The Street Get Inflation Exactly Backwards

One of the odder aspects of analyzing the economy and capital markets comes when you reach a significant disagreement with the mainstream view of things. This includes the punditocracy of economists and strategists, as well as the financial press itself. And while I am wrong so frequently that I have come to expect to
, I do manage to get something dead on every now and again.

There is a special kind of joy – not quite schadenfreude – reserved for those rare occasions when you are exactly right and everyone else is precisely wrong. That has been the case with Inflation. I am
hard pressed to think of another item of such grave economic consequence that nearly
the entire street has precisely bass ackwards.

In 2001/02, the economy was essentially flat lined. Tax cuts hadn’t helped, spending down the surplus was of no avail, nor was the War in Afghanistan. It wasn’t until the Federal Reserve made a concerted effort to “Reflate” the economy by cranking up money supply and radically lowering rates that the economy started moving again.

The Fed was successful. As I wrote way back in December 2002: “In the present disinflationary environment, the spike in [gold] suggests that the Fed’s maneuvers have – finally – started to
gain traction. If their priming of the pump is sufficient to spike gold, the implication should also be that increased liquidity and credit should be
sufficient to initiate economic growth – and market gains.”

The prime risk from artificially reflating a post-crash economy is Inflation. “As ye sow, so shall ye reap:” And that is precisely what followed the Fed’s
planned reflation. With the exception of wages, prices for just about everything
else have risen
: Homes, Oil, Precious Metals, Food, Construction Materials, Natural Gas, Industrial Metals, Education, Transportation, Medical Care, Coal, Insurance, etc. Pretty much any good or service you can consumer costs more today than it did three months or three years ago.

Excepting, of course, real wages and income.

How has the Street managed to get this so wrong? Part of it is due to completely misunderstanding the reason to report core CPI ex-energy. As we have written (all too repeatedly), removing a volatile component from a single month is sensible when an event gives
cause (i.e., hurricanes). But with the
overall trend for the CRB index
has been up for 51 consecutive months, the ongoing reporting of inflation ex-inflation is nothing short of sheer idiocy.

As to that 4.7% Unemployment Rate: it was only so much more NILF: The BLS reported in January that as the overall population grew, the “civilian labor force” itself got smaller. Its not that the  numerator is getting larger; rather, its that the denominator in the unemployment fraction is getting smaller: 4.7% (7,040 / 150,114 = 4.689%).

Wage pressure? Hardly – it’s nothing more than basic arithmetic.

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What's been said:

Discussions found on the web:
  1. pete Preissle commented on Feb 6

    Barry’s not quite the Lone Ranger on inflation. At the very least, Gary Kaltbaum and Donald Luskin have been preaching the same sermon. I agree with them…but then, who am I?

  2. DJ commented on Feb 6

    Barry, I disagree with your take on inflation. CPI registered at 3.3% in 2005, which is not insignificant. But the larger increases (and the specific items you mention) are largely input prices and asset prices. For the most part companies have not been able to pass higher prices to consumers, hence inflation is downplayed and rightly so.

    There is significant asset inflation in gold, housing, and bonds – but that is due to wealth consolidation and is correctly excluded from consumer inflation. Cost-push inflation is usually a myth. Common sense will tell you consumer inflation is unlikely with stagnant wages.

  3. BOPnews commented on Feb 6

    Stimulus compared in two economic cycles.

    Barry argues that the economy didn’t get going until the Fed got serious. The inflationary point of “core” CPI should be killed dead by a simple graph, which we hereby reprint: Note how sustained spikes of CPI over CPI core…

  4. Dru Nelson commented on Feb 6

    So how do we hedge inflation? Especially since the government bonds that hedge are using an understated rate of inflation (over long periods).

  5. Greg commented on Feb 6

    Disturbing fact: BLS appears to use hypothetical survey data, not actual data, to calculate imputed rent, the largest single component of CPI.

    “However, the expenditure weight in the CPI for rental equivalence is obtained by directly asking sampled owner households the following question:

    If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

    I think that there is a profound bias towards underestimating this hypothetical rent. When answering, I suspect many homeowners think in terms of covering their mortgage payment (a primitive and erroneous cash flow criterion), regardless of whether their equity is 10% or 50% of the home’s market value.

  6. DJ commented on Feb 6

    What did I buy – certainly not TIPS.

  7. quietpc3400 commented on Feb 7

    I think it was HL Mencken who said (approximately) “It’s impossible to make someone understand something they’re being paid not to”.

    Obviously the parallel here is that Kudlow and the other biz talk kewl kids are paid to tout (or have such a large personal/political stake in touting) a ‘market’s going up forever, no inflation here’ narrative and willfully ignore anything contrary. I’ve noticed over the last year or so that it’s much easier to make money by simply betting against obvious lies and/or stupidity that makes up 70% or so of the “conventional wisdom” than it is to find smart plays on one’s own, e.g. bets on commodities, ‘hidden’ high inflation, against the dollar, and bets opposite CNBC stock touts that are obviously talking their book, vs. trying to find 5-baggers on my own.

  8. Greg commented on Feb 7

    To DJ:
    3.42% YOY a/o Dec. 2005 per BLS, not your “3.3%”.
    Perhaps your low inflation stance explains you lowballing this fact?

    Separately, would you agree that since hedonics are in BLS *practice* only used to diminish reported CPI, that’s a bias on their part? E.g., BLS makes no effort to hedonically adjust for reductions in customer service, which are just as measurable as a new DVD recorder feature.

  9. DJ commented on Feb 7

    My point isn’t about the accuracy of CPI, it is that I believe Barry is using an incorrect definition of consumer inflation. He is lumping in producer prices and asset prices. I believe, once housing really cools off, we’ll be fighting deflation as consumers check out completely.

  10. Robert commented on Feb 7

    Inflation without an increase in wages can only be temporary … ones HELOC will eventually be maxed out.

  11. Dru Nelson commented on Feb 7


    Not unless you are exporting jobs.

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