The Importance of Inflation Expectations

Do Mutual Funds Feed Inflation Or Live Off It?

Do Mutual Funds Feed Inflation Or live off it?
Miami News – Google News Archive – Sep 6, 1958

“A general expectation of inflation can be a great accelerator of inflation,” the Guaranty Trust Co. of New York warns in its September survey.

“When the people lose faith in the future value of their money and refuse to hold it, the velocity of circulation can increase almost without limit, and this rise in velocity is, for all practical purposes, equivalent to an expansion of the money supply itself.”

The two examples below show help understand how inflation expectations influence the value of money.

Swiss franc provides an example of what LOW inflation expectations look like.

The balances for Switzerlandinclude substantial amounts of cash held by nonresidents in safety deposit boxes at Swiss banks. … Currently, almost 90 percent of Swiss currency value is held in three largedenomination notes—100 francs, 500 francs, and 1,000 francs—with almost 50 percent of total currency held in the largest of these. Because 1,000-franc notes rarely circulate in Switzerland, we suspect … the currency is held in safety deposit boxes.

In contrast, Zimbabwe shows what HIGH inflation expectations look like.

One of my graduate school classmates is from Zimbabwe. He has a 10,000,000, yes that is million, dollar bill hanging above his office computer. He said that is practically worthless. He estimates that inflation is at least 250,000%. Though he lives here now for school, he owns a store with his brother in Zimbabwe. He said the key lesson is NEVER go to bed with cash. Buy SOMETHING. Food, oil, etc. Its a real real mess.

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“Conquering the psychology of inflation” = DECEIVING THE PUBLIC

Uncertainty— The Tool To Halt Inflation?

Uncertainty— The Tool To Halt inflation?
Deseret News – Google News Archive – Jun 2, 1969

How can we conquer a psychology of inflation? What policies are appropriate when the psychology already has so firm a grip in our land that mounting millions of Americans believe the soundest thing for them to is to Buy, Borrow Now, Build Now, invest Now on the premise that any delay in buying, borrowing, building, investing will only mean they’ll pay more later?

This psychology is the new, unprecedented factor in our economic pattern. This acceptance of inflation as inevitable is the additive which to date has so profoundly blunted the impact of monetary, fiscal restraints. This is the unanticipated development which to date has made a mockery of all forecasts of business slowdown.

“The U.S. has never before had to deal with this factor in consumer spending,” says an expert in consumer behavior. …

Gold Data: Lesson in Artful Dodging

Gold Data: Lesson in Artful Dodging
Wall Street Journal - Aug 1, 1967

WASHINGTON — "In this business, you have to choose between lying to people or scaring them to death.” The speaker isn’t a doctor or a nuclear bomb expert but a Johnson Administration official coping with the balance of payments problem. His choice is usually clear: Don’t let the public, or more pertinently the nervous bankers abroad who could cash in their dollars and touch off a run on the nation’s gold supply, know the truth

Illustrating the uncertainty among outside analysts is this year’s decision of the New York based National Foreign Trade Council to halt its long practice of forecasting of payments deficit. Instead the respected council estimated most components individually and stopped right there cautioning that it no longer dared predict such items as the dollar inflows.

AII the shadowy activities revolve around the persistent payments deficit—which has as foreigners acquired more dollars than they returned to the U.S. … With $29 billion of foreign owned dollars stacked up as potential claims on $13.2 billion gold stock figure, they have ample reason for what’s left as best unsaid…

Since international high finance is so subtle, … the dilemma rarely has to be resolved with the outright lie either. Instead the Administration is ever more shrewdly guarding the dollar’s value abroad and intelligence about it through little known techniques that range from doublecounting gold bars to tinkering with of otherwise routine Government securities. The result is a web of statistics that mask almost as much they display about the dollar outflow.

Some of this double counting dates back to the 1950s when the IMF made gold investments in interest earning short-term Treasury securities. The fund can reclaim this $800 million gold whenever it wants. And 5228 million more is gold the U.S sold outright for dollars in the last year or so to smaller nations so they in turn could make their mandatory quota payments to the IMF. Swiftly before these show up in Government data, the IMF restored this gold to the Treasury as a special deposit. The purpose was clearly by both parties. Mitigation of the original sales effect on the U.S. statistics…

Only a discreet footnote following in Government statistical publications brings these double countings to light. But because they were openly announced when they were initiated, Washington officials contend they aren’t really deceptive

Happily for officials anxious to put the best face on the figures, there’s no simple standard for deciding just what is a dollar going into foreign hands and thus swelling the payments deficit. Few of them are greenbacks carried out of the country the basic measure comes from major banks reports of how foreigners checking accounts went up or down during a reporting period. These dollar deposits are considered liquid liabilities. Also counting as liquid liabilities are the dollars foreigners invest in most Treasury securities regardless of their maturity and dollars they invest in other Federal securities and bank certificates of deposit having original maturities of less than one year. But the self-imposed accounting standards that class these as liquid liabilities are sterner than those in most other nations, so Administration men argue that it’s not dishonest to bend events around them to America’s best advantage. Thus it was that, because a single day’s added maturity would make these short-term investments count as a favorable dollar inflow, a recent a 400 million debenture offer by the Federal National Mortgage Association appeared with maturity of one year and two days. If foreigners should chance to buy some it would help rather than hurt the payments position.

Privately foreign financial officials are delighted to see Walther Lederer, the Department’s chief payments economist, persistently pointing out that there’s no real advantage for the U.S. in getting foreigners to put dollars in securities that are just barely over an arbitrary line.
  The Treasury is very clever but Walther spoils it by being so honest one embassy aide snickers.

foreign purchases of such securities aren’t being left entirely to chance. Other governments are frequently coaxed to rechannel their dollar investments into the most statistically soothing forms. It’s partly because the Treasury can quietly arrange such investments at the last minute before a balance of payments reporting period ends of course that forecasting the deficits has become so much less attractive to private predictors. In the first 1967 quarter for instance it was largely a spate of foreign official purchases that spared the Government from having to report a deficit close to $900 million instead the figure was roughly $540 million…

It’s not all arm-twisting a State Department official insists arguing that interest rates on short-term Federal securities and bank certificates of deposit have been high enough to inspire such purchases voluntarily. Even so, the growing awareness in Washington that pressures are applied makes the topic a sensitive one.

Discreet Dissembling

The discreet dissembling is squarely in the public interest officials are convinced. To give the world a glimpse at raw payments deficit figures for just a single month or at one day’s actual gold outflow they argue could prove disastrous. While U.S. authorities might take an immensely adverse number calmly knowing a big inflow is on the way, such a figure might so frighten outsiders that greater exodus of dollars would result.

Even a prominent private financier who helped create the Government’s dollar defenses confesses that he can’t tell anymore what our balance of payments trend is. Since he has left Washington ho says the dodges have become even more artful.  The Treasury’s credibility problem is becoming terrible…

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New focus on inflation expectation in 1978

Save Dollar: Rockefeller

Persistence Will  Save Dollar: Rockefeller
Pittsburgh Press Google News Archive Nov 13, 1978

“The President’s earlier anti-inflation speech, in which he stressed reducing expenditures and complying with wage and price guidelines, was not successful (in helping the dollar) partly because the program was long-term and didn’t involve specific action,” he said.

Rockefeller said even intervention on a massive scale, either by the United States or by foreign countries, would not be effective while there was a lack of confidence in the dollar.

“Any program can be effective only if the international money traders are persuaded that the United States is on the right track—and the admirn.straLion’s dollar-support program was very, very specific.

“Once you have re-established confidence, then intervention can be successful,” Rockefeller said.

… Rockefeller said, the dollar’s decline in value is a signal—and a “desperately important one. The international money market is trying to tell us something. . . It is telling us to stop frittering around . . . It is asking for some assurance that American policymakers understand the very real and often implacable dangers of inflation.”


The key to controlling inflation lies “in fine-tuning our own minds”

Turning the revolution of a rising inflation into a revolution of a falling inflation

Recession is no cure for inflationary illness
Eugene Register-Guard – Google News Archive – Oct 12, 1979
NIW YOlK Semeebse to the

The key to control lies not only in using interest rates or “fine-tuning” the economy, but also in fine-tuning our own minds. The economy is not a machine but an organism, and must be seen as such.

Like ourselves, it functions through decisions, expectations, hopes and fun. Roughly a third of it operates by economics, a third by politics, and the third by psychology.

economic decisions are made by corporate managers, trade union leaders, consumers, bankers, investors, speculators — in fact, by all of us. But they are basically psychological decisions.

We talked in the ‘60s, in another frame, about the “revolution of rising expectations,” in income and life choices. In the last half of the ‘70s it took a different form — a revolution of rising price expectations. As food and other prices roee, and the dollars value fell in world markets, we geared our expectations every day to more of the same tomorrow.

The result was a flight from the dollar into gold, consumer goods, reel estateinto material thinge whose values would keep pace with inflation. But by doing it we fed inflation.

In the past decade, since 1969, prices have doubled. At the present rate they will double again in six years, by 1985.

The cure is not a recession in itself, although a recession may come along with it, willy-nilly.

The cure, if any, is to reverse the revolution of a rising inflation and turn it into a revolution of a falling inflation.

The strategy for breaking inflationary expectations

Federal Reserve Puts Clamp On Credit

Federal Reserve puts clamp on credit
Lakeland Ledger – Google News Archive – Oct 8, 1979

WASHINGTON (AP) — The dramatic anti-inflation initiative announced by the Federal Reserve Board is part of a delicate effort to dampen rising prices without causing a severe economic slowdown.

The board is boosting the cost of borrowing and risking a further economic slowdown in hopes of breaking that psychology of inflation, which makes people willing to pay higher prices because they expect them to rise further in the future.

Inflation: Clear Present Danger’ To Us

Inflation: ‘Clear Present Danger’ To US
Ellensburg Daily Record – Google News Archive – Oct 17, 1979

WASHINGTON (UPI) — Treasury Secretary G. William Miller today promised congress the administration will keep pressing the war en Inflation which he labeled “a clear and present danger to our national well-being.”

Miller testified before Congress’ Joint Economic Committee one day after the Treasury Department unveiled a new strategy for dealing with gold speculators — an action taken to supplement the Federal Reserve Board’s Oct. 6 action to make loans more expensive and harder to obtain.

“Basically what we are trying to do is to provide a little more flexibility and, hopefully, to deter speculation,” said a Treasury official.

“Price (reduction) is not really a basic objective,” he added. “The speculative element of the (gold) runup has had an effect on inflation expectations.”

The Treasury said all future sales “will be subject to variation, in amounts and dates of offering”

The Treasury move drew immediate praise from Rep. Henry Reusd, D.Wis, chairman of the House Banking Committee, who called it “a good move.”

“We’ll keep the speculators guessing and thus benefit both the dollar and world economic stability,” he said.

Sources said U.S. allies have pressured the administration to make money more expensive and harder to get — especially for speculative purchases.

The Fed’s new tight credit policies mainly aims to break inflationary expectations by making it more difficult to finance speculative purchasessuch as gold.

The results of campaign to break inflationary expectations can be seen in the transformation of the Federal Reserve. Creating the illusion of a strong, independent fed was crucial to restoring confidence in the dollar.


FALSE NARRATIVE:  The All-Powerful Fed

See Google archive news results for "all knowing" FED

Allan Sloan – The Myth of the All-Powerful Fed - washingtonpost.com

The Myth of the All-Powerful Fed
Washington Post – Tuesday, November 1, 2005
By Allan Sloan

We all like to believe that there’s an all-knowing, all-powerful force looking after us. No, I’m not talking about organized religion and God. I’m talking about
the widespread belief that an all-powerful Federal Reserve Board controls interest rates and inflation and is looking out for each and every one of us.

Since President Bush nominated Ben Bernanke to become the next Alan Greenspan, we’ve heard
endlessly about the Fed’s powers over the financial markets and the economy, and about how hard it will be for Cousin Ben to fill Uncle Alan’s shoes. But despite the outsized attention that any utterance from the Fed chair typically gets, the economic world isn’t controlled by one person, or even one institution.

REALITY:  The Federal Reserve is a joke.

Laughing at the Fed; Monetary ‘In-Group’ Examines Ironies Of

Laughing at the Fed;
Monetary ‘In-Group’ Examines Ironies Of Nation’s Central Bank Operations
New York Times - February 3, 1969, Monday

WASHINGTON, Feb. 2 — There are many "in-groups" in this world, each with its own set of private jokes. In the monetary in-group, which just might have the prosperity of us all at stake, the biggest "yok" in town is the nation’s central bank, the Federal Reserve System. Banks are laughing at it. Economists are laughing at it. Businessmen — getting loans like crazy — are probably laughing at it. Congressmen are not in the in-group. They are just frustrated and puzzled by it.

The easiest laugh around is to ask, at a party, "Say, have you heard? The Fed is tightening money."

The only parallel is in London. There a smaller in-group is saying the same thing about the Bank of England. Elsewhere, as far as can be determined, sensible people still believe in central banks, but they may change.

The Federal Reserve, it often seems, hurls thunderbolts and nothing happens. It raises the discount rate and it furiously buys and sells Treasury bills. It watches such arcane things as the Federal funds rate and net borrowed reserves and the bank credit proxy. It tells the world solemnly that, by golly, it means business in stopping inflation. It doesn’t know how, to be sure. As King Lear said, "I will have such revenges on you that all the world shall– I will do such things–what they are yet I know not; but they shall be the terrors of the earth."

The Fed tells one and all that it will be the terror of the earth. And what happens? Everybody keeps on borrowing just as before. Bank and other lenders keep on lending pretty much as before. The money—for those who care about it—keeps on expanding. …

Pretty big transformation, no?  From joke to being worshiped as god.


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con job perpetually foisted on the American public about the low level of inflation


Haute Con Job
– Posted Wednesday, 29 September 2004 | Digg This ArticleDigg It!
By Bill Gross | October 2004

TIVO probably wouldn’t help much when it comes to
the con job perpetually foisted on the American public about the low level of inflation. “Inflation under control” – (ex food and energy of course) shout the carnival barkers. “The CORE is running at just under 2%,” the barkers shout with glee because a low CORE number tells us that we can continue to run monetary policy with negative real interest rates and fiscal policy with $400 billion dollar deficits. A low CORE number allows us to pretend that American productivity is the best in the world, that the dollar should be strong, and that the markets, by golly are going up. No matter that a gallon of gasoline is over 2 bucks or that a half gallon of milk will set you back $3.69; the CORE is under 2%. Still as Todd Heft, a 44-year-old salesman recently quoted in The Wall Street Journal said, “People have to buy groceries and drive to work. It’s not realistic to strip out food and gas prices.” Ah the core, the core, the core. Semper Fi to low inflation, I guess.

My quarrel though is not just with those who are fixated on the core CPI or the core PCE, but with those who support what we know as hedonic adjustments. Talk about a con job!
The government says that if the quality of a product got better over the last 12 months that it didn’t really go up in price and in fact it may have actually gone down! Why, we could be back to Bernanke deflation real soon if the government would quality adjust enough products. For instance, prices of desktop and notebook computers declined by 8% a year during the past decade, The WSJ reports but because the machines’ computer power and memory have improved, their hedonically adjusted prices have dropped by 25% a year since 1997. No wonder the core is less than 2% with computers dropping by that much every year. But did your new model computer come with a 25% discount from last year’s price? Probably not. What is likely is that you paid about the same price for hedonically adjusted memory improvements you’ll never use. Similarly, government statisticians manipulate the price increases for cars and just about any durable good that comes off an assembly line but find it difficult to extend that theory to underwear or a pair of shoes. Perhaps that’s next. Talk about Uncle Sam getting into your shorts!

Actually, to make the case for a government con job, it’s important to point out that
the bulk of these hedonic adjustments have come only in the past few years, when it became necessary to buttress Greenspan’s concept of our New Age Economy. Back in the 1990s the Clinton Administration blessed a start to quality adjust inflation statistics. But then in 1998, the methodology was adopted for computers – surely the biggest step backward in realistic inflation calculations. Since then, the BLS has expanded the concept to include audio equipment, video equipment, washers/dryers, DVDs, refrigerators, and of all things, college textbooks! Today no less than 46% of the weight of the U.S. CPI comes from products subject to hedonic adjustments. PIMCO calculates that without them, and similarly disinflating substitution biases, Greenspan’s favorite inflation measure, the PCE, would be between 0.5% and 1.1% higher each year since 1987. This implies as well that since inflation was higher than actually reported, that conversely, real growth must have been lower by the same amount.

The first chart shows the hedonically adjusted numbers vs. what would be reported if this hedonic stretch didn’t exist. 


Peter Bernstein in a recent Economics and Portfolio Strategy piece makes the hedonic point, as have Jim Grant, Stephen Roach, Marshall Auerback, Caroline Baum, and a host of other voices in the inflationary wilderness. Bernstein points out that since 1990, total CPI inflation was 2.7% a year, yet
hedonically adjusted durable goods suspiciously managed to increase by only .1% annually. Over the past 12 months the BLS reports that non-durable were up at a 4.61% rate while those quality adjusted computers, cars, and refrigerators by golly managed to actually go down by 1.25%. “Holy Greenspan, Batman!” If we just could focus on those durable goods we could lower interest rates to 0% like the Japanese and drive up the markets one more time!

In addition,
when “substitution bias” (a BLS maneuver that follows your preference for Chicken McNuggets vs. a Quarter Pounder) is eliminated, the gap gets even worse. For those of you sophisticated economists who feel the substitution bias is more than justified, chew on this for a second. If you substitute a pound of chicken for a pound of beef because it’s cheaper, then switch back to beef later on because it came back down in price, the overall round trip which resulted in no ultimate substitution and no relative price change winds up reducing the stated PCE. Oh man, what a con.

Which brings me to a question that no rational money manager or economist wants to answer for fear of becoming a fool, or a conspiratorial kook.
Why does the U.S. government and the Fed continue to foist this hedonic/substitution mantra on a gullible public when they should know better and when, by the way, no other government does it in the same magnitude and with the same conviction? Let me just answer it this way – and hopefully not seem foolish (or worse) in the process. Alan Greenspan has a dual prerogative at the Federal Reserve. He is charged with keeping inflation low and economic output high. The magic of hedonic/substitution adjustments keeps both of these birds flyin’ at the same time, one under the magical 2% radar, which marks the dividing line between benign and worrisome inflation, and the other (real GDP), over the hurdle of 3% which suggests the continuation of high productivity, along with its concomitant implications that the stock market should be healthy, the dollar strong, and all’s well with the Greenspan legacy. Granted Greenspan doesn’t run the BLS, but he pounds the table hard for hedonically adjusted statistics. They might serve him well, but they do a disservice to those grounded in the reality of stretching a paycheck for new cars, laptop computers, and cell phones that somehow haven’t gone down as much in price as the government says they have.


Deceptive hedonic/substitution adjustments also
serve a government burdened not only with hundreds of billions of annual deficits as far as the eye can see, but ladened with a demographically aging U.S. workforce rapidly approaching Social Security time. By fudging on inflation, they pay less and the amount could cumulatively run into the hundreds of billions over the next few decades. They disserve, of course, all of those who receive social security, as well as other private pensioners dependent on an accurate accounting of prices paid. They disserve buyers and holders of TIPS – inflation protected securities – which adjust inadequately to a faulty and near fraudulently calculated CPI that one day could total billions of dollars per year for TIPS holders. And they disserve all owners of U.S. Treasury obligations – including foreign central banks and institutions – who mistakenly assume that they are earning a real return over and above inflation, and that the dollar upon which they are denominated is justifiably strong because of GDP growth and productivity numbers that are pumped by hedonic magic to resemble the Arnold Schwarzenegger of 1980 instead of his verbal “girlie man” analogy of today.

No I cannot sit quietly on this one, nor as I’ve mentioned, have other notables in the past few years. … If the CPI is so low and therefore real wages in the black,
tell me why U.S. consumers are resorting to hundreds of billions in home equity takeouts to keep consumption above the line. If real GDP growth is so high, tell me why this economy hasn’t created any jobs over the past four years. High productivity? Nonsense, in part – statistical, hedonically created nonsense. My sense is that the CPI is really 1% higher than official figures and that real GDP is 1% less. You are witnessing a “haute con job”…


Gross struck a nerve because he offers
an explanation for what seems to be a growing point of confusion among the general public: Why are personal expenses rising so quickly when the government’s consumer price index is rising at just 2% to 3% a year? The typical American household budget has seen major price hikes this year for health care, food, energy, and college tuition, points out Peter Cohan, a management consultant and author in Marlborough, Mass. "There is just no way the CPI is reflecting the actual increase in costs that the typical American family faces," he says. "It doesn’t pass the smell test."

"RUNNING AMOK."  Case in point: One restaurateur in Pennsylvania e-mailed BusinessWeek Online in response to a recent story citing tepid inflation statistics:
"Being one who considers himself ‘in the trenches,’ what the heck is everyone (government, business publications) talking about inflation being kept in check? Talk to the folks down here to get the real deal. Inflation has been running amok for a year and a half."



Why Distort Inflation?

I’ve detailed how
GDP data is inaccurate. I’ve also discussed how hedonic pricing can lead to higher GDP and lower inflation data. It should be obvious why Washington would want to inflate GDP data. But why would it care to suppress inflation data? When you have an economy as vulnerable to a disaster as in America, the most dangerous scenario would be a loss in consumer confidence. But there’s also a direct financial incentive to understate inflation. Consider the fact that annual Social Security (via CPI-W) and Medicare benefit increases are earmarked to the CPI.


In the two weeks since Gross’s thesis appeared,
critics have roared, government statisticians have laughed out loud, academics have expressed disbelief, and portfolio managers have scratched their heads. …

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Bill Gross’s `Con Job’ Was Inaccurate and Flawed: John M. Berry
By John M. Berry – October 6, 2004 00:14 EDT

Oct. 6 (Bloomberg) — Bill Gross, the highly regarded chief investment officer for Pacific Investment Management Co., last week called the notion that the U.S. has a low level of inflation a “con job” foisted on “a gullible public” by the federal government and the Federal Reserve.

Gross may run the world’s biggest bond fund, but his column amounted to an inaccurate and analytically flawed diatribe.

He virtually accused Fed Chairman Alan Greenspan of being part of a conspiracy by government officials to understate inflation and thereby boost estimates of real economic growth.

the Fed chairman’s frequent assertion that the CPI overstates – yes, overstates — inflation by perhaps as much as a percentage point a year.

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Contrarian Chronicles
How the government manufactures low inflation
Some government data suggest computer and car prices, among many other things, are falling. But when was the last time you paid less for a car? Here’s why you should be concerned.
By Bill Fleckenstein

Please join me this week in a trip to the government department responsible for fun with numbers. Those D.C. statisticians may churn out their work with a straight face, but that doesn’t mean we have to fall for it. Among the skeptics are Steve Milunovich of Merrill Lynch, Jim Grant of Grant’s Interest Rate Observer, and, of course, yours truly.

In a recent report, Milunovich noted that
the Bureau of Economic Analysis (BEA), whose job it is to compute the Gross Domestic Product each quarter, has "stopped reporting the real computer hardware shipment figure used to calculate real GDP growth, though it is still used in GDP calculations." The BEA, which is part of the Commerce Department, made this readjustment because it is "concerned the rapid price declines for computers made the figures misleading."

Let’s stop and review the bidding for a second. Remember: GDP is the measure of goods and services produced in this country. The government decided that certain of its data series involved in calculating GDP were misleading. So, what did it do? Simply stop breaking them out. Makes sense to me; how about you?

This would be a humorous window into the lunacy of government calculations, were it not so important to many statistics. …


Hedonics: ‘miracle’ tonic for an ailing economy

For those of you who don’t know, hedonics is the way the government transforms quality improvements into price declines. To wit, you buy a PC with twice as much power, so the government concludes that you really paid only half as much money for it. Hedonics is also the government’s way of taking quality improvements and converting them into price declines when calculating the CPI. Sure, that
brand-new Chevy you just bought cost 40% more than it used to, but it’s a 40%-better car for a variety of reasons. So, the government says, the price didn’t really go up. (I have oversimplified these examples, but you get the point.)

The idea behind the first case at least makes some sense, though the government carries it too far by acting as though improvements can be precisely measured.
The problem with the second case is that those quality improvements are not voluntary. Since you have to pay the new price, it’s sheer silliness to say that the price really didn’t go up.

There are other ramifications as well. It turns out that
the computer-spending component has materially warped GDP calculations in many of the last eight quarters. To put the numbers into perspective, from the second quarter of 2000 through the fourth quarter of 2003, the government estimated that real tech spending rose from $446 billion to $557 billion, when nominal spending only increased to $488 billion. That extra $72 billion represents the value the government imagines the improvement in computer quality is worth.

Now $72 billion doesn’t sound like a huge amount in a $10 trillion economy, but at the margin, it makes a difference. And in fact, the contribution of this tech component to real GDP comprised about 12% of growth in the third quarter of 2003 and more than 30% of growth in the first quarter of 2003, i.e., a big chunk of the growth. Since real growth is a factor in the calculation of productivity and productivity growth, these statistics are also distorted.

Slippery CPI, iffy TIPs

Our government has admitted
its Alice in Wonderland hedonic-adjustment exercise has produced numbers so distorted that it doesn’t want to show them to you. Yet it continues to use the "analysis" and some of the data in calculations of real GDP, productivity growth and CPI calculations. This is one of the reasons I’ve never been a big fan of Treasury Inflation-Protected Securities, or TIPS. I have stated a million times that the government’s calculated cost of inflation, in the form of the CPI, is a joke. So, I refuse to buy a security that’s indexed to the CPI, unless the price of the security reflects my skepticism. TIPS may be better than straight bonds, but they’re not as good as most people think. As you can see from these two examples, the government aims to cheat you in the calculation, and besides, TIPS don’t protect you from a decline in the value of the dollar.

Grant on BEA balderdash

Further reason to be suspicious of all government data comes from the current issue of Grant’s Interest Rate Observer, in which the ever-alert Jim Grant broke the story that "the Bureau of Economic Analysis is weighing a study to explore the merits of adjusting the prices of medical services for quality changes."

In other words, the BEA is considering the use of hedonics to lower the impact of rising medical costs on the CPI by subtracting the imagined value of quality improvements in medical care from the price were really paying. The government recognizes it has a problem with exploding health costs and is studying the use of that same quick fix which has "worked" when unwelcome rising prices have been an issue in other areas, i.e., to define the problem away. I would imagine that when the folks at AARP and organized labor find this out, they’ll be up in arms. Maybe their clout can stop this nonsense before it gets even worse.

Take heed, enjoins Sir John

On a final note, I would like to share with readers a rather interesting comment that John Templeton, founder of the Templeton Funds, made to Paul Kangas during a PBS interview last Monday.


Templeton’s quote … echoes one of my most fervently held views:
"In a social democracy with a fiat currency, all roads lead to inflation."

And now for Sir John’s wisdom:
"All currencies, not only the American dollar, but all currencies, always go down, mainly because of democracy. The voters will vote for a person who is going to spend too much, and so you have to expect all currencies to go down." In future columns, I’ll have more to say about the dollar, the variables affecting it and why this should be of concern to you.


How Washington is Fooling You: Trick #1, Hedonic Pricing
by: Mike Stathis
July 27, 2008

For all of you out there
who listen to economists and think they know what’s going on, hopefully you will begin to realize that the official data you see is nothing but an illusion after you read this multi-part series of articles. And for all of you skeptics and "loyal" republicans, who care only about supporting the current administration, take note – this economic deception is not party-specific – it’s Washington-specific.

When you see headlines like "Stocks Advance Following Better-Than-Expected Inflation Read," what do you think will happen once people realize they’re being fooled? The fact is that
inflation is well above government numbers. Most likely, it’s hovering around 10% today, and I expect it to go much higher under Bernanke’s weak dollar policy. If short-term rates are not raised to combat soaring inflation, the situation will get much worse. And this must happen very soon – not by 200 basis points, but much higher. Will such a move slow consumer spending? Sure it will. But that’s much better than hyperinflation and the continued destruction of the dollar.

The problem with deciphering the nation’s economic data is that it’s so voluminous. As well, appropriate frames of reference are rarely provided. And
many assumptions are not disclosed when the data is reported to the public, making interpretation problematic. This leads to reporting by the media that mirrors what the "experts" state about the economy. But this deception has a purpose. For Wall Street and off-beat financial institutions, it provides more confidence to investors who shuttle more money into the stock market, leading to increased business. For corporate America, it provides higher profits as consumers spend more credit thinking their future is promising.

For several years now,
this financial deceit has kept the economy running. Perhaps if consumers are kept in the dark long enough the economy will rebound; or so Washington figures. But where will future spending come from now that home equity loans and credit cards have been maxed out, there’s no net job or wage growth while outsourcing strengthens each day? How will Washington convince foreign banks to continue financing its record debt against the weak dollar, while American diplomacy continues to create global discontent?

How is it possible that inflation has remained low over the past decade while housing, healthcare, energy and higher education costs have skyrocketed? Does that seem reasonable to you? How has the government been able to conclude that inflation doesn’t present a problem for the economy? Furthermore,
how can the government report inflation without measuring food and energy costs? Does that seem reasonable?


The Truth About Inflation
By Barry Ritholtz
10/22/05 – 08:00 AM EDT

the biggest factor not reflected in the CPI basket is the cost of housing. Home prices have gone up dramatically — the National Association of Realtors’ Housing Affordability Index is now at 14-year lows. But you cannot tell that from the CPI.

While commodities and education are being undercounted, housing actually lowers inflation readings. Tony Crescenzi addressed this relationship earlier this year in an article called "How Housing’s Surge Is Suppressing CPI."

The way BLS accounts for housing expenses is an oddity that creates all sorts of problems. Before 1983,
CPI measured housing inflation by looking at what it actually cost to own a home: house prices, mortgage rates, property taxes, even maintenance. After 1983, BLS changed the housing component, using the concept of "owner’s equivalent rent." It’s a measure of what homeowners could get for their homes if they rented them. It accounts for 23% of the overall CPI and about 30% of core prices, according to BLS.

Since the housing market began soaring, rental properties have languished. Vacancy rates rose, and rents came down in price.
This had the surreal effect of pushing CPI measures down. At exactly the time housing became extremely expensive, the BLS measure of this component made inflation appear to be going lower.

The CPI’s miscalculation is even worse than you might imagine. As utility costs go up, inflation is further under-reported in the CPI (core or headline). Why? BLS perversely removes the value of any landlord-provide utilities in its calculation of owner’s equivalent rent.

And you wondered why I mock the Labor Department’s statistical methodology. Talk about adding insult to injury.


August 2006 Newsletter
August 21st, 2006
Issue Number 22
August 21, 2006

the use of incredibly low GDP inflation rates prevented a quarterly contraction in real (inflation-adjusted) growth. Generally, the lower the inflation rate used to deflate GDP, the higher will be the reported real growth. Regardless, the 2.5% second-quarter GDP growth rate, which presently is statistically indistinguishable from an outright contraction, should face some downward revision based on the latest revisions to and reporting of retail sales and the monthly trade deficit (see the respective reporting sections).

The GDP series is the most heavily politicized of the popular government economic reports. In conjunction with the annual GDP revisions, Shadow Government Statistics this month introduces an alternate measure of estimated annual real GDP growth (see the Reporting/Market Focus section for methodology and further detail).


Incorporating the downside revisions to recent annual real GDP growth, the SGS series not only shows the 2000/2001 recession to have been much deeper and longer than officially reported, but also that the current downturn is just the second leg of a double-dip recession.

The key is how you define consumer inflation. I operate on the premise that the post-World War II CPI concept of inflation measured based on a fixed-basket of goods – a measure of the changes in prices related to maintaining a constant standard of living — was a reasonable, meaningful and useful approach for most consumers

Some years back, then Fed Chairman Alan Greenspan began making public noises about how the CPI overstated inflation.
Where the fixed-basket of goods approach would measure the cost of steak, year after year, Mr. Greenspan argued that if steak went up in price, people would buy more hamburger meat, mitigating the increase in their cost of living. The fact that switching the CPI concept to a substitution-based basket of market goods from a fixed-basket violated the original intent, purpose and concept of the CPI, never seemed to be a concern to those in Washington. Artificially reducing reported CPI inflation would have a variety of benefits, beginning with reduction of the budget deficit due to the cutting of cost-of-living adjustments for Social Security payments.

Yet, as oil prices began their current uptrend, substitution-based inflation reporting still was not low enough for the former Fed Chairman, as he began embracing the concept of "core" inflation, inflation net of food and energy price changes. Eliminating bothersome price increases in energy and food products – such as seen with oil at present — would make the Fed’s job of containing reported inflation all the easier.

In general, if a government economic measure does match common public experience, it has little use outside of academia or the spin-doctoring rooms of the Fed and Wall Street. The two SGS measures included in the above table have gimmicked methodological changes removed from the reporting so as to reflect more accurately the common public experience as embodied by the post-World War II CPI.


The July 2006 SGS Alternate Consumer Inflation measure shows inflation at a 25-year high of 11.0%.

The following graph shows the relative impact of the historical methodological changes to the CPI-U and as removed with the SGS alternate measure. The graph shows that inflation was contained in a self-correcting process before the founding of the Federal Reserve in 1913 and the abandonment of the gold standard in 1933.


This graph plots the level of consumer prices during the last 341 years. …

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Constant Upwards Revisions To Personal Saving Rate

The personal saving rate is one of the Government’s most important and least reliable statistics.


Tuesday, August 18, 1998

‘Low saving, high spending gum up economic machinery’

‘The bull market has added to household wealth without the need for the usual belt tightening.’

A penny saved? Hardly

Martin and Kathleen Feldstein

AMERICANS have been saving less and less of their income. The Commerce Department recently announced that the personal saving rate hit a new low in May of less than half of 1 percent of disposable (i.e., after tax) income, compared with more than 5 percent a decade ago and 9 percent in 1982. If this staggeringly low level of saving continues, there will be serious harmful effects over the longer term.

Why worry that Americans are not thrifty if their stock of wealth has nevertheless soared? To avoid confusion, lets define saving.
Personal saving is the difference between after-tax income and spending on consumption. Savings include money deposited in banks and money used to purchase stocks and mutual funds. It also includes money spent to reduce debt, like paying off a mortgage. And less obviously, saving as officially defined also includes the money that employers contribute to pension funds.

For the economy as a whole,
total personal saving is the difference between the saving of those Americans who do put aside some portion of their income and the dissaving of those who spend more than they are earning. While some demographic groups like the baby boomers are now buying mutual funds and stocks to prepare for their retirement, for bequests, and for possible rainy days, an increasing number of newly affluent retirees are drawing down their past savings just as fast to spend on current consumption. The result is that there is almost no net saving in the economy.

But as always,
there is no free lunch. By reducing their saving, Americans are investing less of our national output in the new plant and equipment that is critical for increasing productivity and long-term economic growth. Thats the reason for concern over the low personal saving rate.

Even before the recent decline in the saving rate, the United States had an unusually low saving rate by international standards.
Many factors contributed to the low rate, including high taxes on investment income, easy and tax-favored borrowing, and generous and unfunded Social Security benefits.

Americans are saving less than ever

December 21, 1998
Economists Simply Shrug As Savings Rate Declines

Americans should be saving like crazy. Baby boomers — the oldest in the group of 78 million who were born between 1946 and 1964 are due to retire in a decade or so — are now in their prime earning years. The after-tax return on investments has rarely been better and the proliferation of 401(k) plans, individual retirement accounts and other tax-favored saving plans has made thrift more painless than ever.

Instead, Americans are saving less than ever. Indeed, according to the latest Government figures, consumers have recently been spending all of their incomes and then some. In September, the personal saving rate slipped below zero for the first time since the Great Depression. October was more of the same.

On the surface the reason seems perverse: Economists say the better people feel about their situations these days the less likely they are to set aside extra for the future. The seemingly imperturbable stock market, strong confidence in the economy and the ease of borrowing all make consumers feel richer and less inclined to postpone gratification.

Some experts warn of dire consequences

NIPA: Personal Saving as a Percent of Disposable Personal Income (monthly, SA)
Percent of Disposable Personal Income

Before July 31, 2007, Revision

Personal Saving Rate after July 31, 2007, Revision



Personal Saving Rate today


Graph: Personal Saving Rate

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The financial press is full of dark references to deflation and somberly compares today’s U.S. economy with the 1930s and to Japan since 1990.

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May 26, 2008, 11:24 p.m. EDT
Why inflation psychology has become unmoored
By Dr. Irwin Kellner, MarketWatch

SAN FRANCISCO (MarketWatch) —
Memo to the Federal Reserve: inflation expectations are no longer well-anchored. If anything, they have lost their mooring.

Until recently, the Fed was more worried about recession than about inflation. Even as inflation pressures heated up, Fed chair Ben Bernanke
continued to downplay concerns over rising prices by suggesting that inflation expectations were "well-anchored."

if inflation expectations are well-anchored, by this line of reasoning, then people are unlikely to factor the current rate of inflation into their decisions to buy, sell, save, borrow, and invest or their wage demands.

Guess what? It’s anchor away.

Prices are heating up, and the public is ratcheting up its views on inflation and the expectation of inflation.

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