In dismissing the inflationary warnings of Austrian School economists, the pro-stimulus Keynesians have largely refrained from attacking the root of our logic. (Given that this involves defending the position that money printing does not lead to inflation, their reluctance is understandable). Instead they point to the lack of “evidence” that shows prices going up in step with money supply increases.  Paul Krugman himself unpacked these arguments in a recent blog post designed to specifically discredit my views. 

According to Krugman, the sub 2.5% increases in the Consumer Price Index (CPI) over the past few years are all that is needed to invalidate the fears of the inflationists.

However, there is plenty of evidence to suggest that the measurement tools used by Krugman and his cohorts to measure inflation are as deeply flawed as their arguments. And to conclude that inflation has been quelled requires a dismissal of the macroeconomic forces that have temporarily blunted the impact of an overly loose monetary policy.

Since the 1970’s the preferred government inflation metrics have changed so thoroughly that they bear scant resemblance to those used during the “malaise days” of the Carter years.  Government and academia defend the integrity and accuracy of the modern methods while dismissing critics as tin hat conspiracy theorists. But given the huge stakes involved, it’s hard to believe that institutional bias plays no role. Government statisticians are responsible for coming up with the methodology and the numbers, and their bosses catch huge breaks if the inflation numbers come in low. Human behavior is always influenced by such incentives. 

Beginning in the early 1980’s the methodologies were altered to compensate for a variety of consumer behavior. The new “chain weighted CPI” for instance incorporates changes in relative spending, substitution bias, and subjective improvements in product quality.

Essentially these measures report not just on price movements, but on spending patterns, consumer choices, and product changes. This is fine if the goal is to measure the cost of survival. But that is not the purpose for which these metrics are meant to be used.  But if you simply focus on price, especially on those staple commodity goods and services that haven’t radically changed over the years, the underreporting of inflation becomes more apparent. 

We randomly identified price changes of 10 everyday goods and services over two separate 10 year periods, and then compared those changes to the reported changes in the Consumer Price Index (CPI) over the same period. The 10 items, which we selected are: eggs, new cars, milk, gasoline, bread, rent of primary residence, coffee, dental services, potatoes, and electricity.

We know that people do not spend equal amounts on the above items, and we know their share of income devoted to them has changed over the decades. But as we are only interested in how these prices have changed relative to the CPI, those issues don’t really matter. We chose to look at the period between 1970 and 1980 and then again between 2002 and 2012, because these time frames both had big deficits and loose monetary policy. But they straddle the time in which the most significant changes to inflation measurement methodology took effect. And while nominal price increases rose much faster in the 1970’s, the degree to which the prices rose relative to the CPI was much, much higher more recently. 

Between 1970 and 1980 the officially reported CPI rose a whopping 112%, and prices of our basket of goods and services rose by 121%, just 8% faster than the CPI. In contrast between 2002 and 2012 the CPI rose just 27.5%. But our basket rose by nearly double that rate – 52.1%!  So the methods used in the 1970’s to calculate CPI effectively captured the price changes of our goods, but only got half of those movements more recently. How convenient.

Just to make sure, we ran the same experiment with 10 different goods and services. This time we chose: sugar, airline tickets, butter, store bought beer, apples, public transportation, cereal, tires, beef and veal, and prescription drugs. The results were notably similar. The basket increased 1% faster than the CPI between 1970 and 1980 and 32% faster between 2002 and 2012. In both cases we selected a random array of food and non-food items.

To be convinced that the CPI does a poor job in gauging the cost of living, all one needs to do is look at health insurance. According to the Kaiser Survey of Employer Sponsored Health Insurance, the average annual total cost for family health insurance in 2012 was $15,745, or more than one third of the median family income of $45,018 per year. Yet these costs are largely factored out of the CPI. In 2011, health insurance costs did not even merit a one percent weighting in the CPI. Furthermore, as far as the Bureau of Labor Statistics is concerned, health insurance costs are well contained. From 2008 through 2012, the BLS’ “Health Insurance Index” increased just 4.3% (total), which is far below the general rise of the CPI. In contrast, the Kaiser Survey showed family coverage rising 24.2% over that time.  

A recent poll of likely voters conducted by Fox News in the weeks before the election, revealed that 41% of respondents identified “rising prices” as their top economic concern. This response beat out “unemployment” by nearly two to one.

The underreporting of price movements would explain why inflation is a concern on Main Street even while it’s not a concern on Pennsylvania Avenue. If these price changes in our experiments had been fully captured, CPI could currently be high enough to severely restrict Fed action to stimulate the economy.

But beyond arguments over the accuracy of our inflation yardsticks, there are solid reasons that prices are not rising as fast as they could be given the printing binge that has characterized the last few years. Economies no longer come in the neatly packaged national varieties. To a very large extent monetary conditions within the United States now are being influenced by activities of other countries. 

Over the past years, unprecedented amounts of dollars have been created. But much of that money does not stay within the confines of the U.S. economy. A very large percentage of it winds up locked away inside the vaults of foreign central banks, particularly in the Far East. Countries like China and Japan, that run large trade surpluses with the U.S., need to warehouse these greenbacks so that they can keep their own currencies from appreciating against the dollar. The International Monetary Fund estimates that from first Quarter 2008 and second quarter 2012, U.S. dollars held in reserve by foreign central banks increased by $850 billion, or 31%.    

When these countries decide that holding huge amounts of dollars is no longer in their interest, the money could come flooding back onto these shores, where it will exert upward pressure on domestic prices. In the meantime, the current flow of funds allows for a windfall for U.S. consumers. An artificially supported dollar means that we do not pay as much as we could for imported products. The low prices at Walmart are not the result of a sluggish U.S. economy, but by greater production abroad and dollar support from foreign central banks. 

But in the meantime, it’s not as if those dollars have been neutered of their price raising power. Rather than being spent by U.S. consumers to push up domestic prices, they are creating inflation abroad and helping to push up the prices of U.S. Treasury Bonds, which foreign central banks buy with their excess dollars.

Given how weak the economy has been since the crash of 2008,it is surprising that domestic prices have risen at all. While there have been many similarities between the Great Depression and the Great Recession, one great difference was that the crash of the 1930’s was accompanied by significant deflation. By some estimates, prices fell by about a third.  And so while consumers and businesses then struggled with unemployment and dropping share prices, at least they were cushioned by falling prices. Today we have no such support.

The Bureau of Economic Analysis reports that in December of 2008 food and energy spending, as a share of wages and salaries, had fallen to a low of 18.7%. Today that figure stands at 22.1%, an increase of more than 18% in just four years. This indicates that the stimuli of the past four years have failed to create the beneficial impact its architects had hoped.  People who are spending a higher percentage of their incomes on necessities like food and energy are likely to be experiencing lower living standards. 

Unlike Krugman and the Keynesians, I would argue that it is impossible to create something from nothing. I believe that printing a dollar diminishes the value of all existing dollars by an aggregate amount equal to the purchasing power of the new dollar. The other side takes the position that the new money creates tangible economic growth. I think that those making such absurd claims should bear the burden of proof.  

The Godfather of Newsletter writers, the 88 yr old Richard Russell has lived through depressions and booms, through good times and bad, through war and peace. He was educated at Rutgers and received his BA at NYU. Russell flew as a combat bombardier on B-25 Mitchell Bombers with the 12th Air Force during World War II.

Richard’s comments below:

“You and I are watching, or I should say living through, the greatest bubble in world history.  What could it be?  Is it the world population growth?  Is it the explosion of world communication?  Is it the progress in health?”

“It might be any one of those, but no — it’s the credit bubble.  Think of it.  The US now has a national debt of over $16 trillion.  That doesn’t include incurred debt that is not on the books.  The question is — how will this enormous debt ever be handled?  (1) It might be refinanced, meaning that it might be (if possible) kicked down the road like an old tin can.  

(2) It might be reneged on, which would be a default (unthinkable, since this would be an admission of sovereign bankruptcy.  (3) The debt could be addressed through devaluation, meaning destroying the purchasing power of the dollar.  The third is by far the most likely way that the debt will be addressed, since we are already on this path.  Politically, it is the most palatable way, since it is the way that attracts the least attention from the voters.

Right now sophisticated investors are protecting themselves from the diminishing purchasing power of the dollar.  How do they do it?  Easy, they swap their Federal reserve notes for tangible items of value — million dollar apartments in New York, fabulous works of art, rare gems and jewelry, property such as thousands of acres in New Mexico or Montana, classic automobiles such as rare Ferraris or Mercedes, hundreds of acres of arable farmland, collectibles, and silver, platinum and gold.

For the average person, most of the foregoing are difficult or even impossible to own.  My own thought is that the easiest and most sensible way is to own silver or gold.  The question is always, “OK, so I own some gold coins. Where should I put them?”  Ah, the eternal question.  My suggestion is (1) place them in a good steel safe at home, (2) bury them in a plastic container in the ground, (3) buy the coins through an outfit you can trust such as a Swiss or Canadian bank, (4) place the coins in a bank vault.

My own instinct is to watch the unfolding picture, and “play it as it lays.”  In other words, I honestly don’t know how this is all going to play out and neither does anyone else.  The one thing I feel certain about is that the current debt or credit bubble will be met with devalued dollars.  That means that we should all prepare for tough times and above all, we must PAY ATTENTION.

Below, gold appears to be finding support in the area of its red 200-day moving average.

Technical analysis is more an art than a science.  Often it entails deciding which studies to believe and which studies to jettison at any given time.  Right now, I’m interested in the VIX, often referred to as the “fear index.”  Over the last day or so, the VIX has suddenly surged to a bit over 20, as you can see on the chart below.  This means that options buyers are preparing for an increase in volatility some time during the coming 30 days.

I pair the jump in the VIX with the rising count of distribution days in the markets.  Distribution days are days when the market is down, while volume is more than the volume of the preceding day.  Distribution days tend to be days when the institutions are selling.

Late Notes – We’re now at an interesting juncture where technical conditions in the market are poised against potentially very bullish news.  Even if news of the completion of the fiscal cliff comes out, I’m not sure whether the Dow has enough strength to better its September high — particularly since technical conditions are negative for the Dow. 

For this reason, I have chosen to remain neutral and safe.  Long-term, my preferred position is to have one-third of my assets in cash, one third in my home, and the rest in gold (bullion coins if possible).”

You can subscribe to Richard Russell’s Dow Theory Letters (highly recommended and great value) by  CLICKING HERE. As an added plus for subscribers, Richard publishes the latest Primary Trend Index (PTI) figure for the day on his web site, 9 times out of 10 with a poignant  commentary.

Russell began publishing Dow Theory Letters in 1958, and he has been writing the Letters ever since (never once having skipped a Letter). Dow Theory Letters is the oldest service continuously written by one person in the business.

Russell gained wide recognition via a series of over 30 Dow Theory and technical articles that he wrote for Barron’s during the late-’50s through the ’90s. Through Barron’s and via word of mouth, he gained a wide following. Russell was the first (in 1960) to recommend gold stocks. He called the top of the 1949-’66 bull market. And almost to the day he called the bottom of the great 1972-’74 bear market, and the beginning of the great bull market which started in December 1974.

The Letters, which originally were published every three weeks, covered the US stock market, foreign markets, bonds, precious metals, commodities, economics –plus Russell’s widely-followed comments and observations and stock market philosophy.

In 1989 Russell took over Julian Snyder’s well-known advisory service, “International Moneyline”, a service which Mr. Synder ran from Switzerland. Then, in 1998 Russell took over the Zweig Forecast from famed market analyst, Martin Zweig. Russell has written articles and been quoted in such publications as Bloomberg magazine, Barron’s, Time, Newsweek, Money Magazine, the Wall Street Journal, the New York Times, Reuters, and others. Subscribers to Dow Theory Letters number over 12,000, hailing from all 50 states and dozens of overseas counties.

A native New Yorker (born in 1924) Russell has lived through depressions and booms, through good times and bad, through war and peace. He was educated at Rutgers and received his BA at NYU. Russell flew as a combat bombardier on B-25 Mitchell Bombers with the 12th Air Force during World War II.

One of the favorite features of the Letter is Russell’s daily Primary Trend Index (PTI), which is a proprietary index which has been included in the Letters since 1971. The PTI has been an amazingly accurate and useful guide to the trend of the market, and it often actually differs with Russell’s opinions. But Russell always defers to his PTI. Says Russell, “The PTI is a lot smarter than I am. It’s a great ego-deflator, as far as I’m concerned, and I’ve learned never to fight it.”

Letters are published and mailed every three weeks. We offer a TRIAL (two consecutive up-to-date issues) for $1.00 (same price that was originally charged in 1958). Trials, please one time only. Mail your $1.00 check to: Dow Theory Letters, PO Box 1759, La Jolla, CA 92038 (annual cost of a subscription is $300, tax deductible if ordered through your business).

IMPORTANT: As an added plus for subscribers, the latest Primary Trend Index (PTI) figure for the day will be posted on our web site — posting will take place a few hours after the close of the market. Also included will be Russell’s comments and observations on the day’s action along with critical market data. Each subscriber will be issued a private user name and password for entrance to the members area of the website.

Investors Intelligence is the organization that monitors almost ALL market letters and then releases their widely-followed “percentage of bullish or bearish advisory services.” This is what Investors Intelligence says about Richard Russell’s Dow Theory Letters: “Richard Russell is by far the most interesting writer of all the services we get.” Feb. 19, 1999.

Below are two of the most widely read articles published by Dow Theory Letters over the past 40 years. Request for these pieces have been received from dozens of organizations. Click on the titles to read the articles.

Hint, bet against the US.

Morgan Stanley’s global cross-asset strategy team, led by Greg Peters, is out with its Top 10 Asset Allocation Trades for 2013.

The trades sum up investment bank’s macro views and are fairly straightforward: all of the trades consist of stocks, bonds, and currencies.

One interesting aspect of the team’s recommendations: they are mostly skewed away from investing in U.S. assets, as Morgan Stanley sees other areas they think represent bigger opportunities.

….view the 10 Top Asset Allocation Trades HERE

For what amounts to a touch of good news in what is otherwise a challenging economic environment, home prices have worked their way generally higher over the past year. For some perspective on the single-family home market, today’s chart presents the median single-family home price divided by the price of one ounce of gold. This results in the home / gold ratio or the cost of the median single-family home in ounces of gold. For example, it currently takes a relatively low 105 ounces of gold to buy the median single-family home. This is dramatically less than the 601 ounces it took back in 2001. When priced in gold, the median single-family home is down over 80% from its 2001 peak. However, the recent uptick has home prices once again testing resistance of a steep seven-year downtrend channel.

Notes:
Does the real estate plunge continue? The answer may surprise you. Find out now with the exclusive & highly regarded charts of Chart of the Day Plus.

Quote of the Day
“Nothing beats a little cash in a bear market, of course, and the oldest form of cash is gold.” – James Grant

Events of the Day
January 01, 2013 – New Year’s Day – Rose Bowl – Orange Bowl
January 02, 2013 – Sugar Bowl
January 03, 2013 – Fiesta Bowl
January 07, 2013 – BCS Championship Game

Stocks of the Day
— Find out which stocks investors are focused on with the most active stocks today.
— Which stocks are making big money? Find out with the biggest stock gainers today.
— What are the largest companies? Find out with the largest companies by market cap.
— Which stocks are the biggest dividend payers? Find out with the highest dividend paying stocks.
— You can also quickly review the performance, dividend yield and market capitalization for each of the Dow Jones Industrial Average Companies as well as for each of the S&P 500 Companies.

 Chart of the Day – Where’s the Market Headed

Where’s the Dow headed? The answer may surprise you. Find out right now with the exclusive & Barron’s recommended charts of Chart of the Day Plus.

Due to the Christmas holiday, there will be no articles posted on Michael Campbell’s Money Talks website for a few days, specifically today, Christmas Day and Boxing Day.  We’ll be back in full on Thursday the 27th. 

We want to wish you and your family a very, hery happy holiday and Merry Christmas!

Bless you all

P.S. If you’re looking for something to explore over the next few days, Mark Leibovit shared a fascinating Free Service with 1000’s of articles written by a man who is an international investor, entrepreneur, permanent traveler, free man. To read Simon Black’s Sovereign Man go HERE