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Something’s Going to Give

March 17, 2011

One would think that after the
worst financial crisis since the Great Depression, Americans could at least
catch a break for a while with deflationary forces keeping the cost of living
relatively low. That’s not the case.

A special index created by the
Labor Department to measure the actual cost of living for Americans hit a record
high in February, according to data released Thursday, surpassing the old high
in July 2008. The Chained Consumer Price Index, released along with the more
widely-watched CPI, increased 0.5 percent to 127.4, from 126.8 in January. In
July 2008, just as the housing crisis was tightening its grip, the Chained
Consumer Price Index hit its previous record of 126.9.

“The Federal Reserve continues to
focus on the rate of change in inflation,” said Peter Bookvar, equity strategist
at Miller Tabak. “Sure, it’s moving at a slower pace, but the absolute cost of
living is now back at a record high in a country that has seven million less

The regular CPI, which has already
been at a record for a while, increased 0.5 percent, the fastest pace in 1-1/2
years. However, the Fed’s preferred measure, CPI excluding food and energy,
increased by just 0.2 percent.

“This speaks to the need for the
Fed to include food and energy when they look at inflation rather than regard
them as transient costs,” said Stephen Weiss of Short Hills Capital. “Perhaps
the best way to look at this is to calculate a moving average over a certain
period of time in order to smooth out the peaks and valleys.”

The so-called core CPI is used by
the central bank because food and energy prices throughout history have proven
to be volatile. However, one glance over the last two years at a chart of wheat
or corn shows they’ve gone in one direction: up. And many traders say Fed
Chairman Bernanke’s misplaced easy money policies are to blame.

Over time, the Bureau of Labor
Statistics has made changes to the regular CPI that it feels make it a better
measure of inflation and closer to a cost of living index. It improved the way
it averages out prices for items in the same category (e.g., apples) and also
uses the often-criticized method of hedonic regression (if you’re curious,
you can learn more about that
) to account for increases in product quality.

In 2002, the BLS created this
often-overlooked cost of living index in order to account for the kinds of
substitutions consumers make when times are tough. It is supposed to be even
closer to an actual “cost of living” measure than the regular CPI.

“For example, pork and beef are
two separate CPI item categories,” according to the BLS web site. “If the price
of pork increases while the price of beef does not, consumers might shift away
from pork to beef. The C-CPI-U (Chain Consumer Price Index) is designed to
account for this type of consumer substitution between CPI item categories. In
this example, the C-CPI-U would rise, but not by as much as an index that was
based on fixed purchase patterns.”

Beyond the money

“As the cost of living increases,
we are headed toward a bigger problem with the slowing of housing permits,” said
JJ Kinahan, chief derivatives strategist at thinkorswim, a division of TD
Ameritrade. “As the staples start to cost more, this could lead to a quick
slowdown in the auto and technology sectors as an iPad is an easy thing to pass
on if you are paying more for your gas and food and need to cut back

To be sure, it’s nearly impossible
to get a perfect “cost of living” measure, and the BLS acknowledges this on
their web site: “An unconditional cost-of-living index would go further, and
take into account changes in non-market factors, such as the environment, crime,
and education.”

Still, states will be cutting back
services drastically this year at the very same time they are raising taxes in
order to close enormous budget deficits and avoid a muni-bond defaults crisis.
So while it may be the missing link to a perfect cost of living measure, one can
assume that Americans will be paying more for unquantifiable services such as
police enforcement and education, but getting them at a lesser quality.

Bottom line: The cost of living
for Americans is now above where it was when housing prices were in a bubble,
stock prices at a record, unemployment low and consumer confidence was soaring.
Something has gotta give.

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