Wednesday, 3 September 2014

Don’t Believe Governments About Price Inflation

The “moderate” inflation figure you hear about conceals the real damage of inflation, and real rising prices.

Richard Ebeling explains how the many distortions and imbalances of inflation “are hidden from the public’s view and understanding by heralding every month the conceptually shallow and mostly superficial Consumer Price Index.” Inflation, and the damage of inflation, is going on whether the Consumer Price Index measures it or not.

It is an old adage that there are lies, damn lies and then there are statistics. Nowhere is this truer that in the government’s monthly Consumer Price Index (CPI) that tracks the prices for a selected “basket” of goods to determine changes in people’s cost-of-living and, therefore, the degree of price inflation in the economy…
By this measure, price inflation seems rather tame. Janet Yellen and most of the other monetary central planners at the Federal Reserve seem to have concluded, therefore, that they have plenty of breathing space to continue their aggressive monetary expansion when looking at the CPI and related price indices as part of the guide in deciding upon their money and interest rate manipulation policies.

Not so.

The first problem is with what is considered “core” inflation. The government’s CPI statisticians distinguish between two numbers: the change in the overall CPI, and so-called “core” inflation, which is the rate of change in the CPI minus food and energy prices.

    The government statisticians make this distinction because they argue that food and energy prices are more “volatile” than many others. Fluctuating more frequently and to a greater degree than most other commonly purchased goods and services, they can create a distorted view, it is said, about the magnitude of price inflation during any period of time.
    The problem is that food and energy costs may seem like irritating extraneous “noise” to the government number crunchers. But to most of the rest of us what we have to pay to heat our homes and put gas in our cars, as well as buying groceries to feed our families, is far from being a bothersome distraction from the statistical problem of calculating price inflation’s impact on our everyday lives.

So that’s the first problem. The Consumer Price Index doesn’t measure what you and I actually have to pay. Here’s the second problem: It doesn’t measure what anyone actually pays.

Government statisticians construct the CPI by fanning out across the country, tracking the purchases of households they consider “representative” of everyone else.

The statisticians then construct a representative “basket” of goods reflecting the relative amounts of various consumer items these 6,100 households regularly purchase based on a survey of their buying patterns. They record changes in the prices of these goods in 24,000 retail outlets out of the estimated 3.6 million retail establishments across the whole country.
    And this is, then, taken to be a fair and reasonable estimate – to the decimal point! – about the cost of living and the rate of price inflation for all the people of the United States.

Sounds fine? But there’s a “but” …

Due to the costs of doing detailed consumer surveys and the desire to have an unchanging benchmark for comparison, this consumer basket of goods is only significantly revised about every ten years or so.
    This means that over the intervening time it is assumed that consumers continue to buy the same goods and in the same relative amounts, even though in the real world new goods come on the market, other older goods are no longer sold, the quality of many goods are improved over the years, and changes in relative prices often result in people modifying their buying patterns.

How many smart phone bills were you paying ten years ago? How many iPad apps, or Kindle books, or Netflix movies?  Not even your “average” family stays the same over ten years. And the fact is, there is no “average” family, nor average people within it.

All have their own unique tastes and preferences. This means that your household basket of goods is different in various ways from mine, and our respective baskets are different from everyone else’s.
    Some of us are avid book readers, and others just relax in front of the television. There are those who spend money on regularly going to live sports events, others go out every weekend to the movies and dinner, while some save their money for an exotic vacation.
    A sizable minority still smoke, while others are devoted to health foods and herbal remedies. Some of us are lucky to be “fit-as-a-fiddle,” while others unfortunately may have chronic illnesses. There are about 320 million people in the United States, and that’s how diverse are our tastes, circumstances and buying patterns.

So there’s no point pretending that rising prices affect everyone the same, to several different decimal places. Price rises will always affect every consumer, and every producer, very differently.

This means that when there is price inflation, those rising prices impact on each of us in very different ways, especially when you realise how the different price rises in different categories of the Consumer Price Index are concealed beneath the single CPI figure you hear about. 

This is part of the smoke and mirrors of inflation measurement. Consider food, as measured in US price inflation:

In the twelve-month period ending in July 2014, food prices in general rose 2.5 percent…. However, meat, poultry, fish and egg prices increased, together, by 7.6 percent. But when we break this aggregate down, we find that beef and veal prices increased by 10.4 percent and frankfurters went up 6.9 percent, but lamb rose by only by 1.7 percent. Chicken prices increased more moderately at 2.7 percent, but fresh fish and seafood were 8.8 percent higher than a year earlier.
    Milk was up 5.4 percent in price, but ice cream products decreased in price by minus 1.4 percent over the period. Fruits increased by 5.7 percent at the same time that fresh vegetable prices declined by minus 0.5 percent.

Energy also went up, only by 1.2 percent overall, but if you were a propane user they increased by 7.3 percent, while electricity prices increased by “only” 4 percent. 

So who does a statistician neutrally handle all these changes? How does he pretend he has an index that makes sense? And why does the overall average of the Consumer Price Index always seem so moderate when individual prices are heading skywards? Because of the stats guru’s smoke and mirrors.

We all occasionally enter the market and purchase a new stove or a new couch or a new bedroom set. And if the prices for these goods happen to be going down we may sense that our dollar is going further than in the past as we make these particular purchases.
    But buying goods like these is an infrequent event for virtually all of us. On the other hand, every one of us, each and every day, week or month are in the marketplace buying food for our family, filling our car with gas, and paying the heating and electricity bill. The prices of these goods and other regularly purchased commodities and services, in the types and combinations that we as individuals and separate households choose to buy, are what we personally experience as a change in the cost-of-living and a rate of price inflation (or price deflation).
    The Consumer Price Index is an artificial statistical creation from an arithmetic adding, summing and averaging of thousands of individual prices, a statistical composite that only exists in the statistician’s calculations.

But that’s not even the worst problem. Worse still than the fact the statistical composite is confused for the prices rises you and I actually experience is that  “the obsessive focus on the Consumer Price Index is the deceptive impression that increases in the money supply due to central bank monetary expansion tend to bring about a uniform and near simultaneous rise in prices throughout the economy, encapsulated in that single CPI number.”

In fact, prices do not all tend to rise at the same time and by the same degree during a period of monetary expansion. Governments and their central banks do not randomly drop newly created money from helicopters, more or less proportionally increasing the amount of spending power in every citizen’s pockets at the same time.
    Newly created money is “injected” into the economy at some one or few particular points reflecting into whose hands that new money goes first.

The distortionary effects of those injections can be fatal – especially when, because of greater productivity, prices should really be falling. When prices should be gently falling, making things cheaper for you and I to buy,* governments see this instead as an opportunity to “pump up the volume.”  They call it price stability. What it amounts to is printing money – but more subtly.

Consider this: Russel Norman still thinks governments can just print money to cover their over-expenditure. At least this now recognised as inflationary – but even those who understand that much mostly ignore the distortions that money printing would create.

New money isn’t distributed evenly. Those who get it first get first use of the money before prices rise. As money gets spent, passing into other hands, at each stage prices go up as they spend it on what they want to buy. The process takes time, creating a distortionary wave as it goes…

    Step-by-step, first some demands and some prices, and then other demands and prices, and then still other demands and prices would be pushed up in a particular time-sequence reflecting who got the money next and spent in on specific goods, until finally more or less all prices of goods in the economy would be impacted and increased, but in a very uneven way over time.
    But all of these real and influencing changes on the patterns of market demands and relative prices during the inflationary process are hidden from clear and obvious view when the government focuses the attention of the citizenry and its own policy-makers on the superficial and simplistic Consumer Price Index.

But governments are more subtle these days. These days, “governments and central banks inject new money into the economy through the banking system, making more loanable funds available to financial institutions to increase their lending ability to interested borrowers.”

The new money first passes into the economy in the form of investment and other loans, with the affect of distorting the demands and prices for resources and labour used in capital projects that might not have been undertaken if not for the false investment signals the monetary expansion generates in the banking and financial sectors of the economy. This process sets in motion the process that eventually leads to the bust that follows the inflationary bubbles.
    Thus, the real distortions and imbalances that are the truly destabilising effects from central banking inflationary monetary policies are hidden from the public’s view and understanding by heralding every month the conceptually shallow and mostly superficial Consumer Price Index.

The damage of inflation happens even when the “headline” inflation figure is low.

* M.A. Abrams makes the point clearer:

“In an economically progressive community (that is, one where the real costs of production per unit are falling and output per head is increasing), any additions to the supply of money in order to prevent falling prices will be hidden inflation; and in a retrogressive community, (that is, one where output per head is diminishing and real costs of production are rising), any contraction of the supply of money in order to prevent rising prices will be hidden deflation. Inflation and deflation can occur just as well behind a stable price level as when the price level is rising and falling.”

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