Last week I published two articles examining the real inflation rate in the USA and its implications for your money’s buying power:
A number of readers commented on those articles, both here on the blog and in e-mails. Through them, I learned of a report from Devonshire Research Group dated April 2017, titled “Consensus of the Contrarians: The Alternate Macro Economic View“. It, too, posited that official inflation figures and calculations were woefully inadequate. Here’s its Executive Summary.
A wide variety of Price Indices are used to adjust for the effects of Inflation on the economy. These adjustments are widely applied to derive a number of common measures and underlie many critical economic and asset management concepts.
- Price Indices: the Consumer Price Index (CPI), the Producer Price Index, the GDP Deflator
- Economic concepts: the Standard of Living, Real Income and Output, Real Economic Growth
- Asset Management concepts: Real Interest Rates, the Risk-Free Rate of Return, the Cost of Capital
- Conclusion: These indices and concepts are intimately commingled which is leading to a wide ranging divergence between reality, published government statistics and the assumptions used for investment decisions
A rising tide of Contrarians is arguing that Inflation is understated by the Price Indices chosen by U.S. government agencies in numerous ways for complex reasons.
- The CPI fails to measure a simple basket of goods that consumers typically purchase “out-of-pocket”
- The weights in the official baskets shift over time in ways that mute the impact of higher priced products
- Price increases attributed to quality improvements (hedonic adjustments) are subjective and overstated
- U.S. government agencies have incentives to downplay CPI increases to lower cost-of-living payments, reduce borrowing costs, and increase apparent real economic growth
- Conclusion: The Consensus of Contrarians is growing, shared across several independent critics and supported by concerns among many that official statistics paint on overly optimistic picture of the U.S. economy.
To the extent that the Contrarians are correct, the implications for the U.S. economy and for investors are profound:
- The Standard of Living may be far more difficult for many Americans to maintain than published statistics suggest
- Real Economic Growth may be flatter or actually negative, suggesting a prolonged 21st century recession, not recovery
- Real Interest Rates, already seen at historic lows, may be strongly negative making Fixed Income returns unattractive
- The Cost of Capital most commonly used to measure investment returns may be far too low
- Conclusion: The Consensus of Contrarians suggests that many investors are using incorrect assumptions in their asset allocation models and investment decisions. Capital preservation is compromised, portfolio allocations are distorted and return performance is overstated. The broader effect on capital markets is likely profound and complicated.
There’s much more at the link. If you’re interested in this subject (and I hope you are, because every dollar in your pocket or wallet or bank account is affected by it), I urge you to click over there and read the entire report. It’s worth it – and it generally supports what I had to say in my articles last week.