Streetwise
Lauren Rudd
Sunday, August 24,
2008
Inflation Is Not A Surprise
A recent newspaper headline, in bold
print, read, “Inflation leaps unexpectedly.” Yes, inflation is rising rapidly
but it was not unexpected. The Federal Reserve has made it clear that the
weakening economy and credit debacle take priority over inflation.
Under former Fed Chairman Alan Greenspan, the specter of
deflation and the desire to be “accommodating” were both the tunes of the day
and an encouragement towards future inflation. With all due respect to Fed
Chairman Ben Bernanke, he should be paying closer attention to Dallas Federal
Reserve Bank President Richard Fisher.
Fisher has dissented at every Fed meeting by pushing for
higher interest rates and tighter monetary policy. Fisher’s opinion, and one
with which I strongly concur, is that the Fed must not squander the public’s
trust to keep inflation at bay.
Unfortunately, the inflation genie left the bottle long ago.
Even more distressing is that the government’s data and statements on inflation
understate the problem, despite the fact that producer prices are up over 9
percent, while consumer prices are up 5.6 percent.
One way to put a positive spin on the bad news is to only
consider the core inflation rate, thereby removing food and energy prices.
Unfortunately, it is the rapidly rising cost of food and energy that has
resulted in a lower standard of living for many households. For example, retail
food prices are already up 6 percent this year.
Yet, even within the core rate there are ways to play with
the numbers. For example, shelter costs can downplay the true picture of
inflation and they account for a full 33 percent of the CPI.
Back before 1983, the actual costs of home ownership were
used to calculate the cost of shelter. During Ronald Reagan's first term
something called, “owners equivalent rent” replaced actual housing costs. This
purports to measure what homeowners would have to pay if they rented their home
to themselves. In the 25 years since owners' equivalent rent came into
existence, shelter costs never rose more than six percent.
Maybe if the CPI had reflected the true upward spiral of
housing costs a few years ago the Fed would have acted to increase interest
rates and thereby prevent the housing bubble and subsequent credit crisis.
Then there is the substitution issue. Suppose you substitute
a cheaper good for a more expensive good. For example, you buy hamburger instead
of steak because it is cheaper. Does that indicate lower inflation? In general,
the government says yes. Taking it to the extreme, suppose people substitute
bicycles for automobiles because of gasoline prices, is that a drop in
inflation?
Any increase in the CPI means increased budget deficits due
to higher transfer payments, specifically social security, along with cost of
living allowances for government employees. Therefore, a rising CPI does not sit
well with Congress or the Administration. Need I say more?
So what do you do to battle the inflationary spiral? Short of
lowering your standard of living, you have only two choices.
You can raise your income, which is going to be somewhat
difficult. Corporations are dealing with inflation through lowered wage costs
and increased productivity.
Translated, you are going to have to work harder for the same pay...or less. Now
there is a cheerful thought.
Actually, be thankful if you have a job because many are less
fortunate. Furthermore, the unemployment statistics understate true unemployment
because they do not count those that have given up looking or have been forced
to become self-employed, but that is a topic for another time.
The only other solution is to increase your wealth and purchasing power by
investing in equities. Now I know that answer did not surprise you. Stocks rise
in value for many reasons, including rising inflation. So which stocks should
you buy in today’s economic environment. We will again tackle that problem next
week.
