The Daily Reckoning PRESENTS: Here's a controversial essay.
Gary Shilling explains why the CPI OVERSTATES inflation and
why fears of future inflationary spikes are misplaced. His
conclusion? The Fed will be cutting rates within months...
A FEDERAL U-TURN
by Gary Shilling
Until recently, a revival of inflation in the United States
was a major concern for investors. The spotlight was on
employment and consumer commodities, but the recent slump
in payroll jobs convinced many that perhaps the inflation
scare was overblown.
Now, even though inflation worries have receded, along with
the consumer price index, can investors forget about
inflation? Keep in mind that the price of gasoline leaped
by more than 40% since December 2003 to its summer peak,
and the price of milk - another frequently purchased item -
has risen more than 10% in the past year.
The price spikes in these items - necessities for most
households - have convinced many commentators that despite
June's soft patch, inflation in general is spiraling
upward.
We disagree: Even if some prices have risen sharply,
investors should not position themselves for inflation.
Here's one reason why. Gasoline only accounts for 2.7% of
consumer outlays, while milk accounts for even less, 0.2%.
This concentration on small purchases neglects the big
price declines in big-ticket, infrequently purchased items.
These items are often discretionary, and purchase can be
postponed if price increases appear temporary - or delayed
if further price drops are expected.
New and used vehicles are in this category; outlays for
autos and parts account for 5.2% of consumer spending.
Computers are another example and, adjusted for the rise in
computing power, their cost to consumers has dropped
spectacularly.
Despite the widespread belief that inflation is much higher
than reported, the evidence is that the consumer price
index is overstated. A congressional study found that the
CPI is biased upward in four areas. First, since the index
has fixed weights, it doesn't account for the tendency to
buy more of what's cheap and less of what's expensive.
Second, the group of retail stores sampled monthly in the
survey of selling prices changes slowly over time. As a
result, rapidly expanding discounters like Wal-Mart are
underreported, while those stores selling at full price are
overweighted.
Third, quality improvements are understated, meaning that
prices are recorded as higher than they would be with
proper adjustment. Computers are one example.
The fourth upward bias in the CPI results from the fixed- weight base period, currently 1982-1984. DVD players,
wireless phones and lots of other new tech items didn't
exist 20 years ago, but now account for significant
portions of consumer spending. And their prices have fallen
dramatically, so the CPI is overstated, since it doesn't
include them.
This study estimated that the annual increase in the CPI
was overstated by 1.1%. While some subsequent adjustments
reduced the CPI by 0.2% per year, it still shows much more
inflation than an unbiased measure would report.
In fact, the U.S. government has begun issuing chain-
weighted CPI figures along with the 1982-1984 official
numbers. The chained indexes correct for the substitution
and new products problems and consistently show lower
inflation rates, both for the total CPI and the core index
that excludes food and energy.
But inflationary fears are so deeply embedded in most
Americans that even if they were able to set aside all of
their convictions that inflation is being vastly
underestimated, they would still believe that the Federal
Reserve is oblivious to the threat and is even promoting it
with rapid monetary expansion, especially since the
beginning of 2003.
My problem with this, though, is that, besides the
traditional monetary measures, there are numerous other
measures of money, like credit cards, which many consumers
use to buy everything from groceries to gasoline to
clothing. In any event, the money supply in the past year
has grown less than nominal GDP and has been far from
inflationary.
Furthermore, global excess capacity should keep American
business pricing power in check, and this, in turn, will
maintain steady pressure on labor costs. In addition, the
Wal-Marts of the world are another important factor in
keeping inflation low as cost cutting and lower prices are
made possible by productivity enhancement.
I see the rise in inflation fears as being one more brief
uptick within the disinflationary trend of the past 23
years. And so far, the Federal Reserve apparently agrees.
The central bank will probably raise its federal funds
target rate at a moderate pace. We envision a quarter-point
increase at each policy meeting until the end of the year.
And then, as concerns about inflation turn to renewed
worries about deflation, the Federal Reserve will switch
from raising to cutting interest rates.
How's that for contrarian?
Regards,
Gary Shilling
for The Daily Reckoning
Editor's Note: Dr. Gary Shilling is president of A. Gary
Shilling & Co. Inc., an investment advisory and economic
consulting firm and publisher of the monthly INSIGHT
newsletter.
Not only has Dr. Shilling beaten the stock market by a wide
margin over many years, he has provided consistently
accurate forecasts to his subscribers. Twice ranked as Wall
Street's top economist by polls in Institutional Investor,
Dr. Shilling was also named the country's No. 1 Commodity
Trader Advisor by Futures magazine. And last year,
MoneySense ranked him as the third best stock market
forecaster, right behind Warren Buffett. |
