Con Job Finger-Pointing
By Dan Spillane, The Liberty Whistle
--“Con Man” is actually “Dark Thief in the Night"
(SEATTLE) 10/13/04 -- Bill Gross’s " Haute Con Job” (Pimco, October 2004) drew quick criticism from Bloomberg’s John Berry and the Fed’s William Poole, according to the latest exchange in Gross’s rebuttal.
Yet, the main—and very financially relevant--point of Bill’s original story seems to have evaded both Berry and Poole.
That being, over the long term, an increasing number of hedonic and other adjustments and non-adjustments (such as rent
equivalence) have come to change--and in many cases lower--major headline inflation indices since the 1980s. However,
during the same period, there is absolutely no evidence that government programs and financial instruments keyed on
these inflation indices have factored such changes in. Thus, in practical terms, inflation expectations and fiscal
actions related to inflation reports have been based on indices assuming constant measures—but instead, the measures
have drifted. In scientific circles, this is heresy--imagine the consequences of changing the definition of a mile or
kilometer. Suddenly, cars might be more (or less) fuel-efficient based on a government edict!
So all the talk about “inflation in the 1970s” related to present figures is based largely on non-comparable headline
numbers. And in fact, more recently, and to some unknown extent each year, changes in inflation-measuring indices have
lead to an unidentified gap between the actual cost of things, and reality. So Gross is right on track.
And speaking of reality, you have to question the application of hedonic measures in practical contexts. Take for
example, the measures for personal computers (and as a side note-- Berry’s analysis correctly states the CPI computer
weighting is small, but neglects to mention the high negative magnitude). In the case if computers, it is assumed that
we are always getting “more bang for the buck” in terms of hardware. Yet, as everyone knows, computer hardware is fully
dependent on software. And, as it turns out, new versions of computer software often require more hardware--which
largely negates the hedonic price decay used in US CPI calculations. Therefore, if we assume we live in a globally
competitive economy, in order to retain a level of relative productivity growth, it is correct to assume the amount
spent on computers will not fall by nearly as much as reported in the CPI, if at all. In fact, as the number of software
applications grows to cover more tasks, it is likely a more expensive computer will be not only desired, but be needed
to handle new tasks. In other words, the notion of hedonics and price decay is a sham—or con job. Indeed, over time, and
combined with other factors in the CPI, this heist has slowly and quietly slipped in to the US bond market and social
entitlement programs. That is, very much like a thief in the night—who, being unnoticed, keeps coming back for more.
Unnoticed…or willfully ignored, by Berry and Poole, as the case might be.
ENDS