Will the Real Inflation Rate Please Stand Up?

economic forecastThe American Institute for Economic Research (AIER), a not-for-profit research group, believes that the Consumer Price Index (CPI)—as measured by the government—does not reflect the true inflation rate in this country.

The AIER believes that the true cost of living should include everyday items that consumers must spend money on, which the CPI does not fully reflect. With this theme in mind, the institute went to great lengths to create its very own Everyday Price Index, which stands in contrast to the CPI.

The CPI includes many one-time big ticket item purchases in its inflation rate calculation. Computers, appliances and furniture are just some of the big purchase items that are part of the CPI.

The idea behind the Everyday Price Index is that the typical American family does not plan their budget on big-ticket items like the CPI assumes. The AIER contends that the things Americans must purchase at least once a month are what affect their budget.

The Everyday Price Index gives more weight in its calculation to food, gas prices, child care, prescription drugs, and Internet service than the CPI does. The CPI includes these items as well, but the CPI has less emphasis on these items, because the index makes room for the big-ticket items like furniture.

Over the last 12 months from February 2011 to February 2012, the Everyday Price Index claims that the true inflation rate in America was eight percent. The CPI during this same time period claims that the inflation rate was 3.1%.

The AIER claims that technology has helped bring down the prices of big-ticket items like cars and televisions. However, technology has not done much to bring down the price of bread. As such, the AIER believes that the largest inflation rate increases for the average American household, in the last 12 months, have come from fuel, food, beverages, and prescription drugs.

Any index that tries to capture the true inflation rate in this country will have its shortfalls, simply because it is a very difficult task to undertake. One can debate who has the more accurate number, but I believe the better gauge of who is doing a better job is our average reader. We’ll be doing a survey amongst our Profit Confidential e-mail-only subscribers to get their thoughts on what the true inflation number might be. Our web-only readers won’t be participating in the survey, but you can certainly get in on the results! The survey results will be published in my column next Thursday, March 15.

Michael’s Personal Notes:

In terms of what economic growth will look like in 2012, the mainstream is sticking to the “muddling along” economic forecast theory.

Just as in 2011, the economic forecast talk is of the U.S. being fine and that we will “muddle along” economically. I’ve been watching markets for 30 years and I’ve never seen economies “muddle along.” Economic growth either expands or contracts.

As I’ve been warning readers, the European recession (finally deemed official now by the European Central Bank [ECB], I declared it in January of this year) will affect China, which would eventually hit home right here in the U.S.

What’s startling is the quickness of the decline in the Chinese economy.

It was roughly two months ago that China’s fourth-quarter gross domestic product (GDP) came in at 8.9%. The Chinese economy was slowing, but economic forecasts remained in the 8.5%-9.0% range.

This week, China’s premier reduced the country’s GDP economic forecast for growth in 2012 to 7.5% from 8.0%. This may not seem like a significant drop, but compared to where we were even a few months ago, the drop is significant.

If GDP growth comes in as expected in 2012 at 7.5%, it would be the lowest economic growth experienced in China since 2004. Here are China’s GDP statistics over the last few years, dear reader…

(Is there a pattern developing?)

2010 China GDP: 10.4%

2011 China GDP: 9.2%

2012 China GDP: 7.5% (economic forecast by Central Bank of China)

The slowdown in China and Europe is affecting other nations in Asia, namely Japan, Singapore, South Korea, and Malaysia. The drop-off in exports reported by each of these countries has been dramatic. The drop-off in economic growth for these countries as a consequence has been dramatic as well.

China is being proactive by lowering reserve requirements for its banks (equivalent to an interest-rate cut here in the U.S.).

The question now becomes: will this economic slowdown accelerate or will we “muddle along?” Will China’s economic growth rate drop below the 7.5% economic forecast?

News this week out of Europe showed how Europe’s services industries contracted more than the economic forecast of economists. It is now in five of the last six months that this index has shown negative economic growth, with an ongoing falloff in new business (source: Markit Economics).

So can China’s economic slowdown accelerate? The answer of course is yes, as the economic slowdown in Europe looks to be accelerating.

With this backdrop around the world, how can the U.S. possibly escape difficult times ahead? To make matters worse, I’ve been detailing the plight of the average U.S. consumer. With both these headwinds against the U.S. economy, how can the economic forecasts maintain strong U.S. economic growth?

I would say be careful of that stock market rally, dear reader. Yes, the U.S. stock market sold off on news that China was lowering its growth forecast for 2012, but the selloff was mild in my opinion. The 5.0% to 10% upside the bear market rally has left might not be worth the risk at this point.

Where the Market Stands; Where it’s Headed:

Late last year, I warned that 2012 would be a very difficult year for the global economy. Only three months into it now and the ECB has acknowledged that the European Union is in a recession, China’s economy is growing at the slowest pace in years, inflation is soaring and, no matter what they tell me about the U.S. economy, it’s in trouble, too.

Short-term interest rates cannot fall below zero. The U.S. government can’t borrow above its debt ceiling level until it asks for a new ceiling (what a joke). I continue to call for very difficult economic times ahead…and that’s what will eventually end this three-year bear market rally in stocks.

What He Said:

“The Real Threat to the Economy: U.S. retail sales are falling, the producer price index is crashing, house prices, car prices are all falling—and no one is talking about deflation but me. Fed governors are still talking about inflation—they’ve got it wrong. There’s no need for me to get into the dangers of deflation, as I’ve written about them (many times) before. Let’s just put it this way: Deflation is about the worse economic state a country will experience. The risks to the U.S. economy in 2007 are greater than I’ve seen in years.” Michael Lombardi in PROFIT CONFIDENTIAL, November 15, 2006. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.