Popular investment consultant faults government distortion
Jubak -- Fake inflation numbers masked crisis
Not just the usual critics but business people also decry how government manipulates the data. GIGO is one reason economics is not a science, unlike geonomics, which takes into account the politics in statistics. As would a geonomist, todayís writer distinguishes between finances and the physical economy of producing and distributing. But he stops short of seeing the difference between the values of land that society generates (location, location, location) and the values of labor and capital that individuals generate. Todayís writer is the most widely read investment consultant on the web. We trim and append this 2008 article from Jubak's Journal of Dec 5.
By Jim JubakHow fast are prices going up? The official inflation number, the Consumer Price Index (CPI) calculated by the Bureau of Labor Statistics (BLS), is misleading.
3 major shifts in figuring inflation
* The BLS argues that a $100 increase in the price of, say, a car wasn't really a $100 price increase if the power, safety features, or general usefulness of the car improved substantially. Yet trying to determine the increased usefulness of a product or service requires a subjective judgment. What is the extra horsepower of a car worth to a user? How about extra safety features? And to which user? And wasn't the price still $100 higher?
* The BLS measures changes in the cost of housing by looking not at the cost of a house but at what an owner would get if he or she rented out that house. Since in a housing bubble the price of houses rises about three times as fast as rents do, this change understated the rate of inflation.
* Also, the BLS assumes that if the price of something went up, people would use less and would substitute a less costly product or service. So when steak went up in price, consumers might buy more pork or chicken. Including substitution destroyed the whole point of the exercise because it turned the government's shopping basket from an inflation measure to a set of lifestyle choices.
How big an impact?
The St. Louis Federal Reserve Bank calculated that the use of just rental equivalents to estimate housing cost increases might have subtracted somewhere around half a percentage point from the official CPI.
Bond guru Bill Gross figures all three changes were worth a full percentage point off the official inflation number. Other estimates put the effect anywhere from 5 to 8 percentage points.
Adding even 1 percentage point to the official rate would have made it harder for the Federal Reserve, which believes it must raise its lending rates to fight inflation, to keep cutting their rates instead earlier this decade. Keeping interest rates at 1% helped the mortgage bubble develop.
Lessons from the bubbles
If the price of a can of soup goes up 10 cents, that's inflation, but if the price of a stock soars by 100%, that doesn't count as inflation at all.
Letís recount. Traders can borrow yen in Tokyo to bid up the prices of stocks in New York and London. The Nasdaq Composite Index climbed 39% in 1998 and 86% in 1999. In the rest of the economy, the prices of goods stayed relatively flat.
The central bank could have raised interest rates to slow the economy as a whole -- and the stock market along with it -- or it could have used its power to set margin requirements to reduce traders' ability to borrow money to buy shares without affecting the economy as a whole. But since the central bank doesn't include asset prices in its view of inflation, it could excuse doing nothing.
Same pattern in the run-up to the mortgage bubble that broke in 2007. Despite housing prices rising in a speculative fever, with official inflation so low the Fed could eschew raising interest rates to slow the general economy or using specific powers -- in this case its power over bank reserve requirements and lending standards -- to reduce the amount of credit available to homebuyers without slowing the economy as a whole.
Another look at the numbers
When we talk about the growth rate in the economy, thatís the rate of growth after subtracting inflation. If the real rate of inflation is higher than the official rate of inflation, the actual rate of growth is lower than the official rate.
So when the economy grew officially 0.6% in 2007 Q1, the actual growth rate was close to or below zero; we were in a recession. But because the economy officially grew, the Federal Reserve could ignore the recession.
How could home sales be booming and prices soaring even as the real economy delivered something near zero growth?
Editorís Note: Thatís a softball for geonomists. Every time that land (homes actually depreciate) soars out of the price range for most people, then recession follows. Like clockwork, every eighteen years.
Reality, as measured by the official numbers, distorted the truth of the real economy and the real asset markets. With distorted data, policymakers had a ready excuse for setting policies that benefited the few at the expense of the many.
Jeffery J. Smith runs the Forum on Geonomics.
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