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CPI, PPI, Forex - What's going on w/Price Inflation?

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agrippa1
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Measured against the Euro, our dollar has seen a 7% per annum decrease in value since 2001.

Measured against producer prices (PPI), a 5.3% decrease.

But CPI shows only a 3% per annum decrease.

I understand that during the Clinton Administration they shifted the manner of CPI calculation to take more account of substitutes, but this seems inherently bogus, since as the "average man's" purchasing power falls, he will naturally pursue substitutes as one part of the two part strategy to deal with price inflation (the other part is to stop buying luxuries).

My question is: Does anyone know of a detailed explanation of how they calculate CPI now, and also, is there a better source to let us know what is really going on?

"Inflation" numbers came out today, and the stock market is rallying because the low numbers free up the Fed to print more money.

On edit: Does anyone know the validity of shadowstats.com? They are showing a CPI of about 6% and rising.

Edited by agrippa1
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"Inflation" numbers came out today, and the stock market is rallying because the low numbers free up the Fed to print more money.

Because Wall Street and stock investors are usually the first to gain from the inflation of the currency. As for everything else, I'm not for sure, but it's funny that you brought it up because I'm starting to research it all myself. The weak dollar means there are some investment oppurtunities in other currencies.

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Because Wall Street and stock investors are usually the first to gain from the inflation of the currency. As for everything else, I'm not for sure, but it's funny that you brought it up because I'm starting to research it all myself. The weak dollar means there are some investment oppurtunities in other currencies.

The gov't is scrambling to save Bear Stearns this morning. They are stuck; they can't let a big bank fail right now, and they can't pour much more money into the economy without triggering a dollar collapse.

The question you have to ask yourself about other currencies is how much do those economies depend on the U.S. It used to be if we had problems, the rest of the world had big problems. Now, not as much, but it's a matter of degrees. If the U.S. economy takes a nosedive, it could take everyone else with it, and you might find the old power hierarchy reemerging to some extent, in which case foreign currencies could get hit hard.

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Price Indices always have the issue of what prices to tabulate, and what weights to give to each price. The Bureau of Labor Stats (BLS) compiles multiple CPIs. The commonly-used one is CPI-U (CPI for all urban consumers), which tries to look at a typical urban consumers budget-mix while assigning weights. However, there is another (CPI-W) that is "CPI for Urban Wage Earners and Clerical Workers". As an example, the 12-month change in CPI-U has been 4.0% while the 12-month change in CPI-W has been 4.4% [Feb 2008]. Then, there are separate calculations for various cities.

"Hedonistic Adjustments": Even after weights have been decided, based on the current pattern of consumer spending, that pattern changes all the time. So, one has to account for substitution. For instance, suppose in 1998 housing cost the average family $1000 a month for an "average home" [Home type A]. Suppose a slightly better than average home [Home type B] cost $1100 a month in 1998. The square footage is the same, but it has better features -- whether it is windows or fixtures etc. Now, jump forward to 2008 and suppose that Home type A costs $1300 a month (30% up), while Home type B costs $1430 (30% up). Have prices risen by 30%? It would seem so. However, what if home type B is now considered the "average home". The average family spent $1000 in 1998, and $1430 in 2008. So, they saw a 43% rise in their home-spending budget. Did prices rise 43%?

The government now tries to adjust prices, to make the so-called "hedonistic adjustment" and say that home-prices have risen by 30%, not 43%.

Owner Equivalent Rent: Another factor that complicates US BLS-calculated CPI is the way home ownership costs are calculated. Since so many people take out Fixed mortgages in the US, their monthly outflows reflect past prices and also reflect interest rates. At some point, the BLS decided that a better way to calculate housing cost would be to use "Owner Equivalent Rent" (OER). What this means is: instead of using the actual mortgage payments, they try to estimate how much an owner would have to pay is he were renting his property. That is the number that goes into the CPI. It is quite a big component of CPI (about 30%).

There are a couple of downsides to this method. Firstly, in many categories -- three bedroom and up -- the rental market is much smaller than the number of owned homes. So, the relevance of the rental-price is suspect. In other words, if all those owners actually were renting, the prices might be different. More important, while rent and ownership costs are generally related in the long term (based on the underlying cost of land and building, etc.), they can actually have some negative correlations in the short run (even across a few years). For instance, we just saw a period where mortgages were cheap and people were moving into new homes a bit more rapidly than in the past. The two effects were: upward pressure on home-prices, but downward pressure on rents. At the peak of the housing boom, just three years ago, many apartments were offering great deals. Therefore, in a year like that using rents as a proxy for home-ownership costs will show home-costs (using OER) staying steady or even going down, while actual ownership costs are rising. In other years, the home-component of the CPI can be rising even though housing prices have dropped! [For more, see this.]

Motivation: Good arguments can be made for both the above techniques -- hedonistic adjustments and using OER. It is true that the government benefits when hedonistic adjustment shows lower CPI than without such an adjustment, however there are also good theoretical arguments to be made in their favor. The same for the OER. Finally, different things are being measured, and one has to figure out exactly what one wishes to measure.

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Price Indices always have the issue of what prices to tabulate, and what weights to give to each price...

"Hedonistic Adjustments": Even after weights have been decided, based on the current pattern of consumer spending, that pattern changes all the time...

Owner Equivalent Rent: Another factor that complicates US BLS-calculated CPI is the way home ownership costs are calculated...

Motivation: Good arguments can be made for both the above techniques ... different things are being measured, and one has to figure out exactly what one wishes to measure.

Wow, I had no idea about OER. After watching the housing bubble the past few years and low CPI growth, I assumed they didn't count housing at all. The real answer is much worse, as it seems that in addition to counting a false measure of housing cost, far below actual, they also omit any mitigation of the effect of the actual cost of housing, that effect being deflationary pressure due to lower demand due to lowered disposable income of homeowners.

Thanks loads for this answer.

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If you wish to have in-depth reviews on the direction of world economy, where to invest your money, I recommend subscribing to International Speculator by Casey Research Group. You can find them on the web.

They recently published a study showing that global inflation is where we're heading.

Basically, the government tries to lower inflation numbers by using fairly unrealistic calculations in some cases, so to understate the gravity of the problem.

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  • 2 weeks later...

In the last couple of years or so, I have noticed the price of eggs to jump by about 300%. Other edible commodities seem to be following similar suit, yet when I checked the CPI (http://data.bls.gov/cgi-bin/surveymost?ap) for eggs 2006/07, eggs have only increased by about 128%. Obviously prices vary geographically and what not, but there is a huge difference b/t 128 and 300%.

Can someone explain why this might be so?

Also, if you check the inflation calculator on this site (http://www.bls.gov/cpi/), you'll see that $1 in 2000 was worth $1.23 in 2008. That can't be right. Is that calculator solely taking into account inflation alone (maybe then I could believe the comparison)? Does that mean that $1 in 2000 had the same buying power as $1.23 does now?

One more question out of pure curiousity, do those of you who have jobs demand an increase in salary every year proportional to the decrease in the buying power of the dollar?

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I don't know specifically about eggs, but in general, one of the features of the way the CPI is calculated is something called "hedonic" adjustments. The idea is that if something gets too expensive, consumers will switch to a lower cost alternative. So one explanation for eggs might be that they switched from one type of egg to another -- maybe large AA to small, or something like that.

The CPI is a heavily manipulated number. For a more realistic estimate, see the graph below. For a calculator that uses those numbers, see:

http://www.shadowstats.com/inflation_calculator

It says that $1 in 2000 is worth $2.07 today.

Very, very few people are able to "demand" wage increases that match or exceed the real rate of inflation if their work output is constant.

sgs-cpi.gif

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Very, very few people are able to "demand" wage increases that match or exceed the real rate of inflation if their work output is constant.

Those few are typically government employees(teachers,beauracrats,etc) that get yearly increases in pay divorced from merit. The closer you are to the printing presses the more likely you are to not get burned...Thats the problem with inflation is that the first person(government/bank) to spend the new money gets to use it at todays value. Those of us in the free market(what's left of it) get the new dollars last, after we have traded our goods for less then they are actually worth. So every time they print another dollar we(the producers) are, in part, defrauded of our goods. As a business it would be impossible in most cases to try to have pay keep up with inflation. You'd be getting nailed by inflation at both ends. So instead, you go as long as you are able and when the work gets unreasonable compared to the compensation, you ship it overseas or import cheap labor.

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AceNZ,

how do you know the CPI is a very manipulated figure?

Also, what is the correlation between inflation and buying power? If inflation increases by 2%, does that mean I can say the buying power has decreased by 2%? (Seems like I would have to take into consideration the price of goods--assuming inflation does not do that).

Thanks

Nick

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how do you know the CPI is a very manipulated figure?

Well, for instance, if you thought the higher cost of housing in the recent bubble would result in a corresponding increase in CPI, think again. The gov't uses Owner's Equivalent Rent to calculate the cost of housing for homeowners. This means that not only were the skyrocketing costs of owning a home completely excluded from CPI, but the lowered cost of renting, due to lower demand for rental units, actually had a downward effect on that portion of CPI. OER accounts for 23.8% of CPI, which means the CPI figures for the past eight years are extremely suspect. (look at the cost of commodities, or at the Producer Price Index for a clue on what inflation really did the past few years)

One wonders if the gov't will switch to "Renter's Equivalent Mortgage" calculations once the price of renting starts rising as house prices plummet and former homeowners start flooding the rental market.

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  • 1 month later...
  • 3 months later...
The CPI is a heavily manipulated number. For a more realistic estimate, see the graph below. For a calculator that uses those numbers, see:http://www.shadowstats.com/inflation_calculator
The "Shadow Stats" version of CPI has been doing the rounds on blogs. Two economists from the Bureau of Labor Statistics (BLS) have written an excellent article defending the existing calculation.
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I haven't been keeping up with all of the economic news in the details, but given that the DJ Stock Market has had some rather heavy down days, I looked at the one year chart -- wow! down about 21%!

You can see it here.

If you click on the customize time period button, you can see that the market had a pretty steady rise from about 2003 to a year ago, and then began to fall steadily.

Looks like Yaron Brook's prediction from many months to almost a year ago was correct -- there is too much uncertainty to be in the stock market these days.

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