Worries about Inflation: A Chat with Mark
Another month of data shows inflation to be contained while many forecasts for economic growth show a brisk rebound. The stock market made an appropriate response, so a pleasant weekend was in store.
Then the phone rang. It was Mark, a very intelligent investor who does a lot of reading from many sources. Mark was worried about inflation.
Mark: I just read the real truth about those inflation numbers. First the government fooled us by rounding down the increase in the core rate. What a joke! The market did not see that, so it rallied.
Jeff: We have talked about this before. Do you think that because you divided the price index for one month by that of another, you have information that is better than the rest of the market?
M: I read it on a web site. More than one, in fact!
J: And you think that all of the big money traders did not do the calculation for themselves. Or read the same web sites?
M: Hmm. Well maybe they were off in the Hamptons and the "B" team was on duty
J: Or maybe the collective wisdom of the market was that a 1.5% annualized rate of increase was pretty good — better than expected? Maybe it means the Fed is doing something right.
M: Why do you say that? Everyone I read tells me how stupid the Fed is. They created various bubbles and have basically caused the terrible conditions we have now.
J: Would you be referring to corporate profits — at a record with great increases? Or employment? At record lows? Remember what I told you about being a contrarian? It is easy now. You only need to think that the Fed is doing a reasonable job. That seems to put you in the minority.
M: But they do not understand inflation. They use some silly core rate with a bunch of adjustments. I know that my costs are increasing much faster.
J: As we have before, Mark, we come back to measuring the cost of living. Here is the simple version. At any given time, the price of some items is going up and the price of others is going down. Any fair method has to take this into account. It is also possible to substitute things that get cheaper for things that are more expensive. Finally, there are a lot of changes in quality.
J: I understand. When I try to write about measuring inflation, absolutely no one agrees with me. Everyone — all non-economists who have NEVER had the job of actually trying to do this — believe that they know best. They know better than economists who make a career of this. They know better than Congressional Commissions tasked with finding the best measure. I understand. There are some arguments where a writer can appeal to the lowest common denominator and readers will buy it.
But you see — that is an investment opportunity. The Fed is not going to change its view about inflation measures because some bloggers and TV pundits do not understand what they are doing.
M: Barry Ritholtz says that the Fed will lose credibility.
J: The Fed is not worried about their credibility on inflation measures. They are worried about their credibility on containing inflation expectations. That is why we see so many jawboning speeches.
M: I know that you are wrong, because I am watching the Big Mac Index and the Martini Index. Food and energy prices are higher, also. This is real inflation, not the bogus core rate.
J: Part of the reason that food is higher is that our energy policy has driven up corn prices. I wrote about this months ago. But here is a good test for you. We can make a little bet.
M: OK, Jeff, you know I am always up for that.
J: Here is the bet. There are certain websites that always find the worst in the data for any week. This week the core rate was low and the energy prices were high. There will be a time when the core rates will be high, but the monthly change will be lower. I will bet you that the websites you are citing will not point that out for you. Our customary stakes.
M: We need to agree on the sites.
J: Of course.
Here is a bonus —
Let us assume for a minute that energy prices were rising, basically because of OPEC control. What would be an appropriate policy response?
Those writing at various perma-bear websites seem to think that the Fed should hike interest rates. These guys need to review their Econ notes. Tightening rates to kill demand is not a good weapon against cartel pricing.
While the Fed does not discuss it much, the members of the Open Market Committee and their 350+ economists are smarter and more knowledgeable than the bloggers. While they want to control inflation expectations, they are not going to crush the economy in a pointless move against energy prices.
The next time someone wants to give you a lesson about "core inflation" you should think about that concept.