The Realities of 2% Inflation

I have read so many articles by Ritholtz , Melduke and others how the official core inflation numbers spawned by our government are flat out false. Truth be told, the numbers are accurate. What the disbelievers sense but don't get is how these numbers are compiled.

I'm not going to breakdown the components; rather take an overall simplistic view to explain the emotional opinion and rational realism.

Food, clothing, transportation, electricity, gas and every other consumable component that goes into core inflation and the CPI (o.k., exclude food and energy from core) have been rising for a protracted period of time. Housing, computers, 'iPhone' and all durable goods and assets (none consumable assets) have been declining in value. When you put the two together, they tend to cancel out each other to the realm of a 2% increase per year.

The problem that our friends are emotionally experiencing but not verbalizing very well is that rationally if at the same time that your consumable items keep costing more, your durable assets decline in value, then the 2% doesn't do you any good because you can't eat (consume) your house. Now if the tables were turned and your durable assets were to appreciate while your consumable inputs decline, then all would think that even a 4% core inflation rate was baloney and would be screaming that the government is lying. This time though, they would all be screaming from the top of tall buildings that there is deflation and no inflation. At least that is how it would feel.

This may not alleviate the pain, but it at least explains why the retail and specialty retail sectors have been hard hit over the past six weeks. Wall Street gets it. The current 'low' 2% core inflation is forcing a consumer consumption reduction. If it costs you 10% more to live yet your house declined by 8%, there may be only 2% inflation but you have 10% less to spend, not 2% less.

This is not how inflation is calculated (I'm not that daft!), just using this analogy to explain the difference between consumable components and durable components in the core and none core inflation figures. Until consumable components start to decrease, there is still a chance for a recession. With the dollar falling to new lows, being that many consumables are imported, the likelihood of consumable inflation spiraling upwards increases. I dare to say that the only offset is an even bigger decrease in durable components.

The market has punished just about all the retailers collectively though not equally as it is hard to predict which players in the discretionary spending segments will fair better than others. Dress Barn (DBRN) is currently in good company. Knowing this can help investors navigate their way through the retail and specialty retail sectors, selecting companies that are undervalued due to the collective punishment. The key is to find the companies that do not maintain revenue levels at the expense of profits. Lower revenue coupled with higher profits is acceptable as well.

Look at the bright side: INFLATION IS UNDER CONTROL!

Comments

[benesposito:]

Good point.

2007 Oct 11 09:27 AM

[User 64349:]

Inflation numbers only make sense when disposable income is taken into consideration. If 90 percent of what you can afford to buy, or must, buy are consumables your individual inflation is sky high.

Inflation affects real people. Get Real!

2007 Oct 11 11:45 AM

[CrossProfit:]

User 64349 and Ernie Montague,

1) If you go to the CrossProfit site, you will see on the original article "Alternative Titles" that further explains the closing sentence. We agree with SA's strict editorial policies and the editor was correct in omitting this.
2) From $35,000 in 1967 to $1.2 million in 2007 sounds like a lot. For the real numbers, see link below. Basically the old adage "the rich get richer as the poor get poorer" is correct.
See: goofyblog.net/historic.../

CrossProfit

2007 Oct 11 06:56 PM

[erniem:]

I wish inflation were under control. The end result of the present trend is CHEAP consumer goods made in China propping up the core, and housing and energy prices putting every middle class American further in the hole.

Or perhaps someone can tell me how a house that cost $35k in 1967 is now worth 1.2 million dollars?

2007 Oct 11 04:00 PM

[ritholtz:]

I do not understand your math:

Housing up over 50% over the past 7 years (higher in some areas);

Medical care up 11% per annum for the past umpteen years.

College costs up over 7%+ per year. Insurance costs rising rapidly.

Dairy is up nearly 100% over the past 18 months,

Beef prices up almost as much.

The CRB index has reached an all time high, with Soybeans, Corn, Wheat all breaking records.

In 2001, Oil was in the teens, and now its over $80.

Timber, aluminum, steel, copper all have gone way way up, breaking record highs.

Yes, iPods and plasma tvs are cheaper, thanks to manufacturing economies of scale as these became mass market products.

But these fun items hardly cancel out all of the goods and services that have risen so significantly in price. Especially when you consider these are items people need -- not discretionary wants . . .

2007 Oct 11 11:31 PM

[Pcatlow:]

The only thing the article misses is WHY do consumables exclude the MOST consumed items!!?????????????? Let's just take one consumable (YES WE CONSUME A TON OF IT): energy components - - diesel, gasolene, etc. Well, those components are items that we consume that affect everything we do in this culture. You will be hard-pressed to find anything that is not affected by this single component. And, those who have government pensions -- well their inflation adjustments simply cannot keep up with the TRUE inflation of these consumables. The government bullshits us and the market laughably enjoys the ride.

2007 Oct 12 11:05 AM

[gordon:]

The only thing I am "emotionally experiencing" is your stupidity. In your own words, you can't figure out those non-durables " declining in price " are items NOT REPLACED THAT OFTEN.

2007 Oct 12 01:26 PM

[gunnersbury:]

Sobering.

2007 Oct 12 02:26 PM

[TraderMark:]

Sorry I could not get past paragraph 3 where the author writes "housing" has been declining in value. For anyone with a timeline over 6 months you will know this is clearly not true save for Michigan. If housing doubles in some markets in 5-6 years then drops 25% in next 2 years, its still up a HUGE amount over a the 7-8 year period and thus its major inflation.

Sorry, Ritholtz et al is right. This is why there is so much unease in the middle class - if every weekly check there is X% more spent on gas, home heating/air conditioning, and food, ALONG with the housing payment (which has been going up most of the past decade) those line items are 50-70% of MOST people's incomes. That's what matters to the bottom 75% of America.

2007 Oct 15 10:53 AM