Friday, September 28, 2007

Barry Ritholtz on Bloomberg Finally Seeing the 'Truth' in CPI

One of my favorite blogs is Barry Ritholtz's "The Big Picture". He rails about the CPI just like I do (how its such a fictitious measure). He had a great entry earlier this week about how the mainstream press finally is coming around to this view. Now if you just care about stocks and your eyes get heavy when you read entries like this, I urge you to read on. It does matter.

Why does it matter? First, the Fed apparently makes decisions off this number so they are making decisions off fiction. Somehow I think as some of the top economics in the world (in theory) they are smarter than that to see what the reality is, but they can use these fake numbers to justify their pumping of the monetary system. Or maybe they are in such a high income bracket that the things that really affect people like energy, food, tuition, medical costs, don't affect them so they live in a parallel universe. Second, many pensions/wages etc are tagged to 'cost of living' and a favorite measure is the Consumer Price Index (CPI). So just imagine how much more it would cost governments and corporations if they had to pay at a rate that reflects true inflation? Answer: more than they want to. So a low (fiction) inflation number is great for them too. I am sure there is a third, fourth, and fifth negative associated with it but let's get on to the article.

On to Barry's post and Bloomberg's piece
  • We have long railed against the absurdity of the CPI data. The ridiculous adjustments, the lack of correlation between CPI prices and reality, as well as the Fed focus on the core
  • For the most part, the media has dutifully reported the nonsensical CPI data as if it were scripture. This drumbeat of criticism -- both here and elsewhere -- has begun to penetrate the MSM. We've seen a few critical columns over the past year or so. But I never expected to see this kind of critical reporting in a mainstream outlet: CPI's Lie on Household Inflation Doesn't Wash.
  • From Bloomberg: "The U.S. consumer price index continues to be a testament to the art of economic spin. Since wages, Social Security cost-of-living increases and some agency budgets are tied to it, the government has a vested interest in keeping it as low as possible.
  • Yet your real cost of living -- what you keep after taxes, medical bills, college expenses and other household costs -- is probably much higher than the 2 percent annual rate the government reported in July, showing a slight decline.
  • Millions are falling behind inflation because wage increases aren't keeping pace with the cost of medical care, lost employment benefits, homeownership expenses, energy and transportation.
  • And there's also a goliath looming in the U.S. economy that makes the government's consumer gauge more deceptive. Even with the stinging reality that housing values are dropping in many markets, homeownership costs such as taxes, maintenance and financing are still rising much faster than the index."
  • Back to Ritholtz: Let's expand on some of those examples from the Bloomberg column:
  • Since 2001, health premiums have risen 78%; Wages have gained 19% over the same period. CPI inflation measure? 17%.
  • Housing is the single-largest expense for most Americans -- as much as a third of total cash outlays. The Labor Department's Bureau of Labor Statistics only tracks "owner's equivalent rent" (OER). Housing costs/Owners’ Equivalent Rent is 23.158% of CPI.
  • During the housing boom, OFHEO had housing prices increasing 13% per year; Non-government foundations had real estate taxes increasing about 6%; Over the same period, BLS measured ‘housing cost increases’ at 4% -- about half of its actual price increases.
  • Median real-estate taxes on owner-occupied housing went from $1,614 in 2005 to $1,742 in 2006, an increase of 7.93%. (That's more than double CPI inflation rate).Oh, and ‘Owners’ Equivalent Rent’ doesn’t account for real estate taxes.
  • A real CPI would’ve eradicated most it not all of GDP during that period. And the more realistic GDP figure would be more in line with the lack of growth in real income and ‘real’ jobs.
  • So why haven't we gotten a more realistic version of inflation -- one that has a high correlation with the construct known as reality? Well, it would wreak havoc with GDP, and potentially, the stock market. An accurate cost of living increase -- in theory, what CPI is supposed to measure -- would’ve eradicated a whole lot of GDP gains over the past 5 years.
  • That "Real Real' GDP figure -- adjusted for CPI inflation, which was adjusted for ACTUAL inflation -- would be far more in in line with the lack of growth in real income and ‘real’ jobs
Takeaway: I think this is why people (despite their out of control spending) in general feel uncertain about their financial situations (in aggregrate) despite government reports showing (in aggregrate) the best economic times of our lives. In aggregrate the US is doing great - in part due to statistical inaccuracy and in part due to the growing wealth inequality - the top 2-5% is now controlling more wealth than any time since the age of Rockefeller. So while in aggregrate times are great, the distribution of that wealth is becoming more narrow. I could write a 30 page essay on this topic but will spare you. Unfortunately we have a very financially illiterate country, so I just don't see any chance of backlash other than the constant unease people feel that "if the economy is so great why don't I feel better off". Now that was offset in part by the housing boom, but even that is now gone. Oh well, we can always fall back on buying things to make us feel better - that seems to be the American way!

Getting back to the CPI - what does upset me/many who watch this stuff is the outright deception in it all.

Long truth and accuracy

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