Pro-forma CPI, or Let's Pretend There's No Inflation
Today, as the Labor Department reported that April consumer prices rose at a faster than expected .5%, which follows yesterday's release of a .6% rise in April producer prices, Wall Street and the financial media once again celebrated the irrelevant fact that core consumer prices were unchanged. What I have repeatedly dubbed as "pro-forma CPI," a benign "core CPI" despite ever increasing actual CPI is as meaningless a statistic as positive pro-forma corporate earnings despite consistent losses. Bond investors foolish enough to believe the "core CPI" propaganda will likely be just as disappointed as stock investors who fell victim to the same scam with pro-forma earnings.
The reality is that year-over-year consumer prices are up 3.5%. Thus far, during 2005, CPI is rising at an annualized rate of 4.8%, its fastest pace since 1990, and .3% higher then the 4.4% rise in 1971, the year in which inflation was so bad that Richard Nixon imposed wage and price controls to contain it. Perhaps had President Nixon been a little more "tricky," he might have come up with the concept of "core CPI" himself, rather than resorting to such draconian and misguided measures.
In fact, those arguing that inflation is not a problem often point to low bond yields to support their conclusion. This is similar to the arguments that were made during the tech bubble that high stock prices reflected the present value of all the future earnings such companies were sure to generate. The reality is that just as stock investors of the 1990's were wrong about future earnings, today's bond investors are wrong about future inflation. Also, since so many of today's bond buyers have no intention of holding their bonds to maturity, the fact that they are buying does not necessarily reflect a benign outlook for inflation. With the market dominated by leveraged hedge funds, mortgage hedgers, and foreign central banks, today's demand for treasuries has much more to do with speculation, hedging, and politics, than it does with actual investment merit. Once these forces reverse, expect bond prices to plunge, and interest rates to soar, as there is no legitimate investor demand for a ten year bond yielding 4% with CPI inflation running at an annualized rate of 4.8% and heading higher.
For a more in depth analysis of the fraud of "core CPI" please read my previous commentaries on this subject below.
Friday, October 18, 2002
Pro forma CPI
Today's government announcement of the CPI should be given as much creditability as an Enron earnings report. That is why the CPI should be referred to as Pro-Forma CPI. The government manipulates the data to artificially minimize increases in consumer prices. That is because the government has a vested interest in maintaining the illusion that inflation is not a problem, just like Enorn had a vested interest in maintaining the illusion that it had earnings! The U.S. government is the world's largest borrower, with a 6 trillion dollar plus national debt, mostly financed with short term paper, a large percentage of which in the hands of foreign creditors. If our creditors were to get wise to the true inflation threat, they would demand that the United States government pay much higher rates of interest on its debt. This would cost the government hundreds of billions of dollars in additional annual interest payments, sending the annual budget deficit soaring, creating a self-perpetuating spiral of bigger deficits causing rising interest rates, causing bigger deficits, etc. Not to mention the negative effect sharply higher interest rates would have on the American economy so heavily dependant on spending from over-leveraged consumers deriving their incomes from over-leverage employers and collateralizing their borrowing with over-valued real estate! Also, by manipulating the CPI data the government is able to reduce its cola adjustments to social security recipients and other inflation indexed programs, while limited increases in inflation indexed income tax exemptions, not to mention the money the government saves on interest pays to holders of inflation protected treasury obligations (TIP's).
Inflation, properly defined, is an increase in the supply of money and credit. The Federal Reserve has recently pursued the most inflationary monetary policy in its 89 year history. Initially inflation resulted in the stock market bubble. However, as stock prices are not components of the CPI no one cared. Next, inflation made its way into rising real estate prices. Again, no one cares. More recently, inflation is causing commodity prices to rise. The CRB is up 22 percent this year, and is now within 1 percent of a 4 year high. That is the biggest annual increase in the CRB since 1982. Inevitability inflation will result in rising consumer prices, and will ultimately be reflected in significant increases in the CPI, despite the government's best efforts to manipulate the data.
One of the main reasons that the CPI has not been increasing at a more rapid rate (other than government manipulation) is the enormous merchandise trade deficit. Today's release of the August data show yet another all time record high trade deficit. As dollars flow out and foreign manufactured products flow in domestic consumer prices are held in check. But when the buddle in the dollar finally busts consumer prices will soar as wealthier foreigners out-bid poorer Americans for all sorts of merchandise and natural resources, sending the CPI through the roof.
In fact, it is the trade report, not pro-forma CPI, that is the one truly significant economic release of the day, for it shows just how unproductive, non-competitive and mal-invested the U.S. economy really is.
March 17, 2004
Pro-forma Inflation Revisited
With the release of February's CPI, Wall Street once again rejoices under the delusion that there is no inflation. For the month of February the CPI rose by.5%. However, seasonally adjusted, it only rose by.3%, and excluding food and energy, it rose by only.2% It is the.2% figure, the "core" CPI, which Wall Street and the Fed are celebrating despite the fact that.2% was twice what had been forecast. However, the actual, unadjusted CPI, which is what consumers really paid, increased.5%, for an annualized inflation rate of over 6%.
If we look at what actually happened to prices in February, as apposed to what government reports pretend happened, we see the following price increases: soybeans 13.2%, corn 7.75%, copper 19%, silver 7%, lumber 11.3%, crude oil 12%, unleaded gasoline 11%, heating oil 9.5%, and natural gas 8.5%. Those percentages are not annualized, they are the actual percentage gains during the month of February alone! All of these prices have increased significantly thus far in March as well.
Perhaps the most bizarre of Wall Street's CPI rituals is the routine exclusion of food and energy prices from the CPI because these components are considered volatile. However, over the past several years, all of the volatility has been in one direction, up. Therefore excluding food and energy on that basis makes no sense. It is similar to a CEO excluding regularly occurring expenses when reporting earnings by labeling them as extraordinary. To me "core" CPI is the Fed's own version of pro-forma inflation!
The "core" CPI is actually of little value since about 40% of it is comprised of rent (either actual or owner-equivalent). In the current low interest rate environment, which has drawn in an ever-widening pool of home buyers, rents are being artificially suppressed. What's more, the proliferation of adjustable rate mortgages and no down payment loans have temporally turned many renters into buyers; fully one third of first-time homebuyers are putting zero down! As a result, the national rental vacancy rate is at a 40 year high, and rents are under pressure. Therefore, the Fed's inflationary monetary policy is paradoxically helping contain rent increases which represent 40% of the "core" CPI, while causing housing prices themselves, which are not even included in the CPI, to soar. The more inflation the Fed creates, the lower the "core" CPI. How convenient.
As an example, if a tenant who rents a two-bedroom apartment for $900 per month discovers he can purchase a two bedroom condo with a zero down one year ARM for only $800 per month, his landlord is forced to either lower the rent or lose the tenant. Under a normal interest rate and credit environment (which requires down payments), the barriers to purchasing condos would be much higher, giving landlords the flexibility to raise rents.
In fact, one of the main factors restraining increases in the CPI is the low interest rate environment. Interest rates represent the cost of capital. Businesses are able to pass on their lower cost of capital to consumers in the form of lower prices. One of the reasons that the landlord in the above example is able to reduce the rent is that his interest costs are lower. Most landlords have mortgages, and are able to pass on their lower interest payments to their tenants in the form of lower rents. So, for example, even as General Motors faces higher steel costs, higher energy costs, higher workman's comp. fees, and higher health insurance premiums, its cost of capital it significantly lower. Lower capital costs help offset higher raw material and labor costs, restraining the over all increase in consumer prices. The same is true for businesses in general, particularly those with significant amounts of debt to service.
The irony of the situation is extraordinary. The Fed points to an absence of inflation as indicated by a benign "core" CPI as justification for its low interest rate policy. But it is that very low interest rate policy that is temporarily suppressing the "core" CPI. The prices that are increasing, such as commodities and housing, are either excluded from the "core" CPI or from the index entirely.
The problem for the Fed is that once general price increases become so powerful that they overwhelm the restraining pressure currently being exerted by rents, the Fed will be forced to raise interest rates. That will have the immediate effect of driving up the cost of capital, and increasing the cost of buying a home. This will provide landlords with the impetus and the ability to raise rents. Since rents represent 40% of the "core" CPI, each time the Fed raises interest rates to fight inflation, the "core" CPI will rises faster, necessitating further rate increases. Thus, the virtuous cycle becomes a vicious one. Housing prices, on the other hand, will be falling, but those price declines will not offset rising rents, as housing prices are not part of the CPI. An economy that lives by "core" CPI, will die by it, as well.
May 18, 2005
Peter D. Schiff
President/Chief Global Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200
Newport Beach, CA 92660