Last week’s Market Commentary sparked a lot of commentary about what should, and what should not, be included in the inflation metrics used by the Fed. This kind of response is what I had hoped. Our intention in creating an “adjusted CPI” was simply to begin a conversation about incorporating asset prices in the formulation of monetary policy.
We continue to feel that the Fed, by repeatedly failing to stem excessive speculation in the asset markets, has put our economy in a seemingly endless cycle of boom-and-bust. Each of the recessions over the past twenty years was preceded by rapid increases in asset prices (stocks, bonds, housing, etc), the likes of which have rarely been seen in US history. The bubble in technology stocks ended in disaster early in the new millennium, only to be replaced by a bubble in residential real estate as central bankers tried to lessen the pain and lift up the economy. The bubble in residential real estate burst in 2007-2008, resulting in the worst economic downturn since the Great Depression. These are clear cause-and-effect relationships, in our opinion.
Having said all that, I fully recognize that the “adjusted CPI” we created is not applicable to the entire population and therefore should not be used in place of the CPI that is currently used. Rather, the best way to frame an argument for the use of an adjusted CPI (ie, one that includes asset prices) is in the context of the unbalanced nature of the economic recovery. In other words, the adjusted CPI is really much more relevant for the “have nots” rather than the “haves”. Those that already own assets are of course helped tremendously by a surge in asset prices. But those with very small amounts of assets only fall further and further behind.
Since the beginning of the economic recovery, we have argued repeatedly that the recovery is accruing mainly to the “haves” while the “have nots” are barely participating. Until now, we have said that the “have nots” are getting the short end of the stick because they are experiencing neither better job opportunities nor wage/income increases while expenses for necessities continue to rise. In other words, they continue to get squeezed by weak income growth and higher living expenses.
Higher-income/wealthier individuals, on the other hand, have experienced improved job opportunities and rapid gains in income and wealth since the end of the recession. Many different studies all come to the same conclusion: those at the very top of the income/wealth distribution (top 5%, top 1%, however you want to define it) have claimed the overwhelming percentage of total income growth during the economic recovery. All this is still true.
With the adjusted CPI, we take this argument a step further. We are now saying that the bifurcated economic recovery is being exacerbated by the fact that asset prices have skyrocketed. Again, increases in stock and housing prices have obviously been incredibly beneficial to those fortunate to have significant ownership in these assets. But those who don’t own stocks or houses in a meaningfully way are doubly hurt. First, they have missed out on the huge appreciation over the past six years. Second, they will now be forced to begin building wealth and saving for retirement by investing in assets that are heavily inflated in price (and which therefore have much lower expected returns in the future).
So, I think the adjusted CPI, while not really directly applicable to the population at large, does a decent job at quantifying the overall level of consumer inflation among the less well-to-do. If I am just starting out (for example college graduates, immigrants, poor people, etc), my path to financial independence is significantly handicapped because of the inflation in stocks, bonds and housing. And because we think the economic rebound will only become self-sustaining when the benefits of the recovery are more broad-based, we think that it would be beneficial for the Fed to look at something like our adjusted CPI. But perhaps more importantly, the adjusted CPI makes it clear that asset inflation is not an unambiguous positive. The lion’s share of the increase in asset prices has gone to a small percentage of the population and has not yet trickled down to the masses, as expected. Therefore, the Fed runs the risk of creating asset bubbles when the benefits to the economy at large are still very unclear.
Discussion to be continued!