Thursday, January 26, 2006
For those wondering what Alan Greenspan's gift to the world is, rest assured, non-inflationary growth it is not. Growth has been anything but non-inflationary in recent years, but then, it all really depends on how you define inflation.
While the phrase seems to roll off the tongues of supply-siders almost as easily as "tax cuts", the words "non-inflationary growth" seem to be falling on the deaf ears of much of the middle class and many senior citizens.
The White House appears to be confused by two conflicting sets of data - economic statistics showing that all is well, juxtaposed with polling data indicating that people are not happy with the economy, or the management thereof.
This topic was addressed here a short time ago in Fool Me Twice...
While conservative lawmakers and pundits urge the White House to trumpet robust economic growth with nary a whiff of inflation, political strategists urge caution knowing that GDP means little to those who, today, struggle to make ends meet, and in November will cast ballots.
The chart below shows what policymakers and monetary authorities would like people to think of when they think of inflation - the operative word is benign. After a decade of wild price increases in the 1970s, inflation has been tamed, and that's just the way it is.
While the non-inflationary growth story may be a hit on Wall Street, it is receiving poor reviews on Main Street.
Having poked at the raw data for nearly a year now and having seen how it is cajoled and prodded to answer two percent when queried for the monthly increase in prices, it is clear that the reporting of inflation is the biggest fraud perpetrated on the American people since the mysterious decoder ring in A Christmas Story yielded the disappointing secret, "Be sure to eat your Ovaltine".
For the best example of how non-inflationary growth has been anything but non-inflationary, recall the announcements from last fall when Social Security recipients were informed of their cost of living increase and new Medicare insurance premiums were revealed.
The Kaiser Family Foundation has a summary here - the math isn't that complicated:
Other issues related to the underreporting of rising medical costs in government inflation statistics were covered in detail last fall - Open Enrollment and the CPI - Part One and Open Enrollment and the CPI - Part Two
Yes, productivity has improved around the world and there is excess capacity in Asia, but two important changes have occurred in the last twenty years that make the above chart very misleading - changes to the calculation of inflation and the importing of low-cost goods from around the world, most notably Asia.
From Home Ownership Costs and Core Inflation last year, the chart below shows the impact of having removed home prices from the consumer price index in 1983. In the last few years, as home prices have become completely disconnected from rental costs, reported inflation seems ridiculous.
Click to enlarge
While it is true that real estate is an asset, it is also a cost that is paid by consumers. It is affected by many variables, but when you think about it, it shares many qualities with durable goods - purchased infrequently and paid for over time. Using the rise in real estate prices instead of the rent substitute, consumer prices come out roughly three points higher than that reported by the BLS.
Quality adjustments also put downward pressure on prices - this began in a big way in the 1990s when claims of "inflation is overstated" were being tossed around Washington as congressmen grappled with cost-of-living increases for Social Security recipients.
While quality improvements should be considered when calculating price increases, because a washing machine has more knobs and buzzers does not necessarily mean that it is any better if all you want to do is wash your jeans.
The biggest factor in reportedly Benign Inflation in recent decades has everything to do with low-cost goods imported from Asia. These falling prices (think Wal*Mart) have done a neat job of offsetting rising costs for services in America.
The chart below tells this story for the recreation category within the CPI - falling prices for imported goods offset price increases for U.S. based services. Not surprisingly, the overall rise in prices for this category is, on average, about two percent a year (a seemingly magical number - Two Percent Inflation).
Click to enlarge
When your trading partner has lower production costs and you amass huge trade deficits because you import so many of their goods, currencies are supposed to adjust (causing upward pressure on the price of imported goods) to balance the currency-trade relationship.
When this rebalancing does not occur, prices stay low while trade deficits mount.
That is exactly the situation in world trade today - low price pressure from Asia that U.S. policymakers take full credit for, while at the same time repeatedly asking China to revalue their currency to quell the fears of a labor market that continues to hemorrhage manufacturing jobs.
And, now white-collar jobs too.
No, non-inflationary growth is not Alan Greenspan's gift to the world.