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« Mamet Reads Sowell | Main | Fact for the Day »

March 14, 2008

Something is Rotten…

Friedrich von Blowhard writes:

Dear Blowhards,

Just after absorbing the news on the NY Fed’s bailout of Bear Stearns, I noticed this little item by Shobhana Chandra on Bloomberg:

March 14 (Bloomberg) -- Consumer prices in the U.S. were unexpectedly unchanged in February, making it easier for Federal Reserve Chairman Ben S. Bernanke to cut interest rates by as much as three-quarters of a percentage point.

The figure followed a 0.4 percent gain in January, the Labor Department said today in Washington. So-called core prices, which exclude food and energy, also showed no change, the first time they didn't increase since November 2006.

Since the core prices are flat, and food is up, we can conclude that energy costs are down? With oil at a record high, and natural gas up? WTF?!

I’m glad to see I wasn’t the only person left scratching his head. Carl Gutierrez of Forbes seems to share my puzzlement in “Flat CPE Brings Sighs of Relief”:

Despite the positive reaction in the bond and equity markets, some analysts were skeptical about the figures.

"It is kind of bizarre," Robert MacIntosh, chief economist with Eaton Vance Management in Boston, told Reuters. "I don't know why you don't see inflation here. It must be a faulty measurement system -- it makes no sense whatsoever. How could energy have fallen 0.5%? Do you think energy-related costs are down? I bet that the market is just going to disregard this and move on."

And, of course, in Europe where the ECB is stubbornly keeping interest rates higher than in the U.S. (generally an inflation-containing strategy) they weren’t nearly as ‘lucky’ as we were. Ms. Chandra remarks:

The report from the U.S. contrasts with figures from overseas also issued today. European consumer prices and wages rose more than economists forecast, leaving the European Central Bank with little room to lower interest rates as economic growth slows.

It's probably nothing but my terminally cynical nature that prompts me to wonder if the "faulty measurement system" mentioned by Mr. MacIntosh of Eaton Vance is perhaps not so much faulty as one suffering from a thumb on the scale by government statisticians. The Bloomberg story goes on to quote Stephen Gallagher, chief U.S. economist at Societe Generale SA in New York, who points out that with such low inflation,

"The Fed certainly has more room to cut rates next week."

So inflation numbers join unemployment numbers in my list of indicators to pay less attention to. Well, do you believe that this is credible?



posted by Friedrich at March 14, 2008


I'm just pleased that our Free-Market Buccaneers have finally agreed on one legitimate governmental role - re-imbursing the affluent when they bet wrong at Wall Street Casino.

Posted by: Don McArthur on March 14, 2008 1:15 PM

Neither food prices nor energy prices are counted anymore in the inflation index.

They pulled these two things out of the count a while back so it would look like there was no inflation. Hence, you have milk rising 30 percent in a few months and gas higher than ever, but reporters (who are usually never good with numbers) are telling us today inflation has remained "steady."

Here is a USA Today story from June, 16 2007 about this. Its titled "Food, energy costs' exclusion debated."

I recently came a cross a Forbes article (which I can't find) that came right out and said the Fed is deliberately ignoring inflation so they can drop the key interest rate, helping out the rich stockbrokers and sticking it to the average citizen or the responsible citizen who will get screwed on his savings account.

If there is anything Americans hate, it's hard working responsible citizens, so this makes sense.

Posted by: Days of Broken Arrows on March 14, 2008 2:24 PM

The inflation figure has been bogus since the mid 90's. Greenspan altered the calculation of inflation in the 90's with the following three alterations: 1) substitution effect, 2) "annualization" of the CPI calculation and, 3) the introduction of "hedonic" factors.

The CPI has continually understated inflation ever since. There is a very good book out that I see in all of the airport book shops, call "Greenspan's Bubbles, that explains all of this.

It is simply outrageous that tax payers money is being considered to bailout the mistakes (and the jobs) of investment bankers who make hundreds of thousands of dollars per year on Wall Street. This is absolutely no excuse for this. The argument that these institutions are "too big to fail" and are, therefor, essential to the operation of the economy is the biggest claptrap I have ever heard. A free market economy abhors an unfulfilled market niche as much as nature abhors a vacuum. If the large wall street banks all go away (which I believe is necessary and inevitable), entrepreneurs will simply invent new institutions to replace them. The process of creative destruction that works in semiconductors, computers, and jet airplanes will work just as well in the financial industry.

The well street whining for tax payers' bailout is the whining of parasites.

Let the parasite die!!!!

Posted by: kurt9 on March 14, 2008 3:04 PM

The shitake mushrooms have hit the fan. Trust no one.

Posted by: Charlton Griffin on March 14, 2008 3:17 PM

I don't have any confidence in the idea that economists can measure anything, at least not until well after the fact when it no longer matters.

Posted by: Todd Fletcher on March 14, 2008 3:24 PM

Friedrich, this may help answer your question...

Posted by: Charlton Griffin on March 14, 2008 4:53 PM

Shadow Stats Gentlemen?

Interesting reading.

Posted by: Slumlord on March 14, 2008 5:02 PM

From the article Charlton Griffin links to:

Gold, the supreme inflation indicator throughout human history, made new all time highs at just under $1,001.

Tells you all you need to know.

Posted by: ricpic on March 14, 2008 5:42 PM


Hundreds of thousands per year is entry-level on Wall St. Sorry to rub salt in the envy-wound...

Posted by: Alan on March 14, 2008 6:09 PM


I think a pair of 20MT devices would be sufficient for the job. One for NYC and the other for Washington D.C.

Posted by: kurt9 on March 14, 2008 6:36 PM

Social security benefits, which by law are supposed to be tied to the consumer price index, have actually not kept up because they are based on "core inflation" which excludes "volatile" things like food and energy. It is how the government welshes on its obligations. Inflation is the age-old method by which improvident governments pay for war and other follies.

Posted by: Richard S. Wheeler on March 14, 2008 8:17 PM

(Note: I am an economist at a regional Fed, so make of that what you will...)

The whole Core vs. Overall debate is ridiculous. Everyone considers overall CPI to be the most important number, and you will never read an article reporting monthly inflation that doesn't also state overall (i.e., including food and energy) inflation. Core, however, is much more useful for policymakers. At some level, we can control inflation, but we certainly have no control over bad harvests or the whims of OPEC. Historically, food and energy are very, very volatile series on a month-to-month basis. That's the only reason core is used; nothing nefarious about it.

As for substitution bias and all that - all I can say is that a) the Fed doesn't even compute CPI; rather the Dept of Labor does, and b) the recent adjustments we've made are almost wholly considered correct by economists, and are now standard worldwide (not simply in the US).

Finally, concerning gold: it stuns me that skeptics who always bash economists about housing bubbles and tech stock bubbles and the like somehow believe that the runup in commodities is something other than an asset bubble. Put it this way: when commenters on a culture blog start, like the shoeshine boy, telling you to invest in something, it probably means its time to pull your money out! Gold is incredibly variable historically - just look at the $/gold price since 1900. And need you be reminded that some of the true *great* inflations in histories were actually caused by gold and silver? Can a brother get some 16th century Spain?

Posted by: cure on March 14, 2008 11:01 PM

CPI does include food and energy, and SS benefits are based on CPI, not on 'core inflation'.

On the other hand, the "Price Revolution", post-Columbian inflation from American silver (and also increased European production of silver) meant that prices increased sixfold over 150 years: peanuts by modern standards.

Posted by: gcochran on March 15, 2008 12:42 AM


I recommend the book "Greenspan's Bubbles".

It mostly describes the unsustainable low interest rates that Greenspan set during much of his time at the FED. However, it also describes the substitution, hedonics, and annualization adjustments to the CPI that he convinced the Department of Labor to accept. These adjustments were most certainly fraudulent and are responsible for much of the mess that we are in today.

I can also tell you that I am certainly no "gold bug" (most of these people are certifiable) and do not advocate a return to any kind of a gold standard. I do believe that the market, rather than the FED, should be allowed to set the interest rates. I also believe that the other major currencies of the world (Euro, Pound, Japanese Yen, etc.) should be recognized as legal tender in the U.S. Having multiple currencies used in the U.S. provides a competitive marketplace in currencies and, thus, reduces the monopoly power of the FED or the Federal government to manipulate the value of money for political expediency.

I have far more confidence in markets than I do in any government or any monopolistic institutions like the FED. Centralization of any kind is bad because it increases, not decreases, the risk of systemic failure.

Posted by: kurt9 on March 15, 2008 1:08 AM

To: Kevin Cure - You wrote "...but we certainly have no control over bad harvests or the whims of OPEC..."

If you think our energy woes are the fault of the 'whims of OPEC,' please exclude yourself from policy-making sessions with the government.

Posted by: Don McArthur on March 15, 2008 8:33 AM

Cure, do you believe the 2-plus percent increase in SS benefits we received this year even begins to cover the actual inflation we experienced last year? I am talking about the real world, not the abstract one of economists.

Posted by: Richard S. Wheeler on March 15, 2008 9:58 AM

Allowing any (or at least a multitude) of currencies to be used as legal tender isn't a terrible idea, but it flies in the face of a theory called Optimal Currency Areas. Basically, you want an area hit by the same shocks to be covered by the same monetary policy. The US roughly fits this bill, so having just one currency allows the central bank to moderate inflation and recessions, which has unquestionably happened over the last 30 years.

The energy problems might not be due solely to OPEC, but they're definitely not something that can be controlled by a central bank. You need to remember that central bank policy is independent from federal govt. policy, so there's nothing we can do if, say, the federal govt. doesn't want to invest in renewable energy. In fact, I'm technically not even a federal employee!

Last year's SS adjustment was 2.3%, but that was based on Quarter 3 2006-Q3 2007. Next year's adjustment will be a bit higher given what's happened to food and energy. Most economists would say CPI is still biased *downwards* due to its treatment of new goods, so SS increases tend to cover *more* that just cost-of-living increases. Everyone buys different sets of goods, and CPI is based on the "average consumer", so it's possible you're hit harder by inflation than the average. But stats are stats, man; I don't see any conspiracy here.

Posted by: cure on March 15, 2008 1:08 PM


Actually, I get all my asset-bubble tips from the shoeshine boys at the Council on Foreign Relations [PDF]. Benn-with-two-N's might call himself "Director of International Economics," but we all know his "office" is right outside the lobby. He might not know much about 16th-century Spain, but he'll sure take the scuff off your wingtips.

As for CPI, it is an average of prices. Who decides what prices go into the basket, and how they are weighted? Some guy in Washington. Is there any conceivable "objective" or "scientific" reason to prefer one set of prices and weights over another? For example, to prefer the Carter-era CPI to the Boskin Commission CPI? Or either to the PPI, the CRB, the Dow Jones, the Baltic Dry, or for that matter the price of gold? All of these are average prices. They all represent goods that someone buys. And they are all quite different from each other.

Speaking of the latter: when you describe anything as being in a "bubble," what you mean is that its price is too high. By "price" we mean of course the exchange rate you mention, the dollar-gold ratio. This fraction can of course be seen from the other direction, which tells us that what you're saying is that the price of the dollar in gold is lower than it should be.

And perhaps you're right. There is certainly a large and liquid market between these two goods. If you are interested in "going short" and do not know how to put on the trade, drop me an email and I'll give you some pointers.

Is gold "worth" $1K/oz? I dunno, but that's what it trades at. Are a thousand of your employer's little green slips of paper "worth" 31.1 grams of element 79? Frankly, I find this at least as puzzling. But surely the principle is the same.

Civilized societies throughout history have always overvalued at least one good, generally referred to as "money." If you don't understand the economic principles that determine this choice, perhaps now is a good time to learn them. You'll find that while there is much disagreement on the subject, most authors agree that "money" should be a good in limited supply.

Ahem. I do hope you and your employers enjoy the journey to Dr. Bernanke's "lower bound." Is AmeriZIRP far away? When "75 is the new 25," it can't be all that far. And if you ever do decide to pull the price of your paper back up, there's a Mr. Volcker who has just the fix. I am very confident that 20% short rates would get the ol' buck back up to 100 milligrams. Maybe even 200 milligrams. Try it! I dare ya. I double-dog dare ya...

And if you have trouble abandoning your attachment to meaningless averages rather than actual, market-determined prices, try Mr. Rothbard on the subject. Personally, I think Rothbard is mistaken to even talk about the "PPM" and assign it an acronym. This non-variable doesn't even deserve that. Suffice it to say that anyone who plugs it into a model might as well be plugging in the price of plums in Persia, another variable which I suspect will generate all the spurious correlations you require in your quack profession, and which has the benefit of being an actual market price rather than a computer-generated fudge factor. (Try going through your papers and replacing "real" with "fudged" and "nominal" with "actual." Genuine economics in four clicks of the mouse.)

Actually, the Fed does have an important role in our society: it exists to ameliorate the problems it causes. In this it is no different from a hundred other self-licking ice-cream cones in the lower Potomac basin. Perhaps one day we'll be able to restore the fine wetlands that once thrived in this region.

As for your modeling skills, why should they be wasted? You could always go back to school and become a geologist. I hear they're making bank these days - no pun intended.

Posted by: Mencius on March 15, 2008 1:58 PM


The problem is that the FED has been the cause of all of the problems that it is supposed to "solve". The FED created the stagflation problem in the 70's as well as all of these bubbles we have had since the mid 90's. This is a problem common to central banks elsewhere. The Japan bubble of the 80's was an intentional creation of the Finance Ministry and the BOJ. Same for the bubble and subsequent collapse (currency crisis) in S.E. Asia during the 90's.

Central banks are more problem than they are worth. All centralized human institutions cause more damage than they create in value. The reason is simple. There are no perfect people in the world. If I go out and start a business and fail, the damage created by my failure is limited to those who were connected to me. When you create a centralized institution (whether it be a bank, government, or a religion) that no one is allowed to stand free of, and the people who run that institution screw up, everybody ends up taking it in the shorts. This is the single best argument for why any kind of centralized institutions should never be allowed to exist in the first place.

The reason why I believe we should have competing currencies is specifically because it will reduce the FED (or any other central bank) ability to manipulate the value of money for political expediency.

Posted by: kurt9 on March 15, 2008 3:01 PM

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