Most Americans Experience 0.8% Higher Inflation Than Reported by John Mauldin, Mauldin Economics

I have long been a critic of government inflation statistics. Not so much about their methodology, but because the measure of “average” inflation across the broad economy doesn’t really describe the inflation that the majority of Americans experience.

I’ve written about that at length in several letters.

Now my good friend Rob Arnott, along with his associate Lillian Wu, presents us with a research paper that lays out what inflation actually looks like for most Americans—and the picture is not pretty.

In my recent Outside the Box, the authors demonstrate that inflation in the main four categories—rent, food, energy, and medical care—has been running at roughly 3% since 1995, significantly more than the 2.2% the BLS data yields, especially when you think about the compounding effect.

That 0.8% differential has compounded to over 20% in the 20 years since 1995, which has to be deflated against incomes. When you look at the stagnant income growth of the middle class and then reduce that income by 20%, (rather than by the official inflation rate), it is not hard to grasp why significant majorities in both political parties are pissed off (to employ a technical economics term).

This paper is one of the most powerful indictments of central bank policy that I have read in a long time (even if the authors didn’t intend it to be that). It reinforces my contention that the models central banks create and the data they base those models on are inherently flawed.

And those flaws are compounded because the banks’ manipulation of interest rates (the price of money) is perversely doing the opposite of what they think it should do. This is going to cause more mischief and economic pain during the next recession than any of us are prepared for or can even imagine.

Seriously, we’re going to have to restructure our expectations and strategies for our portfolios to deal with what I think is developing into a policy error of biblical proportions.

And on that happy note, I think I will just go ahead and let you read Rob and Lillian’s essay without further comment.

Where’s the Beef? “Lies, Damned Lies, and Statistics”*

By Rob Arnott and Lillian Wu

The price of beef has been soaring over the past five years – up 80% cumulatively at the end of December 2015 – but you’d never know it by looking at the official U.S. Consumer Price Index (CPI), which is up 7%, or 1.4% a year, over the same five-year span, and therein lies our beef. The developed nations of the world, are supposedly living in a low-inflation environment, at risk of tipping over into the abyss of deflation. That’s what the folks at the U.S. Bureau of Labor Statistics (BLS) tell us. And they should know, right?

Well, maybe not. Surveys suggest that the average American’s daily experience may be quite different. One-year consumer inflation expectations have been consistently higher than trailing and realized inflation over the last 20 years, and higher than more recent market-based inflation expectations, measured by one-year swap rates. Figure 1 shows how this divergence has grown larger since the financial crisis, suggesting the average household might have been feeling even greater pain during the recovery process than has been believed.


Consumer Inflation Expectations vs CPI-U & 1-Year Inflation Swaps

Since 1995, households have expected inflation to be, on average, 3.0%, whereas realized inflation has been around 2.2%, leaving an inflation “gap” of almost 0.8%. What explains this gap? The following is our hypothesis. The four “biggies” for the average American are rent, food, energy, and medical care, in approximately that order. These “four horsemen” have been galloping along at a faster rate than headline CPI. According to the BLS definition, they compose about 60% of the aggregate population’s consumption basket, but for struggling middle-class Americans, it’s closer to 80%. For the working poor, spending on these four categories can stretch to as much as 90% of total spending. Families have definitely been feeling the inflation gap—that difference between headline CPI and inflation in the prices of goods they most frequently consume.

Since 1995, the average year-over-year inflation rate for energy has been 3.9%; for food, 2.6%; for shelter, 2.7%; and for medical care, 3.6%. If we strip out all other items and recalculate the index based exclusively on these four components, we find the average rate has been about 2.9%, right in line with households’ expectations. Let us be provocative. If inflation – as experienced by the average American – is higher than official BLS “inflation,” then what exactly is the BLS statistic measuring?

It looks like the BLS thermometer is broken! Whatever temperature they show us, the actual temperature is higher as experienced by the average American family. For instance, the reported CPI inflation over the past 10 years ending December 2015 was about 1.9% a year. If we focus on the “big four” over the last decade, the inflation that Americans experienced was about 0.5% more. Let’s call this 0.5% difference a “measurement bias.” Paradoxically, the inflation measures for these four categories are produced by the same people who assemble the CPI. Other sources peg the gap as being considerably larger.

These considerations have a direct bearing on our prosperity. How much real growth, for example, has occurred in the past decade? Officially, GDP has grown 1.4% a year, over and above inflation. Over the same period, the U.S. population has grown by 0.9% a year. Thus, real per capita GDP has risen by a scant 0.5% a year. Subtract the 0.5% measurement bias – probably a conservative estimate – and the average American has experienced zero growth in personal spending power over the past decade. With wealth and income concentration, if the average is flat then median per capita spending power must be lower. Comparing 2015 with 2005, this feels about right. The official statistics do not.

The Great Recession begot a 5% reduction in U.S. real per capita GDP from the peak of 2007 to the trough of 2009. In the wake of the market collapse, major central banks around the world eased monetary conditions in lockstep with the Fed. It took nearly six years for U.S. real per capita GDP to regain its prerecession peak. This herculean task was achieved through massive spending and relentless borrowing from the nation’s current and future income. Has it worked? As always, it depends on whom you ask. We are deeply skeptical of claims that these massive interventions have helped. Real median household income has fallen by 4% since 2007, despite the “recovery” following the Great Recession! Comparing today to 1970, Figure 2 shows that real per capita GDP is up by 110% – more than doubling over the last 45 years! Yet, the median American has experienced less than one-fifth of this growth.


Middle-class Americans are struggling, as are middle-class Japanese and Europeans. Easy money, asset purchases, and negative interest rate policies of central banks across the developed world are intended to ignite the “animal spirits” of the private sector. Are they instead stifling economic

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