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Economists who hold the popular view that expanding the money supply
will provide the best medicine for our ailing economy dismiss the
inflationary concerns of monetary hawks, like me, by pointing to the
supposedly low inflation that has occurred during the current period of
rampant Fed activism. In a recent blog post aimed specifically at me, Paul Krugman noted that the sub 2.5% increases in the Consumer
Price Index (CPI) over the past few years are all that is needed to prove me
wrong. In fact, Krugman and others have even
suggested that the CPI itself overstates inflation and that the Fed
would be better able to help the economy if less strict methodologies were
used. However, there is plenty of evidence to suggest that the CPI is
essentially meaningless as it woefully under reports rising prices.
Magazines and newspapers provide a good case in point. The truth has
not been exposed through the economic reporting that these outlets provide,
but in the prices that are permanently fixed to their covers. For instance,
from 1999 to 2002 the Bureau of Labor Statistic's
(BLS) "Newspaper and Magazine Index" (a component of the CPI)
increased by 37.1%. But a perusal of the cover prices of the 10 most popular
newspapers and magazines (WSJ, Washington Post, Time, Sports Illustrated,
U.S. News & World Report, Newsweek, People, NY Times, USA Today, and the
LA Times) over the same time frame showed an average cover price increase of
131.5% (3.5 times faster than the BLS' stats). This is not even in the same
ballpark.
Some defenders of the BLS may conclude that prices were held down by
the availability of free online news content or the convenience of digital
delivery. But that is beside the point. Prior to the digital age, the BLS
could have claimed that newspaper costs were held down by public libraries
that provided free access. It's also true that online publications deliver
less value on some fronts. Not only do many people enjoy the tactile process
of reading physical newspapers or magazines, but they offer the secondary
value in helping to kindle fires, housebreak puppies, pack dishes, and line
birdcages.
Another stunning example is found in health insurance costs, which is
a major line item for most families. According to the BLS we can all breathe
easy on that front because their "Health Insurance Index" increased
a mere 4.3% (total) in the four years between 2008 and 2012. Interestingly,
over the same time, the Kaiser Survey of Employer Sponsored Health Insurance
showed that the cost of family health insurance rose 24.2% (5.5 times
faster). But even if the BLS had reported higher costs, it wouldn't have made
much of a difference in the CPI itself. Believe it or not, health insurance
costs are assigned a weighting of less than one percent of the overall CPI.
In contrast, the Kaiser Survey revealed that in 2012 the average total cost
for family health insurance coverage was $15,745, or almost one third of the
median family income.
If the BLS could be so blatantly wrong in reporting the prices of
newspapers and health insurance, should we believe that they are more
accurate on all other sectors? If the inaccuracy of these two components were
consistent with the rest of the CPI's components, inflation could now be
reported in double-digits!
Even more egregious than the manner in which prices are currently
reported is the way that CPI methods have been changed over the years to
insure that most increases are factored out. Since the 1970's, the CPI
formula has changed so thoroughly that it bears scant resemblance to the one
used during the "malaise days" of the Carter years. Main stream
economists dismiss criticism of the changes as tin hat conspiracy theories.
But given the huge stakes involved, it's hard to believe that institutional
bias plays no role. Government statisticians are responsible for coming up
with the formulas, and their bosses catch huge breaks if the inflation
numbers come in low. Human behavior is always influenced by such incentives.
The newer CPI methodologies are designed to report not just on price
movements, but on spending patterns, consumer choices, substitution bias, and
product changes. In other words, the metrics have been altered to track not
so much the cost of things, but the cost of living (or more accurately, the
cost of surviving). But if you simply focus on price, especially on those
staple commodity goods and services that haven't radically changed in quality
over the years, the under reporting of inflation becomes more apparent.
As reported in our Global Investor Newsletter, we selected BLS price changes for twenty everyday
goods and services over two separate ten-year periods, and then compared
those changes to the reported changes in the Consumer Price Index (CPI) over
the same period. (The twenty items we selected are: eggs, new cars, milk,
gasoline, bread, rent of primary residence, coffee, dental services,
potatoes, electricity, sugar, airline tickets, butter, store bought beer,
apples, public transportation, cereal, tires, beef, and prescription drugs.)
We know that people do not spend equal amounts on the above items, and
we know their share of income devoted to them has changed over the decades.
But as we are only interested in how these prices have changed relative to
the CPI, those issues don't really matter. We chose to look at the period
between 1970 and 1980 and then again between 2002 and 2012, because these
time frames both had big deficits and loose monetary policy, and they straddle
the time in which the most significant changes to the CPI methodology took
effect. And while the CPI rose much faster in the 1970's, the degree to which
the prices of our 20 items outpaced the CPI was much higher more recently.
Between 1970 and 1980 the officially reported CPI rose a whopping
112%, and prices of our basket of goods and services rose by 117%, just 5%
faster. In contrast between 2002 and 2012 the CPI rose just 27.5%, but our
basket increased by 44.3%, a rate that was 61% faster. And remember, this is
using the BLS' own price data, which we have already shown can grossly
under-estimate the true rate of increase. The difference can be explained by
how CPI is weighted and mixed. The formula used in the 1970's effectively
captured the price movements of our twenty everyday products. But in the last
ten years it has been quite a different story.
If these price changes in our experiments had been fully captured, CPI
could currently be high enough to severely restrict Fed action to stimulate
the economy. Instead, the Fed is operating as if inflation is extremely low.
As a result, they are making a huge policy mistake that will come back to
haunt us. During the last decade the Fed spent many years denying the
existence of a housing bubble, even as a mountain of evidence piled up to the
contrary. That error caused the Fed to hold interest rates too low for too
long, blowing more air into the bubble and imposing enormous negative
consequences on the economy. The Fed, now similarly blind to the inflation threat,
is repeating its mistake, only this time the negative consequences will be
even more dire.
Apart from the statistical problems that hide inflation, there are
also macroeconomic factors that have helped keep prices down despite the
quantitative easing. Massive U.S. trade deficits and foreign central bank
dollar accumulation mean that much of the printed money winds up in foreign
bank vaults, not U.S. shopping centers. As foreign consumer goods flow in,
and dollars flow out, a lid is kept on domestic prices. In effect, our
inflation is exported as foreign central banks monetize our deficits and
recycle their surpluses into U.S. Treasuries. The demand has pushed down bond
yields which has allowed the U.S. government to
borrow inexpensively. Of course, when the flows reverse, bond prices will
fall, yields will climb, and a tidal wave of dollars will wash up on American
shores, drowning consumers in a sea of inflation.
Unlike Krugman and the Keynesians, I would
argue that it is impossible to create something from nothing. I believe that
printing a dollar diminishes the value of all existing dollars by an
aggregate amount equal to the purchasing power of the new dollar. The other
side takes the position that the new money creates tangible economic growth
and that real economic value can therefore be created by putting zeroes onto
a piece of paper. I think that those making such absurd claims should bear
the burden of proof. For more on the interesting topic of hidden inflation,
see my video that I just posted.
Peter Schiff is the CEO and Chief Global
Strategist of Euro Pacific Capital, best-selling author and host of
syndicated Peter Schiff Show.
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