential control on runaway leverage was denied.
ReplyDeleteBack to the core of my argument: switching from CPI to PCE tends to ignore a growing differential between the two. That differential compounds over time as you can see from the second graph in the post. I suggest to you that the impact is not insubstantial.
Ralph Michalske, MBA
ReplyDeleteSemiconductor Product Marketing Professional
John, great point. You have correctly related debt to the M1 multiplier (sometimes called the velocity of money). The M1 money multiplier (MULT) has fallen below its critical point of 1.0. This makes the MULT fractional which means an attempt to increase the money supply (M1) by the Fed to spur investment capital will actually stall GDP growth possibly forever, unless..... Paradoxically, the Fed has to withdraw liquidity and by doing so force the bad debt into the open where it does (and must) default. Let's call this Lehman Brothers II or LB2. This economic storm will come in epic proportions and last a long time until all the bad debt flushes out and the National Debt recedes.
If the above were to happen, then the CPI and CPE could go negative. This would put us in a truly strange economic world.
I can't find data to support this... But I believe that, were it not for QE, we might be in a period of deflation.
ReplyDeleteRalph Michalske, MBA
ReplyDeleteSemiconductor Product Marketing Professional
John, I think our economy is operating off-the-charts. There is little data and few models to support economic forecasts. In some cases we are operating in areas that only existed in theory amongst economists. With the money supply multiplier falling below 1.0, we are in an area that only exists theoretically, never in practice, that I'm aware of. Just understanding the recent unemployment numbers takes an understanding of an economy we've never been in before, or ever thought could exist.
You re right about easing and deflation. The Fed was forced into the lesser of 2 evils. This is similar to Richard Nixon being forced to take us off the gold standard. It gave us great flexibility, but everyone knew floating the currency was a double edged sword.