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“Let Them Eat IPads”

Written by Lance Roberts | Jan, 3, 2013

Inflation_-_CPI_vs_STA_050311Inflation has been the real debate lately and Nail Ferguson recently picked up on this issue.   “I can’t eat an IPad…” could very well go down in history as the line that launched the great inflation of the 2010s.

Back in March, the president of the New York Federal Reserve, William Dudley, was trying to explain to the citizens of Queens, N.Y., why they had no cause to worry about inflation. Dudley, a former chief economist at Goldman Sachs, put it this way: “Today you can buy an IPad 2 that costs the same as an IPad 1 that is twice as powerful. You have to look at the prices of all things.” Quick as a flash came a voice from the audience: “I can’t eat an IPad.”

Dudley’s boss, Ben Bernanke, was more tactful in his first-ever press conference on Wednesday of last week. But he didn’t succeed in narrowing the gap between the Fed’s view of inflation and the public’s.

Nail stated “I respect Bernanke. As an expert on the financial history of the 1930s, he was one of the very few people in power back in 2008 who grasped how close we were to another Great Depression. But if we’ve avoided rerunning the 1930s only to end up with a repeat of the 1970s, the public will judge him to have failed.”

Of course, this is where the Fed and the general public parts ways.   The Fed points to the all-urban consumer price index (CPI-U) and notes that it was up only 2.7 percent in March relative to the same month a year earlier. Strip out the costs of food and energy, and “core CPI”—the Fed’s preferred measure—is just 1.2 percent.

However, to the average American it is a different story with more than 22% of wages and salaries begin absorbed by food and energy alone and not the price of a shiny new IPad that is the issue.   Why?  Because these are the items that you encounter most frequently and have the most direct impact on the daily budget of your family.  

CPI is quickly losing credibility among the average American.   Economist John Williams tirelessly points out, it’s a bogus index. The way inflation is calculated by the Bureau of Labor Statistics has been “improved” 24 times since 1978. If the old methods were still used, the CPI would actually be 10 percent.  However, not all of the “improvements” to the CPI calculation are bad.   Therefore, we look at an average of the way CPI used to be calculated to the way it is calculated today which is probably the most accurate to the real cost of living that we are experiencing today.   This is because there IS deflation in things like services, home prices and products in our livest which is being offset by rises in the basket of goods that we consume.

However, even that average is starting to reach a fairly painful 6% inflation rate.   This means that money has to grow at better than 6% annually just to outpace inflation.   More than ever it is becoming less and less important to chase an all-equity index like the S&P 500 and focus on preservation of capital and keeping purchasing power parity in tact for retirement funds.   Historically, 6% in capital appreciation came from a strong economic environment that was growing at a little better than 6% annually.  With a current economic growth rate at less than 3% with a dividend yield of 2% – forward capital appreciation expectations are 5% and a NEGATIVE 1% after inflation.    This doesn’t bode well of people planning to retire in the next 10 years.

Maybe in June, when the Fed stops quantitative easing (its program of injecting cash by buying government bonds), inflation will recede. Maybe high fuel prices will, as Goldman Sachs predicts, slow the economy and revive the specter of deflation.

Maybe. “Or maybe inflation expectations started shifting when the guy from Goldman—a Marie Antoinette for our times—seemed to say: let them eat IPads!”

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