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The CPI and Three-Card Monte


All of the focus on the CPI by the Fed and its charlatans is nothing more than a game of economic Three-Card Monte.

The March 2007 CPI Numbers are in.

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.3% (3.3% annualized rate) in March.

Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers rose 0.6% (7.5% annualized rate) in March. The CPI less food and energy rose 0.1% (0.7% annualized rate) on a seasonally adjusted basis.

Over the last 12 months, the median CPI rose 3.5%, the 16% trimmed-mean CPI rose 2.8%, the CPI 2.8% and the CPI less food and energy 2.5%.

The Devil is in the Details

Below is a chart of the Disaggregated Median CPI Data (the makeup of the CPI by individual components and weightings).

(You can get the complete chart from the link at the top of this page. I stopped the chart on Owner's Equivalent Rent.)

Does anyone care to go through this line by line? Are the prices of vegetables, hotel lodging, truck rentals, clothes, and watches falling like a rock? Then again what about Owner's Equivalent Rent (OER)?

OER is essentially an estimate of the amount of rent you would collect if you rented your own house from yourself (or to someone else if you prefer). Here is the actual question used in the Determination of OER. "If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?"

Is the amount that people think their house would rent for any kind of valid construct? If that is not an absurd measurement of price in and of itself what is? That single line item has the highest weighting in the CPI with a relative weighting of 24%. The next highest weightings are recreation at 5.5%, medical care services at 4.9%, household furnishings at 4.6%, and motor fuel at 4.5%.

The weighting of housing expenses should be high but what is happening with the OER does not make much sense. When the actual price of housing soared between 2000 and 2005 OER was often dropping. Now that home prices are out and crashing in many places OER is going up.

From my point of view, housing price inflation was dramatically underreported for many years and is now being overstated in the CPI because of the ridiculous way OER is computed. There are other bizarre numbers in this set of numbers even if the weighting is small. Does anyone believe furniture prices are rising? I don't. Does anyone think fresh vegetable prices dropped 19%? I don't.

Just looking at those numbers is a nightmare. For someone with school age kids, education is severely under represented at 3.1%. For a cab driver is motor fuel way under represented at 4.5%? Does entertainment deserve the second highest weighting at 5.5%? For who? What about medical expenses?

Does this mess all average out? Even if by some miracle it does average out from time to time the process itself is flawed given that true inflation is not a measure of a basket of goods and services but an increase in money supply and credit. The latter (for now) is still soaring with all the leveraged buyouts, stock buybacks and debt offerings.

Shills and Three-Card Monte

All of the focus on the CPI by the Fed and its charlatans is nothing more than a game of economic Three-Card Monte. Like the actual card game, the shills and distractions are many: gasoline, hurricanes, oil companies, subprime lenders, insurance, demographics, S&P forward earnings estimates, capacity utilization, terrorism, etc. While the shills rotate consumer focus from one distraction to the next, the real problem is hidden.

The real problem is the US government is spending more money than it is taking in, while the Fed is happy to oblige. The Fed's role is to keep the shills happy by attempting to keep consumers in the game via asset price targeting.

Eventually the "mark" (in this case the US consumer) runs out of money to play the game (buy more houses) but Congress is now stepping into the picture in a blatant attempt to buy votes while keeping the shills (the lenders) happy.

The big difference between "Economic Three-Card Monte" and the actual card game itself is the lapse in time that it takes the mark to realize he was had. It took condo buyers in Florida well over a year to realize what happened. Worse yet, the carnage is still accumulating.

Interestingly enough, global confidence in "Economic Three-Card Monte" is still growing in spite of the subprime housing collapse in the US. The result is all sorts of maneuvers like we have seen lately with corporate stock buybacks funded by debt and with increasingly large LBOs funded in part by "foreign marks" as discussed on my blog in Leveraged Buyout Mania. Meanwhile corporate insiders are for the most part bailing as fast as they can.

Confidence games like these can only go on so long as there is a fresh supply of marks (also known as greater fools). With a March Decline in Real Earnings and Mortgage Equity Withdrawal (MEW) slowing with the decline in home prices, US marks have been harder to come by. Given that the supply of marks is not unlimited, the key question now is: How long will foreign marks keep funding the game (in the US)?
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