Mauldin - Where's the Beef? "Lies, Damned Lies, and Statistics"

by John Mauldon
Mauldin Economics
Outside the Box
May 5, 2016

I have long been a critic of government inflation statistics. Not so much with regard to the methodology they use, but because the measure of “average” inflation across the broad economy doesn’t really describe the inflation that the majority of Americans experience. I’ve written about that at length in several letters.

Now my good friend Ron Arnott, along with his associate Lillian Wu, presents us with a research paper that lays out what inflation actually looks like for most Americans – and the picture is not pretty. The authors demonstrate that inflation in the main four categories – rent, food, energy, and medical care – has been running at roughly 3% since 1995, significantly more than the 2.2% the BLS data yields – especially when you think about the compounding effect. In the 20 years since ’95, that 0.8% differential has compounded to over 20%, which has to be deflated against incomes. When you look at the stagnant income growth of the middle class and then reduce that income by 20%, rather than by the official inflation rate, it is not hard to grasp why significant majorities in both political parties are pissed off (to employ a technical economics term). Quoting from Rob and Lillian’s paper:

Since 1995, households have expected inflation to be, on average, 3.0%, whereas realized inflation has been around 2.2%, leaving an inflation “gap” of almost 0.8%. What explains this gap? The following is our hypothesis. The four “biggies” for the average American are rent, food, energy, and medical care, in approximately that order. These “four horsemen” have been galloping along at a faster rate than headline CPI. According to the BLS definition, they compose about 60% of the aggregate population’s consumption basket, but for struggling middle-class Americans, it’s closer to 80%. For the working poor, spending on these four categories can stretch to as much as 90% of total spending. Families have definitely been feeling the inflation gap, that difference between headline CPI and inflation in the prices of goods they most frequently consume.

This paper is one of the most powerful indictments of central bank policy that I have read in a long time (even if the authors didn’t intend it to be that). It reinforces my contention that the models central banks create and the data they base those models on are inherently flawed. And those flaws are compounded because the banks’ manipulation of interest rates (the price of money) is perversely doing the opposite of what they think it should do. This is going to cause more mischief and economic pain during the next recession than any of us are prepared for or can even imagine. Seriously, we’re going to have to restructure our expectations and strategies for our portfolios to deal with what I think is developing into a policy error of biblical proportions.