With the release of last week’s Consumer Price inflation numbers, the debate over the accuracy of the government’s reported Consumer Price Index data was once again front and center. The official numbers showed that the overall rate of consumer inflation rose .2% while the over-hyped core rate rose just a paltry .1%.
However, these incredible April numbers were the result of a seasonal adjustment that removed much of the increase in gasoline prices. Unbelievably, the report claimed that consumer’s energy costs were unchanged while the actual price of crude oil rose about 12.5% and gas prices rose 11% during the same period in question—that’s some adjustment!
One of the reasons it is imperative to accurately calculate inflation is that you need a true reading on price increases in order to get a true reading on economic growth. If we used an accurate inflation rate to deflate nominal G.D.P. it would have certainly settled the argument as to whether we or not the economy is in recession. Since most investors are bound by official government data, I thought it would be worthwhile to use the Consumer Price Index to derive real G.D.P. rather than the chain type price index—which is an even more tortured inflation measurement than the C.P.I. The reason why the C.P.I. is a better estimate of inflation than the chain type price index is the chain type index allows substitution between categories, while the C.P.I. is limited to substitution within a specific category.
The following graphs show G.D.P. growth rates using the chain type price index, annualized quarterly growth rate in C.P.I. and the year over year growth rate in C.P.I.
| |
Nominal G.D.P. |
Chain Type Index |
Real G.D.P. |
| Q1 - 2008 |
3.2% |
2.6% |
0.6% |
| Q4 - 2007 |
3.0% |
2.4% |
0.6% |
| |
Nominal G.D.P. |
C.P.I. Annualized Growth Rate |
Real GDP |
| Q1 - 2008 |
3.2% |
2.8% |
0.4% |
| Q4 - 2007 |
3.0% |
5.6% |
-2.6% |
| |
Nominal G.D.P. |
C.P.I. Year Over Year Growth Rate |
Real G.D.P. |
| Q1 - 2008 |
3.2% |
4.1% |
-0.9% |
| Q4 - 2007 |
3.0% |
4.0% |
-1.0% |
Using the government’s data on year-over-year inflation growth rates instead of chain, the recession began in Q4 2007 and the last two quarters produced negative real G.D.P growth rates. I hasten to add that investors know this; they experience real-world inflation everyday and know actual economic growth is much weaker than reported. And I’m not even using a more realistic rate of inflation, just the understated, “official” gauge that is the C.P.I.
The two most important takeaways from this are that
A) the economy is much slower and
B) inflation is much higher than what is generally accepted. And it is that misconception that provides investors with the ongoing investment opportunity in real assets.
*I discuss this and more on my podcast, The Mid-Week Reality Check!
