Replacing CPI with Gold and the S&P with the S&P/ Gold Index

[Graham Osborn]

I'm increasingly starting to feel that CPI is meaningless in the face of QE.  The true cost of living is just not being captured.  And if CPI is meaningless, money is meaningless even if there is relative meaning through exchange rates.  And if money is meaningless, the indices we use for tracking the performance of financial assets are meaningless as well.

 

I am not a gold bug and actually think gold is a bad buy right now.  But gold at least has some sort of tangible reality which is lacking in the world of fiat money.  For this reason, I think the S&P/ Gold index is a far more meaningful indicator than the S&P of market values.

 

Here's the link: http://www.macrotrends.net/1437/sp500-to-gold-ratio-chart

 

Make sure to turn off log scale for the full impact.

 

According to this way of thinking, we are in the final stages of the greatest economic collapse since 1929 and 1974, with probably 15% to go to reach rock bottom.  The market profits people have enjoyed the last 10 years have been more than offset by the vastly reduced purchasing power of the dollar.  The magic of central-bank policy has been to hide rather than change the outcome.

 

 

[RichardGibbons]

Why choose gold as the commodity to measure against?  Why not choose the price of zinc, mangos, or pork bellies?  Or, if you believe that commodities are the only true way to measure inflation, at least use a basket of commodities rather than just one?

 

I suspect that this sort of S&P 500/gold ratio analysis is post-hoc reasoning meant to justify a particular point of view rather than an unbiased attempt to understand the world (not saying this of you, Graham.  I'm saying this of whoever makes the charts.) 

 

In other words, if the chart had shown the S&P 500 ratio steadily increasing, I don't think anyone would have shown us the chart.  For instance, there's this oil and S&P500 chart on the same website: http://www.macrotrends.net/1453/crude-oil-vs-the-s-p-500.  But for some reason they don't include the ratio.

 

That said, I suspect the CPI doesn't measure inflation accurately (because of chained CPI and quality adjustments).  I'm just not a fan of using a single commodity to argue anything, even if the "gold is money" argument is very popular.

 

[sys]

what good or services are excluded from the cpi that you think would need to be included to capture the true cost of living?

[Graham Osborn]

Why choose gold as the commodity to measure against?  Why not choose the price of zinc, mangos, or pork bellies?  Or, if you believe that commodities are the only true way to measure inflation, at least use a basket of commodities rather than just one?

 

I suspect that this sort of S&P 500/gold ratio analysis is post-hoc reasoning meant to justify a particular point of view rather than an unbiased attempt to understand the world (not saying this of you, Graham.  I'm saying this of whoever makes the charts.) 

 

In other words, if the chart had shown the S&P 500 ratio steadily increasing, I don't think anyone would have shown us the chart.  For instance, there's this oil and S&P500 chart on the same website: http://www.macrotrends.net/1453/crude-oil-vs-the-s-p-500.  But for some reason they don't include the ratio.

 

That said, I suspect the CPI doesn't measure inflation accurately (because of chained CPI and quality adjustments).  I'm just not a fan of using a single commodity to argue anything, even if the "gold is money" argument is very popular.

 

S&P/ Crude looks qualitatively similar:

https://www.google.com/search?q=world+supply+of+oil+chart&rlz=1C9BKJA_enUS633US633&hl=en-US&prmd=nisv&source=lnms&tbm=isch&sa=X&ved=0ahUKEwiepvKr69XNAhUDkh4KHUOaDJwQ_AUICCgC&biw=768&bih=909#hl=en-US&tbm=isch&q=s%26p+to+crude+oil+ratio&imgrc=43RiJ_ft9waAuM%3A

 

I generated the hypothesis that gold would be a better metric than USDs before generating the chart.

 

I think you could do a similar analysis for other commodities as well.

 

I think we shouldn't give any particular denominator a priori favor, including CPI.

[Graham Osborn]

what good or services are excluded from the cpi that you think would need to be included to capture the true cost of living?

 

Here's the detailed weighting:

http://www.bls.gov/cpi/cpid1605.pdf

 

I am looking at this document for the first time but a couple things stand out.  For some reason tuition is only given a 3% weighting.  And home-buying costs are excluded as "investments" (a typical mortgage/ rent payment is 18-30% of household annual income and mortgagers/ renters ratio is probably procyclical):

http://www.bls.gov/cpi/cpiqa.htm

 

I'll have to dig through this more, but the home exclusion obviously helped hide the inflation in money supply leading up to and following the housing bust.  It's a bit like not deducting recurring acquisition and debt repayment outflows from FCF - you are ignoring a large/ recurring cash outflow for American families even though that outflow may have been one of the most significant cost-of-living increases over the past few decades.

 

If a small isolated country debases its currency you should be able to see that in the exchange rates.  But if the world's currencies were to be symmetrically debased, looking at just the exchange rate could be misleading.  It seems to me that any government agency-defined CPI would have the same conflict of interest since watering the money supply is an indirect form of taxation.

[sys]

educational costs may be underweighted, i don't know.  they don't feel like it to me, a childless adult, but a large family might think otherwise.  what the proper weight would be for the mean consumer, i can't say.

 

i'm not sure if i follow your argument regarding excluding the costs of purchasing housing causing the cpi to underestimate inflation.  the house i live in is cheaper than it was 10 years ago.  cheaper than it was 15 years ago.  maybe going back 20 years there's been some inflation.

 

not every market would show the same, but i think the general trend has been similar.  at any rate, i agree that methodologically, it makes sense to differentiate between housing costs and excess spending on housing due to real estate being used as an investment.

[RichardGibbons]

I find the SPY to oil one interesting in how flat it mostly is.  Like, in 2000, there was the big bubble popping, so the S&P 500 was responsible for the collapse there.  And then more recently you can see oil crashing, responsible for the ratio spiking recently.  But other than that, it's pretty flat between 2002 and 2014.

 

I found the one I was interested in, the S&P 500 versus commodity index ratio.

 

http://stocktwits.com/message/21305822

 

I wonder how you tell the difference between just the effects of bull/bear markets and actual inflation.  Or maybe that's a stupid question, I'm not sure....

 

[Graham Osborn]

educational costs may be underweighted, i don't know.  they don't feel like it to me, a childless adult, but a large family might think otherwise.  what the proper weight would be for the mean consumer, i can't say.

 

i'm not sure if i follow your argument regarding excluding the costs of purchasing housing causing the cpi to underestimate inflation.  the house i live in is cheaper than it was 10 years ago.  cheaper than it was 15 years ago.  maybe going back 20 years there's been some inflation.

 

not every market would show the same, but i think the general trend has been similar.  at any rate, i agree that methodologically, it makes sense to differentiate between housing costs and excess spending on housing due to real estate being used as an investment.

 

Where do you live just out of curiosity?  I would say what you've observed is pretty atypical relative to my experience.

 

There are many ways to slice it, but if you think of a situation where you get unprecedented home ownership (for example) and you're only tracking rent payments, you may be missing a big piece of the cost for families.  If (hypothetical #s) it costs an average family 50k/ year to live whereas it cost 30k/ year 5 years ago, I'd argue that should be reflected in CPI whether it is considered investment or not.  My FCF analogy was likely flawed because CPI is not like CapEx - what you are trying to measure is how much money people are throwing at the same old things.  So if families typically invest in a home and have done so for many decades, that cost should be reflected.  Conversely, atypical or inhomogeneous costs (say fine art purchases) probably are best excluded or the calculation would get too complex.

[KinAlberta]

John (Walter) Williams'wrigings on shadowstats might be of interest to the sceptics. I'm staying an agnostic due to my preferred ignorance of the calculations and issues.

 

http://www.shadowstats.com/article/no-438-public-comment-on-inflation-measurement

 

 

[sys]

Where do you live just out of curiosity?  I would say what you've observed is pretty atypical relative to my experience.

 

fresno, ca.

 

There are many ways to slice it, but if you think of a situation where you get unprecedented home ownership (for example) and you're only tracking rent payments, you may be missing a big piece of the cost for families.  If (hypothetical #s) it costs an average family 50k/ year to live whereas it cost 30k/ year 5 years ago, I'd argue that should be reflected in CPI whether it is considered investment or not.  My FCF analogy was likely flawed because CPI is not like CapEx - what you are trying to measure is how much money people are throwing at the same old things.  So if families typically invest in a home and have done so for many decades, that cost should be reflected.  Conversely, atypical or inhomogeneous costs (say fine art purchases) probably are best excluded or the calculation would get too complex.

 

it makes sense to me to consider inflation in the cost of living and inflation in the cost of investable assets separately.

[petec]

John (Walter) Williams'wrigings on shadowstats might be of interest to the sceptics. I'm staying an agnostic due to my preferred ignorance of the calculations and issues.

 

http://www.shadowstats.com/article/no-438-public-comment-on-inflation-measurement

 

I agree.  These data, combined with the obvious inflation in asset prices and therefore cost of shelter and cost to retire, make me think we are actually in the midst of a huge inflation, with more to come.

[petec]

i'm not sure if i follow your argument regarding excluding the costs of purchasing housing causing the cpi to underestimate inflation.  the house i live in is cheaper than it was 10 years ago.  cheaper than it was 15 years ago.  maybe going back 20 years there's been some inflation.

 

The house is cheaper?  Or the monthly payments to buy it are cheaper?  This is a genuine question - I'm not sure which you mean.  But, obviously, they are different:

 

If a house costs $100,000, rates are 5%, and you need 25% down, then your cost to buy is $25,000 plus $3,750 a year in interest. 

 

If the same house costs $200,000 20 years later, but you pay 2% and put 10% down, then your costs are $20,000 and $3,600.

 

Which house is cheaper? ;)

 

Clearly I'm excluding amortisation payments here for simplicity but I do think asset prices should be included in whatever measure of inflation the Fed looks at.  Otherwise they fail to capture the true inflation in the cost of shelter and saving for the future, both of which are key family outlays.  Paying off a mortgage and saving for the future are costs of living.

 

[SharperDingaan]

CPI is pretty meaningless as a personal cost comparative - if only because if your basket of goods is significantly different from the CPI basket, you are comparing apples to oranges. You may have different weightings, &/or entirely different purchases altogether.

 

The reality is that both your costs (in fiat $), & the benchmark (gold) are moving - so you are measuring 'relative' change. Both periodic debasement of the fiat $, &/or panic buying/selling of the benchmark - screw up the comparison. The whole 'basket of goods' concept is a diversification measure aimed at reducing this problem.

 

For most of us - the working measure is monetary growth (central bank target) + GDP growth (export/import) + local area growth (where we live). In simple terms; at 1% monetary (inflation), .5% GDP, & 1.0% local - you would have 2.5% cost growth/yr. The technical measure is ((1+monetary)*(1+GDP)*(1+local) - 1) x 100. If you consume a lot of imported product (foods) & your local currency has devalued - your local growth could be a lot higher (5-10%+)

 

As most of us are primarily concerned with daily cost of living increases - local growth affects us most. Hence the focus on 'cheapness', clipping cents of the cost of gas, coupon clipping, etc.

 

SD

   

[Graham Osborn]

John (Walter) Williams'wrigings on shadowstats might be of interest to the sceptics. I'm staying an agnostic due to my preferred ignorance of the calculations and issues.

 

http://www.shadowstats.com/article/no-438-public-comment-on-inflation-measurement

 

Hi KA, thanks for this link - it's an interesting read.  I guess it's not surprising that Greenspan championed the policy in the 90s given that it would later provide a cloak for his/ Bernanke's stimulatory policies in the 2000s as the recession set in.

[Graham Osborn]

John (Walter) Williams'wrigings on shadowstats might be of interest to the sceptics. I'm staying an agnostic due to my preferred ignorance of the calculations and issues.

 

http://www.shadowstats.com/article/no-438-public-comment-on-inflation-measurement

 

I agree.  These data, combined with the obvious inflation in asset prices and therefore cost of shelter and cost to retire, make me think we are actually in the midst of a huge inflation, with more to come.

 

Retirement cost is an interesting point, particularly when you consider the relative absence of pensions relative to the mid-1900s and the substantial losses to pension funds these past 16 years.

[TwoCitiesCapital]

John (Walter) Williams'wrigings on shadowstats might be of interest to the sceptics. I'm staying an agnostic due to my preferred ignorance of the calculations and issues.

 

http://www.shadowstats.com/article/no-438-public-comment-on-inflation-measurement

 

I agree.  These data, combined with the obvious inflation in asset prices and therefore cost of shelter and cost to retire, make me think we are actually in the midst of a huge inflation, with more to come.

 

This assumes that prices remain elevated which is unlikely from a historical perspective. When looking at equity multiples, traditionally when they reach elevated heights, they correct to form incredibly low bottoms. Sure, retirement is expensive now! After a 50% correction? Not so much.

 

I tend to buy the demographic argument against real estate for most Western countries which would support lower housing prices in places with aging/declining populations. At least for a period of 10 years or so before the real thrust of the millenial family growth outweighs that of the boomer decline. Disclaimer: I'm biased towards deflation and have regularly said that it needs to show up in housing for it to be sustained, so could just be inclined towards my own thesis.

 

As a 27 year old the majority of my friends are content renting. Obviously, this will likely change as they get married and have children, but statistics suggest that this is occurring a lot later for millenials (every year the average age for them to get married ticks up - pushing 30s now). Having lived in TX, MS, LA, NJ, and NY - I can confirm that I only have 3 friends who are married (all from Southern States) and the remainder remain single. Those in NY aren't even in committed relationships and most are late 20s and early 30s. It's hard for me to imagine much of a change in this trend over the next 5 years. 10 years could start to make a difference but remains to be seen.

 

I'd imagine that there's likely to be large imbalances in the real estate inventory and real estate demand as boomers downsize or pass away while millenials continue putting off buying until they establish families. Also, my guess is that they'd be satisfied with smaller houses too given their long-term experience in apartments/condos and their inability to have save as much money as their parents did by that age.

 

It's hard for me to imagine how the trillions of money printed by the Federal Reserve isn't inflationary, but it doesn't seem to have made it's way into circulation for goods yet. Obviously, asset prices are supported, but those prices are established at the margin (each individual trade reprices the whole company and not just a purchase for the whole company). It's quite easy to see a scenario where the Federal Reserve has $4 trillion in "stock" but the marginal flow pushes asset prices downwards regardless of what the Fed owns.

[sys]

The house is cheaper?  Or the monthly payments to buy it are cheaper? 

 

i was talking about the house, although i'm sure the monthly payments are also cheaper.

 

 

obviously the time comparison chosen matters quite a bit in this example.  the price of the house has deflated significantly from 10 years ago, inflated significantly from 5 years ago.

[Graham Osborn]

Some good discussions here.  Now an interesting corollary is: if we accept for the sake of discussion that gold or some other commodity with a relatively stable supply would be a better measure, and that the revised S&P is more representative, it raises the question of what is the effect of central banking policy these last 10-15 years?  Clearly part of the losses have already been taxed away from the world's population through "adjusted" inflation.  But additionally, one must remember that the effect of debt is to migrate future cash inflows to the present.  This may help explain why in at least parts of the developed world (such as the US) the economy feels to be booming even though we are in a 15-year deepening recession.  But it also means that new stimulative fiscal policies will have to fight the effects of older stimulative policies that are now entering their anti-stimulative (repayment) phase.  I refer of course significantly to the QEs.  This implies that while these MPs can delay the onset of the austerity that should accompany such an economic downturn for a time, in the end those policies will only worsen the fate of debtor nations.

 

People have been talking about this since the 80s at least and predicting an imminent collapse which has never occurred.  I guess the question is, when you are near the bottom of a paper recession/ depression, is it reasonable to think that the non-financial world will start to "feel like a recession" or "feel like a depression" in the next 5-10 years?

 

Another interesting thing is if you look at the stock market collapses of 29 and 74, the SPE of the stock market was very low.  To date we haven't seen that at all, although certainly the SPE in 2000 was higher than 2007/ 2016.  The denominator is clearly worth less since corporate profits are also reduced by inflation, but even thus adjusted they would be quite high particularly for dividend-paying stocks eg utilities.  My guess is that the answer has to do with record levels of corporate debt which are supported by QE particularly in this last leg of ECB bond purchases - so perhaps the multiple compression will occur as corporations start defaulting on front-loaded debt servicing programmes - viz SPE ignores whether those earnings are leveraged although that is a key determinant of their forward stability.

[nsa122]

http://investor.visa.com/news/news-details/2015/Visa-Analysis-Shows-Retail-Spending-Up-in-AprilAcross-Most-Major-Categories/default.aspx

 

This certainly doesn't replace CPI, but maybe complementary.  Seems like Consumer Reports or some such organization could do an annual survey of household expenses for those who were willing to spend the time to contribute.