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Why Can't The Fed Recognize The Inflation Disconnect?

Force Democrats
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EDITOR NOTE: Perhaps the clearest way to preface this article is to provide a practical analogy that most of you are familiar with. Suppose you’re looking to move to a new city or town with which you’re mostly unfamiliar. If you use the wrong filter to assess your new location, you may be in for a few unpleasant surprises. Perhaps you'll find stats on your neighborhood’s petty crime rate, but not its violent crime rate (which may be lesser or greater). Perhaps its schools are good, but you’d have to drive an hour away to get the nearest hospital should you need emergency care. Perhaps everything about your new location seems great, but you’re not aware of the underlying “monoculture” which may eventually grate on you. What does this have to do with the article you’re about to read? The Fed seems incapable of seeing, let alone addressing, the inflation disconnect because it’s using the wrong filters (as in the examples above). Home prices have been skyrocketing at an accelerated pace. Yet it’s not included in the CPI--the Fed’s main measure of inflation. However, rent makes up a good portion of the CPI. Homes are not a “consumer expense” but a “capital expense.” But capital expenses provide an important angle on inflation that consumer expenses don’t. There are other examples in the article below. The main point is that what you’re experiencing in terms of rising costs may have no bearing on the Fed’s models. Their models take precedence over your daily economic experiences. And that, in itself, should worry you as inflation is a real, evident, and “underestimated” factor that can have significant negative consequences on your lifestyle and wealth in the years to come.

Home Prices Rise at Fastest Pace in 15 Years

Home prices are running rampant. The national level average year-over-year increase is 11.2%.

Prices have accelerated in the past few months. I discussed the year-over-year acceleration in Home Prices Rise at Fastest Pace in 15 Years

National and 10-city averages do not tell the full story as the lead chart shows. 

Inflation Disconnect

Owners' Equivalent Rent

OER stands for Owners' Equivalent Rent. 

Prior to 2000, home prices, Owners' Equivalent Rent (OER), and the Case Shiller national home price index all moved in sync.

This is important because home prices directly used to be in the CPI. Now they aren't. Only rent is. 

Yet, OER is the Single Largest Component of the CPI with a weight of 24.07%.

In effect, economists substituted rent for home prices in the CPI. Prior to 2000, this did not matter. Now it seriously distorts measures of inflation.

The rationale is home prices are a capital expense not a consumer expense. 

What Should We Measure?

What is it we are measuring or need to measure? 

I suggest we need to measure inflation, not just consumer inflation. 

Home Prices, OER, and CPI Percent Change

Year-Over-Year Percent Changes

  • National Home Prices: 11.2%
  • 10-City Average: 10.9%
  • OER: 2.2%
  • CPI: 1.4%

The CPI allegedly is up a mere 1.4% from a year ago as of January 2021. Let's calculate inflation by substituting home prices for OER in the CPI as it used to be.

I call the result CS-CPI for Case-Shiller-CPI.

CPI, CS-CPI National, CS-CPI Top 10

Inflation Disconnect

Economists claim inflation is up a mere 1.4% year-over-year as of January 2021. 

If we substitute home prices for OER as it used to be (and is far more accurate as well), inflation is up 3.8% from a year ago. 

Having calculated inflation far more accurately than widely believed (yet still understated), we can calculate real interest rates

Real Interest Rates

Inflation Disconnect

To determine "real" interest rates, subtract CPI from the Fed Funds Rate.

  • Real Interest Rate as Touted: -1.31%
  • CS-CPI 10-City: -3.59%
  • CS-CPI National: -3.67%

Q&A

Q: With real interest rates close to -4% is it any wonder asset prices and speculation are booming?
A: No
Q: Why can't the Fed see this?
A: Possibly the Fed can see this. If so it's on purpose. 

The Fed wants inflation and numerous Fed members are openly in praise of it.

Easy Money Quote of the Day: Fed "Won't Take the Punch Bowl Away"

On March 25, I noted the Easy Money Quote of the Day: Fed "Won't Take the Punch Bowl Away"

Numerous Fed presidents made speeches. I awarded gold, silver, and bronze medals for the best "easy money" quotes.

San Francisco Fed President Mary Daly won the gold medal. She said the central bank would show at least “a healthy dose” of patience. ”We are not going to take this punch bowl away,” said Daly.

Does the Fed Understand What They Are Doing?

I don't know. Either the Fed is blindly ignorant of what's going on, or it's on purpose. Take your pick.

The result is a big set of bubbles, whether the Fed sees them or not. 

2% Inflation Target

The Fed's 2% inflation target is monetary insanity.

Full speed ahead with the stimulus in search of inflation that would be visible to anyone who was not wearing groupthink blinders.

I have a set of questions for Fed Chair Jerome Powell on inflation. Please read them: Hello Jerome Powell We Have Questions.

Historical Perspective on CPI Deflations

A BIS study of deflations shows the Fed's fear of deflation is foolish.

"Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive," concluded the study.

For discussion, please see Historical Perspective on CPI Deflations: How Damaging are They?

Japan has tried what the Fed is doing now for over a decade, with no results.

Yet, Powell hell bent on producing more than 2% inflation until the strategy "works".

I discuss numerous ways Powell is on the Bank of Japan's path in Is the Fed Blindly Following Failed Policies of the Bank of Japan?

Originally posted on The Street

All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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