Chief Investment Strategist, The Freeport Society
“It’s not what you say, or what the chair says. It’s what did they hear, and what did they want to hear.”
Captain Obvious, who typically goes by the name of Austan Goolsbee – the Chicago Fed President – hit the nail on the head with that comment.
Based on investors’ reaction to the recent Fed announcement, Goolsbee said that market may have misunderstood the central bank’s intended message.
They sure did.
But the misunderstanding isn’t one-sided. The Fed itself seems to misunderstand the depth and breadth of the inflation ravaging everyday Americans. If it isn’t misunderstanding, then it’s willful blindness.
The inflation numbers the Fed uses to determine its policy are a lie. My good friend, Rodney Johnson of HS Dent Publishing, recently penned an interesting piece discussing this very thing. With his kind permission, I’m sharing this with you today.
Over to you, Rodney.
– Charles
I was a huge fan of Gary Larson’s single-panel comic strip, The Far Side.
Most of these comics were clever, some were downright hilarious, and a few became memes before memes were a thing. The one of a kid desperately trying to get into the Midvale School for the Gifted by anxiously pushing on a door marked “PULL” might be the most famous.
But I also like the one in which a woman is driving and her side mirror shows a giant eyeball with the warning, “OBJECTS IN MIRROR ARE CLOSER THAN THEY APPEAR.”
The government recently reported falling inflation, which made investors cheer, but consumers don’t share their enthusiasm. It could be that waning consumption reflects that inflation on goods has outpaced income by a bit. Or, it could be that inflation has outpaced income by a lot.
When it comes to prices on goods, they can be much higher at the store than as included in the Consumer Price Index (CPI). It all comes down to hedonics.
In general, hedonics is the study of pleasant and unpleasant sensations. In economics, hedonic regression is a way of “estimating the influence of various factors on the price or demand of a good or service.” In other words, it’s about trying to discern how much of the overall cost of a good, like a television, can be attributed to each of its features so that the cost of a new model can be compared to older models (this is an actual example on the U.S. Bureau of Labor Statistics [BLS] website).
The BLS estimates how much of the total price of a television is attributable to its screen quality, speakers, connections, remote, etc. The newest version, with more features, might cost $1,250, whereas the old version, which is no longer available, might cost $250.
On the face of it, the newest one costs $1,000 more than the old one, or 400% more, but if the BLS adjusts for the quality difference, the newest television actually costs 7% less than the old one.
Instead of experiencing 400% inflation, the BLS estimates that consumers spent less to get the new television with all the improved features, and therefore experienced 7% deflation… that is, on paper at the BLS and as a part of CPI. At the store and in your pocketbook, you spent $1,000 more money.
The thing about hedonic regression is that it doesn’t ask if consumers think they are better off or even if they had a choice. Most new televisions have built-in microphones. If I cannot get a television without a microphone, then the BLS will count it as an upgrade and adjust the cost of the no-longer-available television higher, even though it no longer exists.
That leads to another problem: What if I don’t want the new features? What if I don’t care about televisions having microphones or would rather have a television without one?
Tough luck. In the eyes of the BLS, we experienced the bliss of 7% deflation, even though we had to spend $1,000 more to get it.
As you check items off your Christmas list and are stunned at how much more things cost compared to previous years, don’t worry. The BLS can show you in their hedonic calculations where inflation is quickly falling. Even if you can’t “save” their calculations in your checkbook or at the store, at least you can feel better while shelling out for improved features that you probably didn’t want.
– Rodney Johnson
* Rodney has spent two decades researching how people spend money in predictable patterns, and then using that knowledge to estimate how our economy and financial markets will change in the years ahead. He began his career in financial services on Wall Street in the 1980s. He started working on projects with Harry in the mid-1990s. He’s regularly appeared on radio shows across the country and has also been featured on CNBC, Fox News, and Fox Business, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University & Southern Methodist University.
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