Economists who hold the popular view that expanding the money supply will provide the best medicine for our ailing economy dismiss the inflationary concerns of monetary hawks, like me, by pointing to the supposedly low inflation that has occurred during the current period of rampant Fed activism. In a recent blog post aimed specifically at me, Paul Krugman noted that the sub 2.5% increases in the Consumer Price Index (CPI) over the past few years are all that is needed to prove me wrong. In fact, Krugman and others have even suggested that the CPI itself overstates inflation and that the Fed would be better able to help the economy if less strict methodologies were used. However, there is plenty of evidence to suggest that the CPI is essentially meaningless as it woefully under reports rising prices.
Magazines and newspapers provide a good case in point. The truth has not been exposed through the economic reporting that these outlets provide, but in the prices that are permanently fixed to their covers. For instance, from 1999 to 2012 the Bureau of Labor Statistic’s (BLS) “Newspaper and Magazine Index” (a component of the CPI) increased by 37.1%. But a perusal of the cover prices of the 10 most popular newspapers and magazines (WSJ, Washington Post, Time, Sports Illustrated, U.S. News & World Report, Newsweek, People, NY Times, USA Today, and the LA Times) over the same time frame showed an average cover price increase of 131.5% (3.5 times faster than the BLS’ stats). This is not even in the same ballpark.
Some defenders of the BLS may conclude that prices were held down by the availability of free online news content or the convenience of digital delivery. But that is beside the point. Prior to the digital age, the BLS could have claimed that newspaper costs were held down by public libraries that provided free access. It’s also true that online publications deliver less value on some fronts. Not only do many people enjoy the tactile process of reading physical newspapers or magazines, but they offer the secondary value in helping to kindle fires, housebreak puppies, pack dishes, and line birdcages.
Another stunning example is found in health insurance costs, which is a major line item for most families. According to the BLS we can all breathe easy on that front because their “Health Insurance Index” increased a mere 4.3% (total) in the four years between 2008 and 2012. Interestingly, over the same time, the Kaiser Survey of Employer Sponsored Health Insurance showed that the cost of family health insurance rose 24.2% (5.5 times faster). But even if the BLS had reported higher costs, it wouldn’t have made much of a difference in the CPI itself. Believe it or not, health insurance costs are assigned a weighting of less than one percent of the overall CPI. In contrast, the Kaiser Survey revealed that in 2012 the average total cost for family health insurance coverage was $15,745, or almost one third of the median family income.
If the BLS could be so blatantly wrong in reporting the prices of newspapers and health insurance, should we believe that they are more accurate on all other sectors? If the inaccuracy of these two components were consistent with the rest of the CPI’s components, inflation could now be reported in double-digits!
Even more egregious than the manner in which prices are currently reported is the way that CPI methods have been changed over the years to insure that most increases are factored out. Since the 1970’s, the CPI formula has changed so thoroughly that it bears scant resemblance to the one used during the “malaise days” of the Carter years. Main stream economists dismiss criticism of the changes as tin hat conspiracy theories. But given the huge stakes involved, it’s hard to believe that institutional bias plays no role. Government statisticians are responsible for coming up with the formulas, and their bosses catch huge breaks if the inflation numbers come in low. Human behavior is always influenced by such incentives.
The newer CPI methodologies are designed to report not just on price movements, but on spending patterns, consumer choices, substitution bias, and product changes. In other words, the metrics have been altered to track not so much the cost of things, but the cost of living (or more accurately, the cost of surviving). But if you simply focus on price, especially on those staple commodity goods and services that haven’t radically changed in quality over the years, the under reporting of inflation becomes more apparent.
As reported in our Global Investor Newsletter, we selected BLS price changes for twenty everyday goods and services over two separate ten-year periods, and then compared those changes to the reported changes in the Consumer Price Index (CPI) over the same period. (The twenty items we selected are: eggs, new cars, milk, gasoline, bread, rent of primary residence, coffee, dental services, potatoes, electricity, sugar, airline tickets, butter, store bought beer, apples, public transportation, cereal, tires, beef, and prescription drugs.)
We know that people do not spend equal amounts on the above items, and we know their share of income devoted to them has changed over the decades. But as we are only interested in how these prices have changed relative to the CPI, those issues don’t really matter. We chose to look at the period between 1970 and 1980 and then again between 2002 and 2012, because these time frames both had big deficits and loose monetary policy, and they straddle the time in which the most significant changes to the CPI methodology took effect. And while the CPI rose much faster in the 1970’s, the degree to which the prices of our 20 items outpaced the CPI was much higher more recently.
Between 1970 and 1980 the officially reported CPI rose a whopping 112%, and prices of our basket of goods and services rose by 117%, just 5% faster. In contrast between 2002 and 2012 the CPI rose just 27.5%, but our basket increased by 44.3%, a rate that was 61% faster. And remember, this is using the BLS’ own price data, which we have already shown can grossly under-estimate the true rate of increase. The difference can be explained by how CPI is weighted and mixed. The formula used in the 1970’s effectively captured the price movements of our twenty everyday products. But in the last ten years it has been quite a different story.
If these price changes in our experiments had been fully captured, CPI could currently be high enough to severely restrict Fed action to stimulate the economy. Instead, the Fed is operating as if inflation is extremely low. As a result, they are making a huge policy mistake that will come back to haunt us. During the last decade the Fed spent many years denying the existence of a housing bubble, even as a mountain of evidence piled up to the contrary. That error caused the Fed to hold interest rates too low for too long, blowing more air into the bubble and imposing enormous negative consequences on the economy. The Fed, now similarly blind to the inflation threat, is repeating its mistake, only this time the negative consequences will be even more dire.
Apart from the statistical problems that hide inflation, there are also macroeconomic factors that have helped keep prices down despite the quantitative easing. Massive U.S. trade deficits and foreign central bank dollar accumulation mean that much of the printed money winds up in foreign bank vaults, not U.S. shopping centers. As foreign consumer goods flow in, and dollars flow out, a lid is kept on domestic prices. In effect, our inflation is exported as foreign central banks monetize our deficits and recycle their surpluses into U.S. Treasuries. The demand has pushed down bond yields which has allowed the U.S. government to borrow inexpensively. Of course, when the flows reverse, bond prices will fall, yields will climb, and a tidal wave of dollars will wash up on American shores, drowning consumers in a sea of inflation.
Unlike Krugman and the Keynesians, I would argue that it is impossible to create something from nothing. I believe that printing a dollar diminishes the value of all existing dollars by an aggregate amount equal to the purchasing power of the new dollar. The other side takes the position that the new money creates tangible economic growth and that real economic value can therefore be created by putting zeroes onto a piece of paper. I think that those making such absurd claims should bear the burden of proof. For more on the interesting topic of hidden inflation, see my video that I just posted.
By Ron Paul
The great news is the answer is not to be found in more “isms.” The answers are to be found in more liberty which cost so much less. Under these circumstances spending goes down, wealth production goes up, and the quality of life improves.
Just this recognition — especially if we move in this direction — increases optimism which in itself is beneficial. The follow through with sound policies are required which must be understood and supported by the people.
But there is good evidence that the generation coming of age at the present time is supportive of moving in the direction of more liberty and self-reliance. The more this change in direction and the solutions become known, the quicker will be the return of optimism.
Our job, for those of us who believe that a different system than the one that we have had for the last 100 years, has driven us to this unsustainable crisis, is to be more convincing that there is a wonderful, uncomplicated, and moral system that provides the answers. We had a taste of it in our early history. We need not give up on the notion of advancing this cause.
It worked, but we allowed our leaders to concentrate on the material abundance that freedom generates, while ignoring freedom itself. Now we have neither, but the door is open, out of necessity, for an answer. The answer available is based on the Constitution, individual liberty and prohibiting the use of government force to provide privileges and benefits to all special interests.
After over 100 years we face a society quite different from the one that was intended by the Founders. In many ways their efforts to protect future generations with the Constitution from this danger has failed. Skeptics, at the time the Constitution was written in 1787, warned us of today’s possible outcome. The insidious nature of the erosion of our liberties and the reassurance our great abundance gave us, allowed the process to evolve into the dangerous period in which we now live.
By Ron Paul
If it’s not accepted that big government, fiat money, ignoring liberty, central economic planning, welfarism, and warfarism caused our crisis we can expect a continuous and dangerous march toward corporatism and even fascism with even more loss of our liberties. Prosperity for a large middle class though will become an abstract dream.
This continuous move is no different than what we have seen in how our financial crisis of 2008 was handled. Congress first directed, with bipartisan support, bailouts for the wealthy. Then it was the Federal Reserve with its endless quantitative easing. If at first it doesn’t succeed try again; QE1, QE2, and QE3 and with no results we try QE indefinitely — that is until it too fails. There’s a cost to all of this and let me assure you delaying the payment is no longer an option. The rules of the market will extract its pound of flesh and it won’t be pretty.
The current crisis elicits a lot of pessimism. And the pessimism adds to less confidence in the future. The two feed on themselves, making our situation worse.
If the underlying cause of the crisis is not understood we cannot solve our problems. The issues of warfare, welfare, deficits, inflationism, corporatism, bailouts and authoritarianism cannot be ignored. By only expanding these policies we cannot expect good results.
Everyone claims support for freedom. But too often it’s for one’s own freedom and not for others. Too many believe that there must be limits on freedom. They argue that freedom must be directed and managed to achieve fairness and equality thus making it acceptable to curtail, through force, certain liberties.
Some decide what and whose freedoms are to be limited. These are the politicians whose goal in life is power. Their success depends on gaining support from special interests.
By Ron Paul
This neglect ushered in an age of redistribution of wealth by government kowtowing to any and all special interests, except for those who just wanted to be left alone. That is why today money in politics far surpasses money currently going into research and development and productive entrepreneurial efforts.
The material benefits became more important than the understanding and promoting the principles of liberty and a free market. It is good that material abundance is a result of liberty but if materialism is all that we care about, problems are guaranteed.
The crisis arrived because the illusion that wealth and prosperity would last forever has ended. Since it was based on debt and a pretense that debt can be papered over by an out-of-control fiat monetary system, it was doomed to fail. We have ended up with a system that doesn’t produce enough even to finance the debt and no fundamental understanding of why a free society is crucial to reversing these trends.
If this is not recognized, the recovery will linger for a long time. Bigger government, more spending, more debt, more poverty for the middle class, and a more intense scramble by the elite special interests will continue.
By U.S. Rep. Ron Paul
Wednesday, November 14, 2012
This may well be the last time I speak on the House floor. At the end of the year I’ll leave Congress after 23 years in office over a 36 year period. My goals in 1976 were the same as they are today: promote peace and prosperity by a strict adherence to the principles of individual liberty.
It was my opinion, that the course the United States embarked on in the latter part of the 20th Century would bring us a major financial crisis and engulf us in a foreign policy that would overextend us and undermine our national security.
To achieve the goals I sought, government would have had to shrink in size and scope, reduce spending, change the monetary system, and reject the unsustainable costs of policing the world and expanding the American Empire.
The problems seemed to be overwhelming and impossible to solve, yet from my view point, just following the constraints placed on the federal government by the Constitution would have been a good place to start.
How Much Did I Accomplish?
In many ways, according to conventional wisdom, my off-and-on career in Congress, from 1976 to 2012, accomplished very little. No named legislation, no named federal buildings or highways — thank goodness. In spite of my efforts, the government has grown exponentially, taxes remain excessive, and the prolific increase of incomprehensible regulations continues. Wars are constant and pursued without congressional declaration, deficits rise to the sky, poverty is rampant, and dependence on the federal government is now worse than any time in our history.
All this with minimal concerns for the deficits and unfunded liabilities that common sense tells us cannot go on much longer. A grand but never-mentioned bipartisan agreement allows for the well-kept secret that keeps the spending going. One side doesn’t give up one penny on military spending, the other side doesn’t give up one penny on welfare spending, while both sides support the bailouts and subsidies for the banking and corporate elite. And the spending continues as the economy weakens and the downward spiral continues. As the government continues fiddling around, our liberties and our wealth burn in the flames of a foreign policy that makes us less safe.
The major stumbling block to real change in Washington is the total resistance to admitting that the country is broke. This has made compromising, just to agree to increase spending, inevitable since neither side has any intention of cutting spending.
The country and the Congress will remain divisive since there’s no “loot left to divvy up.”
Without this recognition the spenders in Washington will continue the march toward a fiscal cliff much bigger than the one anticipated this coming January.
I have thought a lot about why those of us who believe in liberty, as a solution, have done so poorly in convincing others of its benefits. If liberty is what we claim it is- the principle that protects all personal, social, and economic decisions necessary for maximum prosperity and the best chance for peace — it should be an easy sell. Yet history has shown that the masses have been quite receptive to the promises of authoritarians which are rarely if ever fulfilled.
To Be Continued
I don’t have a crystal ball but I follow the fundamentals and the market is screaming to get out of your adjustable mortgage if you have one as soon as possible. Here is why.
The federal funds rate is the interest rate at which banks lend their excess reserves to other banks which don’t meet the minimum reserve requirement established by the Fed. Currently the banks park their excess reserves with the Fed for which they are paid 25 basis points. Even though it’s known that the Fed controls this rate (by selling and buying securities to banks via the Open Market Operations) today we’re living in a climate of banks controlling such rate. Their excess reserves which exceed $1.6 Trillion create a liquidity trap that keeps rates below what the market would otherwise dictate. Take a look at the St. Louis Fed chart and ask yourself how much higher can these excess reserves go.
From 2009 until now the banks’ excess reserves grew exponentially. Such event occurred because the banks were selling securities (in many cases the toxic assets of the foreclosed real estate they held) to the Fed in exchange for dollars. In addition, they get paid a .25% to keep their reserves at the Fed. This is the reason for which you see on this chart why their excess reserves spiked in a little more than two years.
For the federal funds rate to go up one of at least two events must happen. The Fed sells securities back to banks thus reducing the banks’ excess reserves and contracting the money supply. This scenario is not much likely to happen because Mr. Bernanke is a deflationist and he fears deflation. Politically speaking he couldn’t do that even if he wanted to. Why? Because money deflation leads to Wall Street deflation and the artificially inflated stock market bubble would burst. Such event cannot happen especially during an election year.
The next and a more plausible event to occur would be when banks will start lending again. Banks are in the business of lending money therefore the question is how long will it be until banks start lending again? Obviously it can’t go on indefinitely.
Of course, other events could happen which could trigger the rise in the rate. The collapse of the dollar, China decoupling its economy from ours, the dollar’s status of the world reserve currency replaced with another stronger currency, or a devastating inflation.
Without confusing the matter too much, when the federal funds rate is low generally your adjustable mortgage will be low. When that goes up you can most certainly expect your ARM to go up, as well. And it really doesn’t matter much to which index your mortgage is tide to.
I’ve been told over and over by hesitant property owners that if the rates go up they’ll sell the property. If they can’t sell they will refinance. Here is the problem. For the past four years the real estate activity was sustained by sales of – what many would call – below market value properties. Of course, that’s debatable because the real value is based on what the market dictates (based on supply and demand) and not on what the current owner thinks his property value is nor on what the outstanding balance on the underlying mortgage is.
For he who believes he can sell his property when rates go up I wonder what makes him think that in a higher rate environment his property would sell for the price he’d want to sell it for? If his property doesn’t sell today when rates are low why would it sell later when rates go up?
The second option is to refinance when rates go up. If you study the chart above you’ll notice that during the late 1970′s the rate went up abruptly. It wasn’t a slow and gradual increase, it was fast and furious. That increase was the result of the Fed’s contraction of money supply.
When today’s refinance loans take a minimum of two to three months, if not longer, it’ll take even longer time to close on a loan when rates start spiking. Why? Because everyone else who’s in that position will be standing in line to refinance (before the rate goes higher). Not to forget that tomorrow’s fixed rates will be way higher than today’s. And folks, you must understand that the rates cannot go any lower. The chart above says it all. The federal funds rate is close to zero now.
Getting a low fixed rate for as long of a term as possible is the solution to a not so distant problem. It applies not only to those who have ARMs but also to those who have loans due to mature in the next few years. If your loan has a prepayment penalty it should not deter you from being proactive. The cost of waiting could be steep. In the long run saving today by avoiding the penalty may end up costing way more in form of a high interest rate on your mortgage.