The Big Picture: Inflation Rate Tame?

Barry produces a professional blog. His rantings are often supported by charts which show the data. It takes a lot of work to do such an excellent job. I send my thanks and congratulations to him.

In regard to the inflation rate, he is wrong. The traditional CPI index does not capture the true situation in our dynamic economy. We substitute better quality at lower prices all the time. In a comment to the post, Chad states that he believes his personal CPI would show little or zero inflation. Mine might even show a negative rate because I buy a lot of TVs, computers and other electronic devices.

In a few weeks, I will buy my wife a new lap-top. I will pay less than 25% of what I paid for her old lap-top. The new one will be about 1000% better. If one saves $2,100.00 on a computer, the price of hamburgers must go up a lot for the two to break-even at zero inflation.

The reason the PCED is the measure favored by Greenspan is because it captures the substitution effect. The law of substitution is big, but easy to ignore. This law chips away at the cost of almost everything. Consumers routinely make "free" long-distance telephone calls today. There are many more examples.

With the opening of trade, the opportunity to buy the low cost item has expanded. Many times the total savings from substitution are huge but not easily noticed. For example, businesses are saving millions of dollars on lighting by buying lights that do not need to be replaced. In the book titled The Bottomless Well, the author demonstrates that the cost of illumination has declined by 10,000 percent in the past 200 years!

IS THE INFLATION RATE TAME? YES IT IS!

The PCED is running at about 1.6% and the price of oil has recently dropped by 20%. It takes a while for the decline in fuel costs to show up in a decline in shipping costs and thus in the price of many goods. The CPI report was fantastic because it showed no increase in prices. It is fair to ignore volatile food and energy prices if you ignore the big jumps and the big declines. How can anyone honestly hold-out a CPI of .5% as high when they already know that a key component was up to $58 per barrel for just a few weeks. The .5% number is telling us that the price of oil hit $58 during the quarter--old news and irrelevant to current investment strategy.

BUY THE BIG BULL BECAUSE THE FROGS ARE GETTING HOT! (THE FROGS HAVE BORROWED BILLIONS OF DOLLARS OF STOCK AND SOLD THEM--THEY OWE THE SHARES TO THE RIGHTFUL OWNERS)

By the way, a spent a few moments last night explaining to a reader how the Fed "prints" money. It works a lot like short selling. The person who borrows shares to sell have in effect "printed" extra shares--the buyer does not know that they are borrowed shares. The total shares "owned" have been increased by the number of shares sold short. I am nervous when companies are issuing lots of shares but short sellers make me happy--sooner or later they are likely to buy the shares back no matter what the price!