Inflation Rising While Wages Are Falling

Inflation Rising While Wages Are Falling


Holy hump day – markets look to be rockin’ and rollin’ again today after this morning’s data releases from the Bureau of Labor Statistics.


First on the dance floor is the U.S. Consumer Price Index (CPI), which rose more than expected.  Headline figure increased 0.5% seasonally adjusted, over the prior month versus expectations for 0.3% increase and 2.1% over the last 12 months, not seasonally adjusted, versus expectations for an increase of 1.9%. Excluding food and energy, rose 1.8% nsa, versus expectations for 1.7%. The recent market fears that the Federal Reserve is going to get more aggressive in how quickly it takes away its loose policy punchbowl are only going to get worse after this report. Hello volatility, we didn’t think you were done with us!


Most areas saw price increases over the past year, with the exception of commodities less food and energy, declining -0.7%, new vehicles -1.2%, used cars and trucks, -0.6%, and apparel -0.7%. These declines reveal the lack of retail pricing power, even on the auto lot, reinforcing our Cash-Strapped Consumer investing theme as well as the deflationary power of our Connected Society theme whereby consumers are able to quickly compare prices without incurring any meaningful costs.


Next up is the Real Earnings Summary, also from the Bureau of Labor Statistics, which found that real average hourly earnings for all employees actually declined -0.2% from December to January, seasonally adjusted. Nominal earnings rose 0.3%, but the 0.5% increase in CPI wiped out that gain. What is even more disconcerting is that the over 80% of the population in the Production and Nonsupervisory Employees category saw their real average weekly earnings declined by 0.8% over the month thanks to both a decrease in real average hourly earnings and a 0.3% decline in average weekly hours. Year-over-year this group saw real average weekly earnings rise a meager 0.2% – again reinforcing our Cash-Strapped Consumer investing theme. Who can possibly feel better off when their weekly take home is basically the same as it was last year?


For all the talk of an accelerating economy, the over 80% of workers in the production and nonsupervisory category have now seen their real average hourly earnings decline in 5 of the past 6 months! Remember this when you read about how high Consumer Confidence has reached.


Roughly 70% of the economy is dependent on Consumer Spending. Over 80% have seen their earnings decline in 5 of the past 6 months while Consumer Credit has been rising. How much more can they spend?

Unemployment Problems Persist

Unemployment Problems Persist

Perhaps the reason so few are saving is because the job situation isn’t exactly rosy, nor are income levels. According to the most recent report from the Bureau of Labor Statistic, the unemployment rate has dropped to 6.7% which looks on the surface to be good news. However, if you look a bit deeper, the source of that improvement is troubling. The labor force participation rate, meaning the proportion of the population either employed or looking for employment has continued to drop, see chart at right, and is now at mid-1970s levels. Without the drop in the participation rate, the unemployment rate would be around 13%, rather than just under 7%. Additionally, according to data from the Minneapolis Federal Reserve (see chart at right), the American economy is experiencing the worst performance for labor markets since the Great Depression.


Some argue that the decline in the labor force participation rate is primarily driven by the inevitable retirement waves of the baby boomers. However, the chart below illustrates that baby boomers are in fact participating in the work force at a higher rate than in decades.















Along with the grim jobs recovery, household income levels continue to struggle, with income levels close to those 20 years ago, see chart above. Bottom Line: The fiscal and monetary stimulus has been unable to get employment or income levels back to anywhere near the levels enjoyed during the start of the 21st century. So far the impact appears to be more visible in rising prices in the stock markets and more recently rising home prices.

Inflation is a tricky game

Inflation is a tricky game

On February 19th, the Bureau of Labor Statistics (BLS) recently reported that inflation, as measured by CPI, remains low in the United States at a non-seasonally adjusted 12 month rate of 2.6%.  On February 12th, 2010 Olivier Blanchard, the IMF’s chief economist, called for central banks to raise their inflation targets, perhaps to 4% from the current standard around 2%.  I find it interesting that this recommendation comes as nations across the globe are facing the momentous challenge of controlling the potential time bomb of their “quantitative easing,” a polite term for printing money, while Germany and the EU debate how to bail out Greece.  Remember that debtors love inflation!

The most widely used measure of inflation in the United States is the Consumer Price Index (CPI), published by the BLS.  According to the BLS,

(1)     The index affects the income of almost 80 million people as a result of statutory action

  • 47.8 million Social Security beneficiaries
  • About 4.1 million military and Federal Civil Service retirees and survivors
  • About 22.4 million food stamp recipients.

(2)     Since 1985, the CPI has been used to adjust the Federal income tax structure to prevent inflation-induced increases in taxes.

The BLS calculates CPI using a weighted basket of goods and services, with occasional substitutions to account for changing preferences, using hedonic regression.  There is much debate over the accuracy of the CPI, but it is clear, given the stakeholders mentioned above that there is a potential conflict of interest for the federal government in reporting accurate data.

(1)     The higher the CPI, the more the federal government’s expenses increase, such as Social Security benefits.

(2)     By keeping CPI below the actual rate of inflation, federal tax receipts rise as tax payers are pushed into higher tax brackets through inflation induced wage increases rather than a true increase in purchasing power.  This is illustrated in the example below.

25%  Bracket Reported CPI Wages Actual Inflation
Year 1 30,000 3% 28,000 8%
Year 2 30,900 3% 30,240 8%
Year 3 31,827 3% 32,659 8%
Year 4 32,782 3% 35,272 8%
Year 5 33,765 3% 38,094 8%

Here we have an individual making $28,000 in Year 1.  His/her wage increases along with the true rate of inflation.  Tax brackets are adjusted according to CPI to prevent an individual or family from being taxed at a higher rate due to inflation rather than as increase real wage rates.  Here we can see that if CPI is reported to be 3%, the bottom of the 25% tax bracket increases by only 3% a year while wages increase at 8% a year.  By Year 3 the individual is squarely in the 25% tax bracket although real wage rates/purchasing power has not increased.  So now they are paying higher taxes, although inflation-adjusted income has remained flat.  This means the federal government can increase tax receipts by creating inflation above the reported CPI.  I’m not aware of any government in history that would be able to resist that temptation!

There’s both opportunity and motive for bias and manipulation.  Be skeptical.  The chart below shows the percentage change in CPI as reported by the BLS starting in 1959 vs. the seasonally adjusted M2 as reported by the Federal Reserve.  M2 is currency, traveler’s checks, demand deposits, and other check-able deposits, Money Market Mutual Funds, savings, and small time deposits.  M3 is considered the best estimate of the money supply and includes time deposits over $100,000, institutional money market funds, short-term repurchase and other larger liquid assets in addition to M2, however the Federal Reserve stopped reporting on M3 in March 2006, thus I have used M2 as an approximation.

CPI has not kept up with the increase in the money supply, thus I would argue that CPI has been understating inflation since around March of 1982.  You might recall that the 10 year Treasury Bond hit a high of 15.32% in September of 1981 under Volcker as he sought to combat a brutal inflationary environment with a sharp spike in interest rates.  At this time as well, unemployment had reached a 26 year high of over 10%.

The BLS states that, “As the most widely used measure of inflation, the CPI is an indicator of the effectiveness of government policy.”  Again, the government is incentivized to show lower CPI.  Be skeptical when there are conflicts of interest.