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CPI Indicates" rel="bookmark">Money Supply and Economic Data Weekly Watch – Deflation Is Worse Than CPI Indicates

Last week’s eco­nomic data is under­es­ti­mat­ing defla­tion. On Wednes­day the Bureau of Labor Sta­tis­tics (“BLS”) announced that the con­sumer price index (“CPI”) declined by 1.0% in Octo­ber which was the biggest sin­gle one month reported decline since before World War II. Broad based defla­tion exac­er­bates the already severe credit cri­sis and increases cash hoard­ing by house­holds and busi­nesses. How­ever, CPI defla­tion esti­mates are wrong because defla­tion is much worse than reported and the United States has already entered into a defla­tion­ary death spiral.

Unfor­tu­nately, many econ­o­mists are look­ing at the flawed his­tor­i­cal and cur­rent CPI data to con­clude that defla­tion isn’t a clear and present dan­ger. Fed offi­cials also don’t seem to under­stand the threat. In a dis­turb­ing denial of real­ity, on the same day as CPI reported broad based defla­tion, Fed Vice Chair­man Don­ald Kohn said that the risk of sus­tained and broadly falling prices was slight.

Defla­tion destroys cor­po­rate prof­its and is like pour­ing hydrochlo­ric acid on bank loan port­fo­lios because bor­row­ers have less cash and assets to pay back lenders. Obvi­ously, cor­po­rate bor­row­ers that can’t ser­vice their debts because of defla­tion aren’t a very good stock invest­ment. A real life les­son in how defla­tion affects bor­row­ers, lenders and investors is the fall in home prices and the destruc­tion to national wealth that occurred as a result. There are no win­ners in the cur­rent res­i­den­tial real estate price crash as fam­i­lies lose their life sav­ings, lenders fail and 401(k)‘s and other invest­ments crash.

Defla­tion is here and is prob­a­bly worse than the offi­cial sta­tis­tics indi­cate for the fol­low­ing reasons.

  • BLS is over­es­ti­mat­ing the price level for hous­ing which makes up approx­i­mately 42.4% of CPI.

Curi­ously BLS is report­ing that hous­ing costs went up 3.2% from Octo­ber, 2007, to Octo­ber, 2008. It isn’t clear whose house went up in value or how hous­ing costs could have pos­si­ble increased. But some­where in the alter­nate uni­verse of BLS sta­tis­tics it must have hap­pened and CPI is sig­nal­ing hous­ing infla­tion. Specif­i­cally, CPI data includes an increase of 2.3% in the cost of home­own­er­ship (through an obscure def­i­n­i­tion of the cost of own­ing a house exclud­ing util­i­ties, fur­ni­ture, heat­ing and other oper­at­ing expenses), 3.7% increase in rent and a 2.0% increase in the cost of fur­nish­ings. Some­how CPI has missed the res­i­den­tial real estate cri­sis and as a result is grossly under­es­ti­mat­ing deflation.

  • BLS is over­es­ti­mat­ing the cost of new and used cars which make up approx­i­mately 7.2% of CPI.

Sta­tis­ti­cians from BLS prob­a­bly only take mass tran­sit because they can’t have been in a car deal­er­ship lately. BLS is ignor­ing that auto­mo­bile prices are col­laps­ing. BLS esti­mated that the drop in new and used motor vehi­cles was 2.3% from Octo­ber, 2007, to Octo­ber, 2008, which while in the right direc­tion, is still very wrong by a large mag­ni­tude. Read­ing any local paper that runs auto­mo­bile adver­tis­ing quickly val­i­dates dou­ble digit declines in vehi­cle prices.

  • BLS is over­es­ti­mat­ing apparel prices which make up 3.7% of CPI.

BLS is esti­mat­ing that apparel prices actu­ally increased 0.3% from Octo­ber, 2007, to Octo­ber, 2008 which I find shock­ing. First Cap­i­tal finances scores of apparel man­u­fac­tur­ers and over the last 12 months the prices that retail­ers are pay­ing for goods from our clients has dropped. And, whole­sale price declines are being passed on to con­sumers. As an exam­ple, last week my wife pur­chased cloth­ing for our 11 year old daugh­ter. They went to Macy’s and pur­chased 2 pairs of jeans, a shirt with leg­ging and a shirt with a scarf. The total cost for the 4 gar­ments, includ­ing tax, was $21.57. The price tags on my daughter’s cloth­ing indi­cated an orig­i­nal retail price, includ­ing tax, of $71.57 which means that the mer­chan­dise was dis­counted by approx­i­mately 70%. Recently, my wife and I pur­chased men’s printed tee shirts for our 15 year old son and paid $1.99 per tee shirt. And, last month I pur­chased pants for myself and paid less than $20 a pair. 12 months ago the same pants were sell­ing for $45. BLS hasn’t noticed that apparel retail­ers are going bank­rupt by the dozens and one of the rea­sons for the retail­ing col­lapse is that prices are rapidly falling.

While on the sur­face falling prices seems to help con­sumers pay their bills, that analy­sis only works if con­sumers also don’t need jobs. Defla­tion has a quick cor­ro­sive effect on the via­bil­ity of employ­ers because they pur­chase goods at one price and then because of defla­tion have to sell their inven­tory at a loss. While a lot of infla­tion feels like an eco­nomic flu, defla­tion is like “car­diac arrest” for business.

With­out real­is­tic and reli­able eco­nomic sta­tis­tics pol­icy mak­ers can­not do their jobs. More­over, until gov­ern­ment econ­o­mists get “real” about where the econ­omy is, and where it is going, they will con­tinue to destroy con­fi­dence with incon­sis­tent and reac­tive pol­icy solutions.

Since defla­tion is both real and more severe than being reported, fis­cal and mon­e­tary pol­icy options need to be re-examined through the sharp lens of a “wage price death spi­ral.” The longer gov­ern­ment fails to respond to defla­tion the worse the econ­omy is going to get.

Since the week end­ing Sep­tem­ber 22nd sea­son­ally adjusted M2 hasn’t changed very much. Dur­ing the same period the Fed­eral Reserve’s bal­ance sheet grew from approx­i­mately $1.1 tril­lion to $2.2 tril­lion. I think that M2’s fail­ure to grow indi­cates a type of cash hoard­ing in accounts that would have been picked up in M3 (if the Fed­eral Reserve still pub­lished the sta­tis­tic) which is con­sis­tent with deflation.

Dur­ing the 1970’s Pres­i­dent Ford started the WIN cam­paign, i.e., Whip Infla­tion Now, as he used the Pres­i­den­tial bully pul­pit to try to jaw bone infla­tion down. On inau­gu­ra­tion day Pres­i­dent Elect Obama needs to start the DDT cam­paign, i.e., Defeat Defla­tion Today. But he needs to use more than the bully pul­pit to defeat defla­tion, mas­sive emer­gency fis­cal stim­u­lus is needed to shock the econ­omy back to into its nat­ural rhythm before it is too late.

Posted in: BANKS, BLS, Business Environment, CPI, Credit Crisis, Deflation, Economic Statistics, economy, Federal Funds Rate, Federal Reserve, Finance, Fiscal Policy, GDP, Inflation, Liquidity Trap, M2, monetary policy, Money Supply

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