Why You Can't Trust the Inflation Numbers

[steve2470]

http://online.wsj.com/article/SB10001424052748704013604576104351050317610.html

A surprising number of people on Wall Street will tell you not to worry too much about inflation.

After all, they'll say, just look at the numbers. The inflation picture is incredibly benign. In the past 12 months the Consumer Price Index has risen just 1.5%—a remarkably low rate. And when you strip out volatile food and energy costs, they'll say, it's even lower—a meager 0.8%.

It doesn't stop there. Many economists will point out that wages are also rising by less than 2% a year. With so many people still out of work, goes the line, labor costs are going to stay low for a long time too. So what's the worry?

Clearly, a lot of investors agree. Inflation-protected government bonds, which people would buy to protect themselves if they were worried, have fallen in price in the past couple of months. Gold, another inflation hedge, is down. Ten-year Treasury bonds yield less—3.3%—than they did when President Eisenhower left office.

[pinqy]

1. Let's count the errors in the article.

1.

Under the official calculations, if steak prices boom, the government just assumes you buy cheaper hamburger instead. Presto—no inflation!

Untrue. Steak and hamburger are seperate item categories. Some substitution is accounted for in individual item categories now that BLS uses a geometric mean instead of a Laspeyres index, but it it's not to the cheaper item, it's to the item whose cost goes up less. But in all cases it reflects a constant level of living. Filet has gone up to $14/lb say, so you buy 3 lbs less of filet and 6lbs more of NY strip and consider yourself as well off.

2.

Or consider the case of Apple computers. We all know Macs are expensive. And we know Apple doesn't discount. The cheapest Mac laptop today costs $999. A few years ago, it also cost $999. So the price is the same, right?

Ha. Not according Uncle Sam. Using a piece of chicanery called "hedonics," Uncle Sam calls this a price cut. His reasoning? You're getting more for the money. Today's $999 Mac is lighter, fancier and faster than last year's $999 Mac. So the government calculates that the "real" price has actually fallen.

It's not the same computer. Again, the CPI looks at price changes for the same standard of living. Let's say the new Apple has 2x the processing speed and 4x the memory. How much would it have cost you to buy that computer a few years ago? The price then has gone down. Or looking at it the other way, how much would the old computer cost now? Certainly less than $999.

It's the same thing with packaging. If a soda can costs $1 for 12 oz, and they keep the price the same, but make it a 10 oz can, do you really think there's no price change? BLS would calculate an effective price change of 20%.

3.

OK, so the prices of many things haven't risen. Yet. But if the laws of economics mean anything, they will have to. Why? Because costs are rising.

Economists need to stop focusing just on labor costs. The world has plenty of surplus labor. But look at raw materials. Around the world prices are skyrocketing, from copper to cocoa. The United Nations Food Price Index has just hit a new record high. Oil's back near $90 a barrel. Wheat prices have nearly doubled since last summer.

Rising costs of raw materials and intemediate goods are covered in the Producer Price Index.

Further reading that debunks much of this: Common Misconceptions about the CPI: Q&A
http://www.bls.gov/opub/mlr/2008/08/art1full.pdf">Addressing Misconceptions About the CPI