Ever hear someone say, “You can't trust those government statistics”? When they say inflation is 1.6 percent, do you feel they might be fudging the numbers to bamboozle the masses? Many people, even the highly educated, feel there is a government conspiracy to doctor the numbers and make them look better or maybe just make us feel better. Investopedia, one of the more respected sites, has a particularly harsh view of these numbers.
Is that true, though? Is your government “cooking the books,” as it were? Let's take a look at one of the most quoted, and disputed, sets of statistics people look at — the Consumer Price Index, or CPI.
The goal of the Consumer Price Index is to get an idea of whether inflation went up or down. The agency which gives us the CPI is the BLS (Bureau of Labor Statistics, an agency of the Department of Labor), which also happens to be the agency which compiles unemployment statistics. (At that, critics nod their heads sagely: “Hmmm … it figures.”)
Critics of the CPI seem to feel inflation statistics are always understated, pointing to some item which has gone up way more than 1.6 percent, or whatever number the BLS says it is. “Why, the price of beef at my supermarket (or home prices, or any other item) went up 20 percent last week. How can they say inflation only went up 1.6 percent?”
Indeed, how can they? Without using the National Security Agency, how can any government know how much you paid for your cheese this week? Not just you, but the other 300 million people in America? How do they figure the price of cheese if you had a coupon for 20 percent off, and the gal behind you had to pay full price? And what if cheese was on special this week? Is that inflation going down or something they should ignore? And what if you see that the price in your supermarket went up and you decided to switch to Costco or Walmart, subsequently paying less? Is that now deflation? How does a government tally all this information — assuming they could even get their hands on that many billions of transactions — and do it within a week of month's end?
Can we just admit that it's impossible for anybody to accurately measure each and every transaction everyone makes? And can we also agree that it's impossible to determine an accurate way of dismissing non-recurring things like discounts, coupons, and other irregularities in prices?
The fact that 100 percent accuracy is impossible doesn't mean you can't get an idea by monitoring some transactions, however. As long as we understand that government statistics are approximations, we can still put them to good use.
Should the price of steak even matter? If the government ignores it because it's such a small fraction of total spending, critics complain that they're selective and arbitrary in what they put in. If they put it in, they get lambasted for understating its impact.
Let's look at some numbers to see how this plays out. If you earn and spend $40,000 (after taxes) a year, how much of that do you spend on steak? $200 maybe? (If that.) Well, that's only half a percent of your total expenses. If the price of steak went up by a whopping 20 percent in a single month, it may feel quite dramatic to you, but it will add exactly 0.1 percent to your overall inflation — way less dramatic. Simple math.
When you're talking to a critic of “those rubber statistics,” you usually deal with two known traits of the human mind:
- The first is the tendency to listen to things that agree with our views and dismiss facts which run counter to our beliefs. “I've made up my mind. Don't confuse me with facts,” as the saying goes. The American Psychological Association published the results of an experiment in July, 2009, which confirmed this: People were twice as likely to select information that supported their own point of view as to consider an opposing idea, with two thirds going for supportive views as opposed to a third going the other way. Critics will criticize, even if the facts contradict them — but we are all guilty of this to one degree or another.
- The second is a known trait of the human brain to exaggerate a point of pain and to tune out things that don't change. Nowhere is this as evident in the national accounts as when people evaluate the CPI. Your rent of $1,500 per month didn't change this month, so you ignore it. The price of steak, though, hit you in the eye and you grumbled all the way back home because you invited your friends over, promising to throw a few steaks on the grill, and now you're stuck with a higher bill than you expected. If a pollster stopped you at the front door and asked you if you believe inflation was going up more than 1.6 percent, you'd be likely to say, “Heck, yeah!” and give him an earful.
Let's take another item: gas prices. Let's say the price of gas went up 10 percent so that your monthly gas expense went from, say, $80 to $88. Annualized, that's $8 every month (or $96), which comes to 0.2 percent of your annual expenses. It gets even more complicated, though. What if Sally next door traded in her SUV for a Prius? Even though the gas price went up, her personal “gas inflation” went down, because she changed what she does.
Let's agree: It is tough to compare what you do with what Sally does, especially when you are trying to figure if prices went up, and by how much.
Let's put the shoe on the other foot and say you're the government and your citizens want to know by how much prices went up or down. How do you measure that? Holly is a vegetarian, and I love a good ribeye. So, when the price of steak jumps for half the population, but leaves the more sensible half unaffected, how should the BLS calculate inflation?
Most governments solve this dilemma by picking a “basket” of representative purchases. It's like those mythical 2.3 children — nobody actually has 2.3 children, but that's what the average comes out to. Same with “the basket.” (The government is very transparent about all of this, by the way.)
A while ago, the BLS started fiddling with the basket, taking out some things and adding some new things — and the critics went ballistic. (They still haven't calmed down, actually.)
But what is the government supposed to do? Do you still buy film? No, times change, and the things people buy change too. Before, many people bought film and you had to include film in the basket so film price changes get accounted for. Now you have to take it out. We don't buy VCR's or record players anymore, either. What about cell phones? The amount you spend went from $40 for that old “dumb” phone to over $600, the price of an iPhone, even though you never pay that out of pocket. Should they factor that in? How? Or, how does the government keep track of cell phone companies introducing “family plans” or users who switch to Republic Wireless (like Holly did) and save themselves money? Is that deflation?
That's called the “hedonic” thing. You point at the price of that $1,500 big screen TV set you see at Best Buy. Wow, TVs have gotten expensive. But have they? The BLS says no, that's not inflation: “The cost of televisions didn't go up,” they say. “It's just you upgrading your 17-inch, old-school tube TV to a 40-inch HD flat screen.” Is that new baby on the wall more expensive than the old one Goodwill refused to accept? Of course it is. But is that inflation? You know it's not — it's you upgrading your lifestyle. So the BLS tries its best to adjust the upgrades people give themselves out of the inflation number. People keep upgrading their lifestyles (itself a whole series of topics, but let's leave that for another time) and when the BLS tunes those upgrades out, the critics howl like banshees.
Take housing. Sixty years ago, people lined up around the block to buy Levittown houses. They were so hot, the builder made the cover of “Time” magazine. Well, a Levittown house was just over 900 square feet and had one bathroom, no basement and no garage. That was normal housing, desirable housing even. Today people buy 4,000 sq. ft. McMansions, with three garages, for $500,000. Is that inflation or an upgrade we buy ourselves? Where do you draw the line?
Let's say you joined the mighty throng of cord cutters and decided you're no longer going to get cable. You just saved more than $50 per month. Now, did your inflation go down for that month? Or, what if people switch from gas-guzzling Suburbans to Priuses? Did the price of cars and gas go down? No, but people are spending less on cars … and on gas, tires and other related expenses. How should the government keep track of all of that?
There are other tricky issues. Certain things affect some groups more than others. Let's say Kimberly-Clark decides their executives aren't making enough millions already so they raise the prices of Huggies and Depends. Young parents and retired folk howl in pain, while people in their forties are blissfully unaffected. Now, was that an inflationary event? It would seem so, but by how much? Whatever number the BLS computes, you can guarantee the AARP will throw a hissy fit about government fudging the numbers when the full cost of the Depends hike is not included.
Can you see how difficult it is for anybody to arrive at a number that reflects the inflationary pain every person feels? It's not only difficult; it's impossible, especially when people keep changing what they're doing.
Just like that mythical 2.3 children statistic, you know the basket the government uses doesn't reflect what you, I, or any other person or family buys. Therefore, the inflation statistics the government provides won't match the reality of any individual or family.
Given the complexity of the numbers, and the speed at which they change, and the speed with which we want them, the best anyone can hope for is “a feel,” and transparency by those defining the numbers.
We have that.
So, next time you feel tempted to blast those boffins for “cooking the books,” stop and ask yourself: How can you do a better job? More tellingly, will Heather or Mike down the road agree with your number? Much better to focus on what you can do in the face of an economic landscape that changes every day.
And what is that, you say?
1. Keep track of your expenses. Some things “creep” on you. I don't know about you, but here in Denver all the trash companies find a way to agree on a fixed price. Still, every month the bill goes up with things like fuel surcharges until you threaten to cancel. Then they reset and the game starts all over. Same with phone and cable bills.
2. Keep your commitments as short as you can, and always keep an eye out for competitive deals.
3. Keep an eye out for specials. There's nothing like 20 percent off to help you beat inflation.
4. Make your own hedonic adjustments: Cut the cable cord, get a smaller car, vacation in cheaper spots. People here already have a pretty good idea how to trim expenses.
5. Gravitate to the impervious industries. Jobs or wages at utilities rarely get cut because they simply pass on their cost increases. There are many others. If you are able to get a job there, you're insulating yourself from the ravages of inflation. Not everybody can do it, but it's a consideration for the next time you consider making a change.
Whatever you do, don't raise your blood pressure blasting those government statistics. They're not perfect; nobody ever claimed they were. The odds are that any improvements will be shot down by just as many people. On the other hand, recognize that they do give us a fair idea of what's happening around us.
The bottom line is we have very little control over prices, unfortunately, and no amount of ranting will change them — or the government's estimate. It would be much better, instead, to focus our attention on what we can do about it.
Author: William Cowie
William Cowie spent 30 years in senior management (CFO/CEO) before retiring. He has a bachelor's, a master's, and a partial doctorate in management and strategy. Author of the book “The Four Seasons of the Economy,” William also assists medium-sized businesses in the use of the Four Season Strategy to help them capitalize on economic cycles. He runs two blogs: Bite the Bullet Investing (investing) and Drop Dead Money (the economy) and writes for several other blogs in addition.