Don’t Believe the Latest CPI and Inflation Reports

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When most of us think about inflation, we think of the prices of the things we buy regularly. The government supposedly measures that in the CPI – the Consumer Price Index.

I think that, intuitively, most of us experience a higher level of inflation than the government reports.

There’s a reason for that. The government doesn’t measure inflation – at least, not as it’s classically defined. The classical definition is a rise in the “general” level of prices. That should include all things that are bought and sold – that have prices.

The CPI doesn’t do that. It measures a narrowly defined and statistically manipulated basket of consumption goods and services. And the government does its best to suppress the inflation rate of those items. That’s because the CPI was never intended to measure a rise in the general level of prices. It was intended as a means for indexing the cost of labor contracts and government contracts in eras of high inflation.

Given that purpose, government statisticians have habitually looked for ways to get these numbers to understate actual inflation. They use hedonics to substitute lower-priced goods for higher-priced goods when prices are rising because, in theory, consumers will make that switch. But if we wanted to measure general inflation accurately, wouldn’t we survey the prices of the same goods over time?

Then there’s the biggest trick of all.

Assets Don’t Count, and That’s Bad News for Us

Assets don’t count at all, only consumption goods. So if housing is inflating at 6% a year, it doesn’t count because houses are “assets,” not consumer goods. I’d argue that they’re wasting assets that are being consumed because they require regular expenditures to maintain, but the government says they’re assets. They don’t count.

Instead, the government replaces home prices with rent. But it even manages to make that phony by ignoring market rent, which is rent as paid in current market transactions. Instead, they ask tenants how much rent they are currently paying. It doesn’t matter if they just rented the place or have been there for years with a lease with nominal increases – or worse, rent control.

It just bears no resemblance to the actual inflation rate of housing. The government imputes housing inflation at the reported rate of increase of contract rent. That counts for nearly 40% of core CPI. It has meant that through the years, CPI has understated inflation by between 0.75% and 1% ever since house prices began to recover in 2012.

So we know, right off the bat, that inflation is running a lot hotter than the government reports. How hot is it? I like to look at several alternative measures that don’t manipulate the numbers, plus an adjusted CPI that includes housing at the actual rate at which it is rising.

Here’s How Hot CPI Really Is

First, here’s how the Wall Street media treated Wednesday morning’s CPI release. The Wall Street Journal headlined with, “U.S. Consumer Prices Flat in November.” It said that “U.S. consumer prices were flat in November, a sign a recent drop in oil prices is holding down inflation.”

Now, I don’t know about you, but it seems to me that when oil prices are falling, the Journal and its ilk like to emphasize the top-line number. But when oil prices are rising fast, they like to strip it out and emphasize what they call core inflation – which is the CPI excluding what they routinely describe as “volatile” food and energy. All right, there’s rationale for that, but let’s be consistent. Use core and ignore the huge swings in energy prices all the time, not just when it helps the bullish case.

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CNBC.com indeed noted that “U.S. consumer prices were unchanged in November, held back by a sharp decline in the price of gasoline, but underlying inflation pressures remained firm amid rising rents and healthcare costs” [emphasis mine]. So I must give CNBC its due for giving that a fact a shout out.

Unfortunately, they then softened that after pointing out that core CPI rose 0.2% in November, and 2.2% for the 12 months ended November. They added,” While core prices remain firm, the inflation outlook is benign amid falling oil prices and signs of slowing economic growth…” Whoopee! The outlook is benign! Maybe the Fed won’t raise rates!

Not So Fast – the Outlook Isn’t Benign at All

Naturally, that was the seasonally adjusted abstraction. We like reality, so let’s look at the raw, unmanipulated data. Unmassaged, the CPI rose 0.16% in November. That’s close enough to what the media reported. On a 12-month basis, prices also rose at the reported 2.2% rate. Both the monthly and annual rates of change have been rising at a relatively steady rate, just above 2%. There’s no evidence of slowing. And at 2% or so, the rate looks “benign,” as the Wall Street crowd likes to characterize it.

But the published rate understates the reality.

Here’s a chart showing core CPI versus a measure of producer prices of finished consumer goods ready for retail sale (excluding food and energy). What’s wrong with this picture? The wholesale prices of core finished consumer goods are rising at 2.75%, and have been consistently a half-point higher than CPI for nearly two years. Not only that, but their inflation rate has been in a rising trend since mid 2016.


Contrary to conventional wisdom, this is not a benign inflation picture. It indicates that the Fed’s current target rate is still at a negative real rate; that is, interest rates are below the inflation rate. As long as short-term interest rates are below the inflation rate, rate increases will stimulate even more inflation, not suppress it. That will create a vicious cycle until rates become punitive, at a real rate high enough to slow consumption.

Some years ago, I developed an alternative CPI measure with the FHFA house price index that replaced the phony rent component of CPI. I called it “Owner’s Equivalent Rent.” This index has shown that if housing were included in the CPI, it would be rising at about 1% more than CPI. Because this measure includes food and energy, I’ve plotted it with headline CPI.

The adjusted index was only below the Fed’s target 2% inflation rate during the oil price collapse of 2014–2015. But it has been back above that level since January 2016, and it has been persistently 3.5% or higher.


None of this even begins to approach the stupendous inflation of prices, which economists completely ignore, despite the fact that inflated asset bubbles eventually collapse and lead to financial system crashes.

As the Fed tightens, it remains well behind the curve. The inflation numbers will probably get worse as long as interest rates remain below the actual inflation rate. Historically, rising rates have stimulated even more inflation until rates get high enough to choke the economy. We’re a long way from that. It will keep the Fed on course in its program of removing money from the system as it “normalizes” its balance sheet.

The only way to play that from a long-term investment standpoint is to stay away from stocks and bonds, and continue to hold and roll Treasury bills as they mature and interest rates rise. The time will eventually come to buy bonds and stocks again. But it’s still a long way off.

Meanwhile, we can look for trading profits with that amount of our capital that we’re willing to risk. You can work out how much risk is appropriate for you with your financial adviser.

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The post Two Charts Show How The CPI News Increases The Danger By Underplaying It appeared first on Lee Adler’s Sure Money.

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