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The Inflation thread, Discussion
post Posted: May 12 2005, 11:53 PM
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I posted this at another site earlier this week
Thought some people might like to see it here too

The Truth about CPI
An Inflation Debate Brews Over Intangibles at the Mall;
Critics Say U.S. Plays Down CPI Through Adjustments For Quality, Not Just Price; Value of a TV's Flat Screen

WASHINGTON -- To most people, when the price of a 27-inch television
set remains $329.99 from one month to the next, the price hasn't

But not to Tim LaFleur. He's a commodity specialist for televisions
at the Bureau of Labor Statistics, the government agency that
assembles the Consumer Price Index. In this case, which landed on his
desk last December, he decided the newer set had important
improvements, including a better screen. After running the changes
through a complex government computer model, he determined that the
improvement in the screen was valued at more than $135. Factoring
that in, he concluded the price of the TV had actually fallen 29

Mr. LaFleur was applying the principles of hedonics, an arcane
statistical technique that's become a flashpoint in a debate over how
the U.S. government measures inflation.

Hedonics is essentially a way of accounting for the changing quality
of products when calculating price movements. That's vital in the
dynamic U.S. economy, marked by rapid technological advances. Without
hedonics, the effect of consumers getting more for their money
wouldn't get fully reflected in inflation numbers.

But even as the Federal Reserve raises interest rates amid a recent
uptick in inflation, many critics complain the hedonic method is
distorting the picture of what's going on in the economy. They say
hedonics is too subjective and fear it helps keep inflation figures
artificially low -- meaning the Fed may already be lagging in its
inflation-fighting mission.

It's critically important for consumers, business, the governmen,t
and the economy as a whole that the CPI is as accurate as possible.
The CPI is used to benchmark how much is paid to Social Security
recipients, who last year received outlays of $487 billion. It also
plays a role in adjusting lease payments, wages in union contracts,
food-stamp benefits, alimony and tax brackets.

Getting the CPI right is immensely complex and can seem
counterintuitive. Consumers sometimes have the impression that the
government must be missing something -- since inflation has remained
remarkably low in recent years, even as housing prices, medical
bills, and other daily costs have soared. Hedonics helps explain part
of the difference.

There are also differences in the mix of things people buy. For
instance, healthy people spend far less on health care, an area that
has seen particularly strong inflation. And not everyone pays college
tuition, another area where prices have been marching rapidly higher.

The issue is likely to gain more attention now as signs of
inflationary pressures grow. Consumer prices jumped 0.6% last month,
the biggest increase in five months, as the prices of energy,
clothing and airline fares all rose sharply. On an annual basis,
consumer prices rose at a 4.3% rate in the first three months of this
year, compared with 3.3% for all of last year.

Bill Gross, head of the world's largest bond fund, Pimco, caused a
stir last fall by proclaiming that the way the CPI is calculated
amounts to a "con job" by the government aimed at concealing the true
rate of inflation. A key culprit, he said, was the CPI's growing
reliance on hedonics. Mr. Gross, who has other complaints about how
inflation is tracked, estimates the CPI really is one percentage
point higher than official figures suggest.

That's important for bond investors, who view inflation as their
biggest enemy. Bond holders receive a fixed interest payment on their
bonds that is eaten away by inflation. If there is hidden inflation
in the economy, bonds are less valuable.

Likewise, Andrew Harless, vice president of econometric analysis at
Atlantic Asset Management in Stamford, Conn., takes issue with
hedonics. "Price decline and quality improvement are not the same
thing," he says. As a result, any index that treats it as such is
likely to be misleading.

Inflation watchers at the statistics bureau say critics exaggerate
the significance of hedonics, noting that it's used in only seven out
of 211 product categories in the CPI. In most of those, officials
say, hedonics actually magnifies price increases rather than
suppressing them.

Take housing, which makes up about 30% of the CPI. Critics often
blast the CPI for using a measure based on what it costs to rent
homes rather than what it costs to buy them -- thereby avoiding the
recent run-up in housing prices. The bureau says it is more concerned
with monthly costs of housing than the long-term value of houses, so
it thinks rents are a better gauge.

The bureau says hedonics actually helps boost the housing component
of CPI. In order to take into account the aging of housing, and
presumably falling quality that goes with it, the CPI applies a form
of hedonics that links the age of a housing unit to rents. If someone
is paying the equivalent of $500 a month in rent for several years,
the rent has actually gone up as the unit ages and becomes less
desirable, according to the government.

Hedonics, which literally means the "doctrine of pleasure," was a
term first adopted by a General Motors economist, Andrew Court, who
studied auto prices in the 1930s. He had created a method of linking
car prices over time to features such as weight and horsepower, and
wanted a name for the statistical method that emphasized the link
between features and consumer utility.

The technique stirred few passions until the technology boom of the
1990s. By then, government agencies had realized they needed a better
way to track quality changes in computers and other fast-changing
high-tech goods.

Federal Reserve Chairman Alan Greenspan, testifying before the Senate
Finance Committee in 1995, said that he thought the CPI was biased
upward by as much as 1.5 percentage points. The political response
was immediate: If inflation was lower than supposed, it would be
possible to rein in deficits without cutting spending or raising
taxes. That's because the lower inflation rate would translate into
smaller payments to Social Security recipients and other big-ticket
items for the government.

Shortly thereafter Congress established the Advisory Commission to
Study the Consumer Price Index, better known as the Boskin
Commission. The panel confirmed Mr. Greenspan's view and said about
half the bias was due to product innovations, such as those seen in
computers, which were being overlooked in the CPI. Thus began a push
to apply hedonic techniques more broadly.

Today, the hub of this effort is a warren of beige-walled cubicles at
the Bureau of Labor Statistics a few blocks from the Capitol. Here 40
commodity specialists hunch over reports with 85,000 price quotes
that flow in from around the country every month. The numbers are
gathered by 400 part-time data collectors. They visit stores and note
prices on the items that make up the basket of goods in the CPI,
ranging from ladies' shoes to skim milk to microwave ovens.

One of the biggest challenges in this process is finding substitutes
for products that disappear from store shelves or change so much that
they are hard to recognize from one month to the next. With TVs, for
instance, data collectors find the models they priced the previous
month missing about 19% of the time over the course of a year.

When that happens, the data gatherer goes through a four-page
checklist of features such as screen size and the type of remote
control to find the nearest comparable model. Once this process
identifies a product that appears to be the closest match, the data
gatherer notes its price. The commodity specialists back in
Washington check over these choices and decide whether to accept them.

Mr. Harless at Atlantic Asset Management says all these judgment
calls add up to a process that is far too subjective. The CPI "takes
something you can't really measure and applies a metric to it in ways
that are arbitrary," he says. "There ought to be some kind of warning
label on inflation numbers that are derived from hedonic pricing."

David Johnson, the economist who heads the CPI program at the bureau,
says, "There's no doubt the analyst has to make decisions about
what's comparable and what's not, and where adjustments should be
made, but we try to use the data from all the markets to make that

Many price adjustments in the CPI are straightforward: When candy
bars get smaller, but are sold for the same price, the CPI reflects
that as a price increase.

Todd Reese, the commodity specialist for autos, says he doesn't need
hedonics to extrapolate the value of quality changes, because auto
makers present him with a list of changes to the car and the
corresponding prices. Still, Mr. Reese must make some tough calls as
he does his job. For instance, he recently considered a 2005 model in
which the sticker price went from $17,890 to $18,490. The
manufacturer cited an extra cost of $230 to make antilock brakes
standard, while it said it saved $5 by dropping the cassette portion
of the CD player.

The bureau accepted both those items, so the ostensible price
increase shrank by $225.

But the car maker also told Mr. Reese it wanted to subtract $30 from
the price increase for the cost of putting audio controls on the
steering wheel, allowing drivers to change channels without reaching
for the radio dial. "We didn't allow that claim," says Mr. Reese. "We
didn't judge that to be a functional change."

The most visible and controversial application of hedonics in the CPI
has been in computers, where hedonics sharply accelerated price
declines starting in the late 1990s. Recently, the bureau has quietly
stopped using hedonics in computers.

Mr. Johnson, the CPI economist, says the change, which took effect in
September 2003, was mainly driven by "timeliness" issues. With
computers changing so rapidly, the agency found it difficult to keep
its hedonic models up-to-date. At the same time, he says, the
components of home computers have increasingly become commodities,
making it far easier to price the various parts separately, such as
memory or screen size, by going straight to manufacturer sources that
list those prices.

The decision to stop using hedonics on computers in the CPI, which
hasn't been publicized, came in the wake of a 2002 report by the
National Science Foundation's Committee on National Statistics. The
report concluded that hedonics may be one of the most promising ways
of dealing with quality changes, but the agency should be more
cautious in adopting it.

"The controversy is really about a small category of electronic
goods," says the CPI's Mr. Johnson. Rapid quality advances in
everything from DVD players to microwave ovens means that hedonics
does, in fact, have the effect of pushing down that part of the
index, he says. However, electronics accounts for less than 1% of the
overall index.

Meanwhile, the statistics bureau is continuing to look for new ways
to apply hedonics. As part of its research, the agency recently
selected 10 random items, including laundry detergent, to study as
potential new areas to apply hedonics.

Ron Blackwell, chief economist for the AFL-CIO, says he is concerned
about how hedonics is used. For one thing, the method seems overly
focused on capturing quality improvements, he says.

"It's very careful on the adjustments of quality upwards, but not as
careful on judging the deterioration of quality, so it's biased,"
says Mr. Blackwell. Because of this inconsistency, he says, when the
CPI is used to calculate Social Security payments or set wages in
labor contracts, "it really understates the increase in prices that's
taken place and that's experienced by workers and retirees."

Jack Triplett, a visiting fellow at the Brookings Institution who has
written extensively on hedonics, says he often encounters resistance
from people who insist official inflation figures can't be capturing
the real picture, because the government data contrast with their own
experience. Some have suggested the CPI should be broken into
subcategories, such as one for the elderly, which would put greater
weight on items they buy in relatively greater amounts, such as
health care.

In February, Mr. LaFleur received a report about a 57-inch television
in which the price dropped from $2,238.99 to $1,909.97. Going over
the checklist, the data gatherer in the field discovered the old
version had a built-in high-definition tuner. The new one did not.
Running this through the hedonic model, Mr. LaFleur found that the
tuner was valued at $513.69. This turned what appeared to be a 14.7%
price decrease into a 10.7% increase.

In hedonic calculations, the price difference is always added or
subtracted from the previous month's figure in order to calculate the
ultimate change.

Similarly, in the case of the 27-inch television where the price
appeared to stay the same, Mr. LaFleur says it was obvious to him
that the price had declined. The latest model had a flat screen, he
says, something which consumers value more than the curved screen in
the old model. The newer TV also had a 10-watt stereo, compared with
the weaker six-watt stereo in the older model.

Never argue with an idiot. They bring you down to their level and beat you with experience.
post Posted: May 12 2005, 01:59 PM
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Posts: 1,797
Thanks: 3

May 11, 2005

Technical Analysis: Stocks Hang On
By Paul Shread

The S&P and Dow (first two charts below) held some very important support levels today, bouncing at their recent downtrend lines. But now we need to see some follow-through buying or stocks will remain vulnerable. 1164 is first support on the S&P, a level we'd like to see hold at this point, and 1158 is critical. Resistance is 1175-1180. The Dow has support at 10,250-10,263, and 10,180 is critical. Resistance is 10,350-10,405. The Nasdaq (third chart) pushed a little deeper into its old downtrend line than we'd prefer to see. Support is 1944-1950, and resistance is 1174-1180, 1185, 1193 and 2005.


post Posted: Apr 22 2005, 11:56 AM
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Posts: 2,893
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In reply to: Thumper on Friday 22/04/05 11:32am

Hi Thumper,

Interesting .... will have to think about this one.
Yep US needs to change its ways. Changes in US tax laws have the govt facing worse and worse govt numbers as time goes on.

Trade balance for the US ... and US a worry.
It aint going to get better with oil imports set to rise as US domestic oil runs out.
Debt .. the same ... AUS not looking there but the number for AUS went up 14.8% last year alone ... another 12% this year .......

deflation ..... maybe ... longer term. Short term I see stagflation myself for the US.
Will keep raising rates to counter the inflation and boom ... one day all the US numbers will look like poo ..... thats next 2 years or so ... but beyond that yep maybe deflation.

For Australia .... we will not follow the US rise ... if we do ... we get there first ...
expect lower AUD/USD ... maybe the RBA has to follow the US but our market especially domestic borrowing for houses could casue a rout of the banks if we say raised rates by more than 1% from here ....

All fun and games.

Short term expect US lower as the focus turns back around to the really awful inflation numbers they just had. Dow may still try and rally some more but view it like a chiken without its head at present. Fed is going to raise in May and with this last set I am 80% convinced it will be by 0.5% which I suspect will stop the rally dead when the chicken works out its head was just chopped off.

Rising rates and oil sitting up 20% from last year ... only means increased price pressure short term.

Longer term maybe the ugly deflation word ...... not a fan of where in reality our economies both AUS and US are going. At least our federal budget is in surplus .... but our trade numbers and debt make the US look like a picnic .....

Gotta think some more on deflation .....
Myself .... I see a real risk of house prices sliding further either way.
US raises rates ... we follow ....
US economy hits a brick wall stops ... ours will slow ....
US tries and repairs the damage as you suggest and start saving ... same thing ... economy slows ......

Eeeek ... need a drink .....


All views expressed are my own opinions. While I take every care when posting no guarantee to the absolute veracity of the postings is given or implied. Please do your own reseach and consult a professional investment advisor before investing.
post Posted: Apr 22 2005, 11:32 AM
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Hey, Kahuna.

I actually think that stagflation is really a relic of the 70's. Stagflation was in some part a product of inflexible labour markets: labour markets today are much more flexible.

No, I think the biggest danger the US faces today is actually deflation: I can't help but think that the US is sitting today around about where Japan was sitting in the late 80's. As you know, Japan has suffered from around a decade and a half of deflation, after being branded in the late 80's the 'miracle' economy.

So what makes the current US like the 'old' Japan? One thing is that Japan was unable to get its citizens to 'spend' their country out of the deflationary spiral. Asians are typically net savers - and it is true that Americans are the exact opposite. But the thing is is that American's consumption will at some stage have to turn - the Yanks will have to start to save, and will have to cut down on their consumption simply because you cant just keep on running up debt. So America in the near future will be like Japan in this: they will have to stop spending and start saving.

Similarly, the US government is at the same level as its constituents: it has a massive ballooning debt that will only be curtailed by massive cuts in expenditure. The effect on demand both in the US and abroad will be a large one.

The US is also like Japan in that it has massive structural deficiencies in its economy: low interest rates have fueled a channeling of capital away from expanding productive capacity, and into speculative bubbles like property. This leads to another similarity that US has to the Japan of the 80's and 90's: a banking and finance sector that will require massive reform. In the US the banking sector will be hit by a lot of dud loans that only become apparent as interest rates rise. There will be 'forced' reform on the US finance system - higher interest rates will be an emetic that not only flush the speculative bubbles away, but also instil deflationary expectations in a fashion that is very difficult to break free from - just ask Japan.

Anyway, I could go on further and explain exactly how the deflationary spiral might unfold: but I'll leave that for another post.

post Posted: Apr 22 2005, 10:41 AM
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Well we have just seen the best bounce in the US market for many months overnight.
In fact it was the best rally in almost 2 years !!

Dow up over 200 points and the NASDAQ index up even more in percentage terms.

So one has to question, was that the low we saw Wednesday for the US markets ?
Was that the low we saw in our markets with the index for the ASX 200 at 3960 ish ?

Both great questions and if we were able to answer these with any degree of certainty we all would be a lot richer.

After being a bear for a long time and almost picking the actual low on Monday, I am still not convinced we don't see the index and shares overall go lower over time. For myself the bounce on Monday to Wednesday for the shares I liked was massive. In some cases there were announcements in-between which helped the recovery off the lows seen early Monday morning but in a lot of cases there wasn't. When a share bounces from its low on Monday to a high on Tuesday or Wednesday that is 5% or in some cases 8 % higher than the low ... It is almost irresistible not to take the money and run especially when the underlying index has only rallied back 1.6% ........

Sure one could say they overdid the sell off Monday in almost pure panic but the bounce we saw in our markets in Australia between Monday and Wednesday was almost the opposite in some cases. Some shares like CSL which I liked went from around $30.30 low on Monday to $32.80 on the bounce ... That's 8.25% for a bounce. Sure CSL had been hammered more than others in the move down but there were a lot in the same sort of basket in the bounce, IRE $3.58 to its highs seen yesterday was around a 10% move and more than likely even more today.

Others with even quicker or larger bounces COA and PTD were partially due to decent announcements made in between ... But COA bounced within a day from being given and offered at $4.10 to $4.40 before drifting back off. PTD was given heavily down at 133 and 132 to bounce back on an announcement to over $1.50. Now the interesting thing about PTD is that at $1.35 and below it implied a P/E of around 10 ... And this is for a drug company. On top of this it had a share buyback scheme as well going on with over 6 million more shares to buy ... So how it has got down here in the first place was frankly beyond me.

Now today I am sure we will see more of the same. I doubt the ones I mentioned go too much further than the overall markets rise we see today.

Why I am cautious still is what in reality has happened to the numbers behind and driving these moves. The US market is where we have been taking our lead. Friday night the US had a shocker and that's what started it all, Dow was down 181 points. This was the third day in a row for the US market down over 100 points. Bottom line even after the rise of yesterday the US market is still down around 2.7% for the last 2 weeks. This bounce last night might have a lot convinced the worst is over. Myself I remain very cautious and back to almost all cash yet again.

A few concerns had been driving the US markets lower. One was the fear the Fed would raise rates again. Second was the fact that high oil prices would slow the US economy and lastly the US economy may in fact already be slowing down.

Now some of the slide from the oil fear has stopped. Oil hit US$49.70 briefly and the market settled around US $50.50 for a couple of days. So the market stopped looking at this factor. Whilst they haven't been looking oil managed to creep back up this week to US$54.20, but since the market has been focussing on other things this negative has been ignored for now. For myself that the market was unable to even break the US$50- level and close below there despite trying for almost 2 weeks has me thinking we are going to sit in this range if not higher over the coming weeks.

Secondly, the Fed and fears of the raising of rates have really taken a back seat especially with last nights move in the US. Maybe the move down was already overdone is what they are thinking. Personally I am not sure they are thinking at all. In reality the US numbers with regards to what the FED is going to do have been shocking. The CPI number the other night ... Core inflation was expected at 0.2 % and it in fact came out at 0.4%. Not something the fed would be at all amused about. Secondly the Philly Fed numbers out last night were shocking when we look at the implications for US rates. The US Federal reserves watches these numbers very closely and the Philly Fed numbers are a favorite of Greenspan's The Index as a whole was expected to drop to 10 from a reading of 11.4 the previous month, but instead the index rose to a whopping 25.4 which the US equity market focussed on and ran with the ball. The number to them allayed any fears about the US economy was slowing and they put there buying shoes on and pinned their ears back and just bought.

Now the really worrying number for me out last night was the Philly Fed's prices paid index.
This rose again by a massive amount. It rose by 20.8 points to 50.5 ... This is not good.

At present the US equity market solely is focusing on just one aspect of the picture, that being the US economy seems to be going along still with some steam. What I have taken from this week and I suspect the FED will do the same is the inflation numbers look ugly. When the FED meets next month the fear before the US non farm payroll numbers early this month was they might raise rates by even more than the 0.25% increases they have been going at. On the 1st of April the Non farm payroll numbers came out but were a lot weaker than expected so the market pushed that fear aside. The headline number was 110k and about half the expected rise. In complete contrast the overall unemployment rate fell by more than expected.

The April numbers come out exactly in 2 weeks on the 6 Th. May. Personally all the numbers I have seen point to a higher number and a correction to the low initial number reported on the 1st April. The question for me is not whether the FED will raise rates in the US again but by how much ? The set of inflation numbers just out leave little doubt they will move again and even now I suspect the move will be 0.5% unless the numbers get a lot weaker between now and then.

Maybe the US equity markets claw back some more of the losses seen over the last 2 weeks but the writing is on the wall for another rise in US rates and I for one am leaning towards the 0.5% as opposed to the 0.25% rise. For us in Australia I don't think this means we follow, the rise we had really put a big dent in the economy and especially confidence and housing sectors. Not sure another rise would be at all productive.

For myself I remain very cautious as time goes on. Never been a real big fan of raising rates to counter inflation especially when the overall economy is slow or sluggish. When they raise rates I just think this adds to the whole inflation problem, the higher cost of borrowing/financing is eventually passed on to consumers as the producers have to adjust their prices to take into account the new increased cost base. With the oil price still up here and probably from the looks of it not likely to go much lower the increased cost on that side will also be passed on. If the US fed does raise rates just adds more pressure to the whole spiral.

Having been around when we saw rates raised several times in various cycles since the early 1980's this time I am not sure it is the right move. Back then the economies were motoring along and they needed slowing ... This time I am not sure it is the case. Still lean towards the view they are playing with fire here. Higher energy and higher interest rates are both negatives for an economy and take money out of it, worried some day it will just turn around and we will see GDP growth negative or sluggish with higher than normal inflation ... That being stagflation.

Over the last 15 years we have both enjoyed basically falling interest rates and low and almost steady energy prices, times have changed and I believe once we start seeing both go up one feeds off the other and we see higher inflation partially being driven by the rate increases that are meant to be keeping it down.

Who knows ? Just my own feelings from here. Suspect the US will start to focus on the rate side especially as the non farm payroll numbers get closer and the FED meeting in May. Myself I expect the non farm numbers in 2 weeks to be 250k plus and an upward revision to last months 110k number to around 148k if not more.

Not really tempted to chase the ASX 200 up from here for this reason. US markets could turn on a dime if they start focusing on the implications provided by the inflation numbers over the last few days.

Then again maybe I have yet again taken the money and run when the initial positions were the absolute lows to be seen in this move. Thats all the fun of being a trader, some you win and some you loose, but can't go broke taking a profit on a superball bounce.

Good Luck

All views expressed are my own opinions. While I take every care when posting no guarantee to the absolute veracity of the postings is given or implied. Please do your own reseach and consult a professional investment advisor before investing.

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