Many people point to speeches by Federal Reserve "mandarins" in wonder. The Fed claims that "inflationary expectations" are "well grounded" and the consumer price index (CPI), as calculated by the US Bureau of Labor Statistics (BLS), shows there is more room for monetary easing. In other words, the Federal Reserve is telling us that there is "no inflation", even though it conflicts with what most of us are seeing in our day to day lives.
This idea has been expressed repeatedly by Chairman Benjamin Bernanke, his Vice Chair Janet Yellen, New York Fed President William Dudley, and many others. Yet, for anyone who lives and purchases goods and services in the real economy, it is hard to swallow. Inflation seems to be pervasive. We are seeing it in our food, our medical bills, our gasoline, car rental prices, hotel prices, and just about everything else, except home prices.
John Williams, the proprietor of a website, shadowstats.com, attempts to explain the conflict by saying that the consumer price index formula has changed over the years. According to him, it has become more subjective and, therefore, subject to manipulation by those who have an interest in understating the true inflationary reality. According to him, BLS has added highly inaccurate methodologies, such as the so-called "hedonic" quality measure and "product substitution", that corrupt the CPI calculation.
By using an older, 1980 government formula, Williams takes the same base data, gathered by the BLS, to compute CPI at 10.3% per annum. This, of course, is very useful to compare the inflation we are experiencing today, to what the nation actually experienced back in the 1970s. By using the same formula, we can compare apples with apples, rather than apples with oranges. A rate of 10.3%, as calculated by the 1980 formula, was considered unacceptably high back then. So why is it OK now?
Mr. Williams' allegations are bolstered by recent data about the level of producer price inflation being experienced by large manufacturers, as compared to the level of producer price inflation claimed by the BLS. For example, the BLS has calculated producer price inflation at about 4.1% for 2011. Meanwhile, General Mills, which buys a wide variety of the same crude products that BLS claims to be tracking, said inflation ran at a rate of 10 to 11% in 2011.
Adding to the chorus is the American Institute for Economic Research (AIER). The organization maintains an index that it calls the "Everyday Price Index" (EPI). This reflects prices of goods and services that people tend to buy frequently, such as food, utilities, and fuel. That stands in contrast to the CPI calculated by BLS and shadowstats, which both include housing. Some people claim that emphasizing everyday products creates a more accurate measure of the cost of living. The argument is that people buy houses rarely, so that the rising or falling cost of things like meat impact life more profoundly.
According to AIER, the EPI increased by 4.1% during the period March 2011 and March 2012. The BLS CPI registered an increase of 2.7%, and shadowstats' 1980 government CPI formula registered a 10.3% increase, during the same 12 month period. Both shadowstats and AIER, however, are showing a frighteningly sudden increase in February and March 2012, which is not showing up in the BLS index.
The EPI accelerated to 1.9 percent in March alone. This translates to roughly 22.8 percent on an annualized basis. In February, the EPI showed a 1.1 percent increase, annualized to 13.2% in February. Much of this increase is coming from fast-rising fuel prices, but another large part is arising out of food prices. According to the official government numbers, however, after "seasonal adjustment", March inflation ran at just 0.3% or 3.6% annualized.
Who should we believe? If the official CPI formula from 1980 is correct, shadowstats.com is showing us that we are now experiencing annualized stagflation of 10.3%. AIER's formula, which apparently utilizes some but not all of the subjective statistical measures of the BLS, is telling us that inflation was previously higher than desirable but not out of control. According to the EPI, we are first entering heavy inflation, and, if such spikes were to get worse, possibly hyperinflation. If we believe the government, however, inflation is not a problem and everything is coming up roses.
Given the correlation between General Mills' (GIS) data and the government CPI formula, the most accurate read is likely to be shadowstats. Unlike AIER, which measures the prices of things that we buy often, the 1980 government formula includes all the same components as the current official CPI. It simply omits subjective and inherently inaccurate BLS methodologies like "hedonic adjustment" and "product substitution".
Even if the consumer inflation rate is not yet quite at the level reported by shadowstats.com, it will assuredly get there soon. Producer prices are clearly far in excess of what the BLS is reporting, and consumer prices will always eventually reflect the cost of goods sold. We appear to be in the midst of a period of intense stagflation. The intensity will probably increase quickly, as faith in the US currency and its use as the primary means of international settlement progressively diminishes.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.