It’S the biggest scam of our time cpi inflation is being systematically undercounted suppressed in such a way that the bureaucrats are able to gaslight us into an inflation narrative that suits them and in january of next year. The agency tasked with calculating this metric is making some changes, changes that could further pull the wool over our eyes and the rug from under our feet. In this video i’ll tell you everything you need to know about the cpi magic trick and what it could mean for your portfolio. Trust me, you don’t want to miss this [ Music ] before we commence. I must hold you in suspense, as there is some important information i need to dispense, although i may make you wiser, i am no financial advisor education and information.
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So use them at your leisure, okay, enough, fluff, let’s jump into all this cpi stuff in order to best understand the cpi sham. We need a quick intro into this measure. So, quite simply, the cpi is the consumer price index. It’S a measure that examines the weighted average cost of a basket of goods and services over a period of time that could be monthly, quarterly or yearly. The changes in the price of this weighted basket of goods and services is then used in order to determine the cpi inflation rate.
In other words, this is generally used as a benchmark for the average change in the cost of living that consumers face i.e inflation. So, what’s in this basket? Well, it’s composed of over 80 000 different goods and services, but they’re broadly broken down into eight major groups. These are given in this image right here now in order to give the most representative breakdown of the consumer basket.
It takes a look at those consumers who live in urban environments, i.e, city slickers, the agency, that’s in charge of formulating and calculating this cpi measure in the u.s at least, is the bureau of labor statistics or bls. It’S been doing this since as far back as 1913. So it’s a metric, that’s been used for over 100 years, but it’s important to point out just how much power this agency has when it comes to measuring that cpi.
It determines everything from the types of goods and services that are included to how that changes over the years to how that is all calculated and we’ll get onto that in a bit anywho. The bls conducts surveys amongst these urban consumers in order to get an idea of what should be included in that basket of goods and services. Then, every month it tracks the prices generally by asking businesses what prices they’re charging in separate surveys. It is true, though, that they have started to collect information from online outlets, but this is still limited, weird, given our digital age, but hey ho. Now the bls calculates the change of the price in the basket every month and reports it as two numbers.
One is the headline cpi number and another which is called the core component. The core number is the cpi that strips out the impact of so-called volatile items such as energy or housing. The rationale here is that these numbers are easily impacted by exogenous factors and should not be focused on as a metric for policy making. I mean that sounds pretty dubious to me, but we’ll get to that now to say that the cpi measure is important is an understatement. In fact, irrespective of actual inflation, this single published number has a sizable impact, not just on the economy, but your personal circumstances too.
Allow me to explain perhaps the first and most important impact that the cpi print has on your daily life is what it means for your paycheck. In most conventional jobs, your employer will determine the yearly increase in your salary based on a number of factors. Of course, you have a salary increase based on promotions or performance, etc, but the company-wide pay increase for all employees is generally determined based on the general increase in cost of living, i.e inflation. Hence they place a lot of emphasis on what the cpi inflation rate is.
There are also numerous financial products that are issued by mutual funds, banks and other financial services. Companies which are tied to inflation payments are determined based on the official inflation numbers. Then, of course, it goes without saying that the government itself places a lot of emphasis on these official inflation numbers. For example, they’re used to determine exactly how much social security or other government support programs pay out the more the cost of living the higher these payouts have to go. There are hundreds of social programs like this.
Moving on, you have tax brackets. The irs uses the cpi measure to determine where the tax brackets should go. If people are earning more because of the increase in cost of living, then the tax brackets should be moved up to reflect this as well. Then, of course, you have numerous financial instruments that are tied to the cpi: inflation print, for example, the government issues, what are called tips or treasury inflation-protected securities. They pay investors out a real yield that takes account of the inflation in the country.
There are also other very important government statistics that rely on these measures. For example, the bureau of economic analysis or bea produces real gdp growth figures. Obviously, to get the best measure of real gdp growth, it needs to strip out inflation, the lower the inflation, the greater the gdp growth moving beyond government statistics and services. We also have to think about moves by central banks. They track these inflation stats closely because they impact on their monetary policies.
It helps them determine whether they should increase or decrease the speed of their money printing machines. Now, of course, what jay powell and his buddies at the fed decide to do with their money. Printing machine has severe implications for everything in the economy, including wait for it. Inflation yep the fed, uses the cpi to determine how much of an impact its own policies are having on inflation. So if it’s a bad reading, it could be a worse response.
Speaking of cpi measures actually causing inflation, you have the impact of inflation expectations more broadly. If people expect higher inflation, they raise their prices preemptively. So a higher cpi has the perverse impact of actually increasing inflation itself. So it’s pretty safe to say that the cpi inflation number is a massively important number. I would in fact counter that it’s one of the most important government reported numbers out there, mainly because of where it is used, but how bad would it be if this cpi measure was systematically under counting actual inflation?
Be crazy right well buckle up because we’re diving into some cpi accounting now the most important thing to know is that the cpi measure does not track the price of a static basket of goods and services. Rather, it tracks price changes in a basket of goods that itself changes in composition. It wasn’t always like that. Indeed, until the 1980s there was a constant basket of goods that was tracked. However, it was decided that a change in that methodology was required.
The bls decided that this basket of goods would be updated to try and reflect consumer preferences. This is now updated every two years based on consumer surveys that the bls conducts, but there are a number of other rules of thumb the bls uses to account for this, which are quite dubious starting off. You have the fact that the bls takes into account substitution. Quite simply, the more expensive things become, the more likely people are to substitute those goods with something else, because it’s cheaper. If beef is too expensive, they’ll eat chicken.
So let’s change the basket to reflect that back. When the bls changed the methodology, it took the view that the basket should reflect a constant standard of satisfaction and not a constant standard of living. Think about that it’s systematically undercounting how expensive things have become, because it assumes people will move to cheaper items. Now, of course, this isn’t entirely untrue. It’S only logical that people will tend to substitute, for example, people buying soy based product because meat costs too damn much.
These days, but is it fair to tell those people who used to enjoy meat that actually prices are not going up that much because they just stop buying the things they can’t afford, then, on top of the actual composition of what is inside the basket, you have The relative weight of goods and services it contains the bls introduced, what is termed quote geometric weighting. Basically, it’s a mathematical stunt that will reduce the weighting of those goods that are increasing in price. So without much survey data, the bls is applying an arbitrary adjustment that automatically moves the basket away from those goods that are increasing in price. Pretty silly. If you ask me anyhow, so that’s what’s inside the basket and its relative impact on inflation, however, the bls also introduced another adjustment that tries to account for what it terms, quality improvements.
Basically, those goods or services that have increased in price due to easily verifiable improvements. In quality should reflect that as a base argument, this should make sense, for example, if a food item that used to weigh a certain amount increases in terms of quantity, then it makes sense to isolate the price increase as related to the quality of the item. The only problem is that the bls expanded this definition to include what are termed hedonic charges. Essentially, they would alter the price of the goods and services based on certain arbitrary quality changes that were not noticeable nor relevant to the consumer. These are actually done with computer modeling and, as such can be prone to error.
A simple example here could be electronics think about how much the costs of certain items have gone up over the past year, especially because of the global chip shortage. You desperately need a new computer to do your work, but the prices are considerably up on last year. You don’t really care too much about how powerful a chip is. All you care about is the fact that buying a pc this year costs a lot more than it did last year. The prices are inflated, however, because this is a quality improvement, the bls will discount the impact of this price increase.
Of course, this is a really simplified example. I encourage you guys to read this amazing analysis by john williams on these crazy adjustments, i’ll link to it below moving on, though there are a number of other factors in the cpi calculation that also make it questionable. One of the more controversial approaches to the cpi calculation is how it measures the cost of housing. More specifically, it doesn’t directly measure the price of property, but more the cost of rentals in cases where the people own the house where they live. It tries to account for this rent through something called quote owner equivalent rent.
Essentially, it’s an estimate of how much the owners would have to pay were they renting their house. Now, that’s interesting! Okay! So how do they calculate this rent measure? Well, they look at how much it would cost to rent a house of a similar size, location and quality.
Now, let’s put aside the fact that there could be some massive discrepancy here, you should also note that rental rates don’t react immediately. There’S usually a lagging indicator. People who have faced this explosion in the price of buying a home are not reflected in this measure. All those skyrocketing lumber costs that cause the massive increase in home prices are not being directly counted in the cpi measure. That is pretty damn crazy.
So i present to you exhibit a this: is a tweet from james over at invest answers. He has a great youtube channel by the way and i’ve linked to that in the description anywho in this tweet. He mentions that the cpi measure for the cost of shelter is up only 3 8 percent, whereas the case schiller index for the cost of national home prices is up 28. Does that make sense to you course not now beyond that, though, there’s also a really strong chance that this shelter measure in the cpi is under reporting the increase in the cost of rents. That’S because the bls also looks at the leases that are paid by those tenants where the lease was not up for renewal.
So this cost of shelter includes rentals for people who may have signed contracts months or years ago, contracts that are not exactly relevant to the current market conditions. That’S perhaps why it makes no sense to see the cost of shelter is up less than four percent over the year, whereas the costs of new rentals are skyrocketing across the u.s. More broadly, the average monthly rent has increased 12.5 from over a year ago.
This number becomes even more stark when you look at particular urban regions, the exact regions the cpi is meant to track in south florida, they’re up 35 percent in seattle, they’re up 32 percent in new york they’re up 30. These numbers just don’t square up with the stats published by the bls. Now this methodology of calculating the cost of shelter has been under scrutiny for some time, and there are a number of economists who have tried to come up with some sort of an alternative measure for this. I’Ve linked to this paper. In the description that tries to adjust for this bias feel free to give it a gander when you fancy okay, so that’s the shelter measure in the cpi clearly significantly underestimating the real cost that people are paying for housing.
Moving on from this, though, there are other calculation methodologies that i find to be pretty questionable. For example, there is the actual method in which these prices are gathered. As you’ll recall, i mentioned that the bls runs surveys at retail outlets to ask them about the prices they’re charging for certain goods and services. There’S only one problem with that, and that is that consumers have significantly shifted to shopping online, especially over the last year. With the pandemic, according to the bls’s own website, only about eight percent of quotes came from online outlets in 2017.
I can’t locate the stats for the most recent period, but i can only assume that they still make up a small percentage of the price calculations. This shift to online buying is actually something that was noted by the imf of all organizations. The imf, working paper by marshall, reinstall analyzed whether the impact of the covert pandemic was underestimating inflation, spoiler alert. It was anyhow there’s something else that i find quite disturbing about the bls’s methodology for the cpi and that’s the type of people. The measure is trying to track it’s based on people who live in urban areas and who have a median income now.
The only problem here is that it does not reflect the reality of those who are much poorer or who don’t live in urban environments. Now, of course, this is just a fact of statistical averages, it’s not that the bls is deliberately being biased against those who do not fall into these categories. It’S just that the consumer basket of those who are likely to be severely impacted by inflation is not reflected in the average. For example, poor people will be spending a larger proportion of their basket on food than your average income citizen. Those living in rural areas are likely to use cars and hence fuel more than those who live in the city.
All of these items are ones which have accelerated at the fastest pace over the last year. So it’s important to appreciate that now i don’t want to make this a bls bashing exercise when it may indeed be trying its best to reflect the actual cost of living. But then again, it’s hard to claim that the agency cannot be swayed by political forces coming from capitol hill and beyond, for example. The whole reason that we have a core inflation rate separated from the headline number is because of the fed. During the inflation of the 1970s, then fed chair, a chap called arthur burns thought that energy and food prices are driven by outside factors.
Therefore, these should not be used in order to determine fed policy, so the core cpi number was a watered-down estimate of inflation that the fed used to inform decisions right up until 2012. Now believe it or not, this wasn’t the only time that the fed had a hand in policy, as relates to the cpi back in the 1990s fed chair. Alan greenspan may also have influenced politicians thinking during testimony that he gave to congress in 1995. He stated that the way that inflation was measured was overstating the true cost of living by half a percent to one and a half percent. This was a concern for greenspan and congress, more broadly, as it could have stifled efforts to balance the budget.
More specifically because federal payments were linked to inflation, the higher the inflation, the more money paid. This testimony by greenspan led to the establishment of a commission which was headed by an economist called michael boskin in his report. He also concluded that the inflation rate was being overstated by about one percent. In the end, those in congress seized upon this report and greenspan’s testimony as a way to claim cpi was overstated. Of course, the political pressure to balance the budget had no impact on their thinking right anywho.
This saw a number of changes which i shan’t detail here. Changes that, according to this 1999 presidential economic report, brought the official inflation rate down by about 0 98, almost exactly how much they thought it was being overstated by hmm, if only that i’ll leave a link to this washington post story below which goes into it in a lot more detail than i have time for here. It makes for interesting reading. So you have a good idea of how cpi inflation is being systematically undercounted, but why is it so important right now? Well, in case you’ve been living under a rock recently, inflation has been surging, even if you had no idea what the cpi inflation rate was.
You would have known that prices were increasing all around you, it’s something you can feel on a personal level. Of course, despite how skewed the cpi measure can be, it still cannot hide the fact that prices have increased rapidly. Recently, we broke through 6.8 percent in the u.s with november cpi numbers the highest in almost 40 years.
What i found most frustrating about this is the fact that policymakers and central bankers have been trying to downplay the risk of inflation for months. The word transitory comes to mind. It was everyone’s favorite phrase. Don’T worry about these immediately observable price increases you’re, seeing they said they’re only temporary. I remember so many of these articles coming out and trying to downplay the risk of inflation to gaslight people into thinking that what they were seeing was not true, but as abraham lincoln once said, you can fool some of the people all of the time and all Of the people some of the time, but you can’t fool all the people all the time.
The policy makers and policy wonks have decided to officially retire transitory and have now finally admitted that inflation is a real problem and, while there have indeed been cost pressures beyond the control of people in power, the money printing that the fed has embarked upon has also Been a massive factor: this is the reason that the fed has reversed its stance on the bond buying program and is tapering those purchases, but the cat is out of the bag. The horse has bolted. The ship has sailed, choose your metaphor. It will be hard to get that inflation under control. This is especially the case when those inflation expectations and secondary inflation effects start to work their way through the economy.
In all likelihood, the december inflation numbers are going to be similarly high, but it’s what happens post january next year. That will be most interesting. That’S when the bls will readjust its arbitrary basket of goods. It’Ll be interesting to see what impact this will have on the official inflation rate, and that’s it for most of my video folks, but i’m going to close off here as ever with a few final thoughts. The cpi inflation measure is one of the most important economic numbers out there.
It has massive implications for so many factors in our daily lives, given the importance of it, it’s vital that it accurately reflects the cost of living we witness on a daily basis. However, the evidence points to the contrary from the way that goods are substituted to quality adjustments from assumptions around housing to methods of data collection. The evidence points to a measure that is likely being massaged down not up. Even with this dubious accounting. The folks in power have not been able to stave off those high and persistent inflation prints.
Indeed, many would say that those policy makers have themselves been responsible for it. My only hope is that, as we roll into the new year, the policies that have helped to precipitate this inflation are curtailed, and hopefully this will lead to a cooling off of this white hot inflation. Of course, whether that cooling off is real or imagined depends on how much things change in the cpi basket next year. Let’S just hope it doesn’t make the assumption that we all give up meat for soy, and now i’m keen to hear your thoughts folks. Do you think that the cpi measure is under counting?
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