Summary: The headlines blasting the “hot” December CPI report were badly mistaken. After removing the inappropriate OER component, December CPI inflation was just 1.8%, below the Fed’s 2% target. Inflation and the Fed are about to move off the front page, to be replaced by a much more dangerous issue—the proliferation of tribal conflict that always follows plagues, pandemics, and other global natural disasters. That will be my focus going forward.
I find the most useful information in the monthly CPI report to be in Table 7 (below), which may be why the BLS doesn’t report it until page 30. Here are a few of the more important numbers to think about.
Figure 1: All items 12-month inflation, page 30
The first line in Table 7, above, (on page 30) shows the increase in the “All Items” CPI over the last 12 months as 3.4%. As reported on the front page of the report, shelter (housing) accounts for more than half of the increase, continuing a trend I have written about ad nauseam here, here, here, here, here, and here over the past year. (I’m just as sick of it as you are.)
Figure 2: Shelter inflation, page 34
To see the shelter costs, you have to fight your way back to page 34, above. As I have written before, “Shelter” inflation, 6.2% over the 12 months ending in December, accounts for 35.170% of the value of the basket of goods and services used to construct the CPI and contributed 2.117% of the 3.4% increase in the CPI—that’s the “more than half” they were writing about on the front page.
Some of the subcomponents of the “Shelter” number are legitimate expenses. For example, “Rent of primary residence” makes up only 7.714% of the CPI and accounts for 0.487% of the increase in the “All Items” index, is a real expense because it measures the size of the checks that people who live in rental properties pay to the owners of those properties. Likewise, the checks people write to pay for their kid’s dorm room and to pay their hotel bills are legitimate expenses. The rest—”Owners’ equivalent rent”—is complete BS.
“Owners’ equivalent rent” (OER), which makes up 26.018% of the CPI, is an entirely fictitious number that claims to measure how much you would have to pay to rent the house you already own if you rented it from yourself. (Apologies for the long-winded description. Just wanted you to know that I am not making this up.) OER inflation contributed 1.614% of the 3.4% increase in the headline CPI.
For reasons I have outlined before, OER should not be in the CPI at all. If you were to remove it from the index, the 12-month inflation rate would be 3.4% – 1.614% = 1.786%, or about 1.8%, which is below the Fed’s much-advertised 2% inflation target.
Figure 3: All items less shelter, Page 36
The closest the BLS gets to admitting this is in the Special Aggregate Indexes group on page 36, above, where they report that “All Items less shelter” inflation is just 1.9%, almost equal to the 1.8% figure we derived in the previous paragraph.
Bottom line: the December 12 month CPI inflation figure, properly adjusted by excluding imaginary OER numbers, was 1.8% per year, not 3.4%.
Along with the OER problem, there are a few more things to keep in mind when you interpret the inflation reports.
So, if inflation and the Fed are no longer the biggest risks to investors, what should we be worrying about? As I wrote a little more than a year ago, I believe our biggest risk is what I called The Real Long-COVID, the universal tendency of frightened people to “tribe-up,” accept autocratic leaders, and engage in conflict with out-groups in the years after plagues and pandemics. We can see that in Russia’s invasion of Ukraine, in the Israel/Palestine conflict, in the Houthi attacks on shipping in the Red Sea that increases the risk of direct confrontation with Iran, and in continued erosion of US/China relations. But most seriously, we can see it in the increasingly bitter internal divisions among U.S. voters that threaten to tear the country in two; I say most seriously because this is the one that threatens to derail the U.S. role in keeping all the other conflicts at bay. That’s why I have shifted my energy to trying to understand tribal conflict.
Figure 4: The books on my desk today
As you can see in the graphic, above, when I get into a topic I like to attack. The tribes pile on my desk includes books on the origin of life, genetics, cognitive science, paleontology, sociobiology, evolutionary anthropology, history, psychology, civil wars, information theory, conspiracy theories, philosophy, and complex systems. I build the pile by starting with a few of the books out of the many that I’m embarrassed I haven’t read yet, then drill down into the citations in the footnotes and references until I reach bedrock, i.e., they all reference each other.
Most of these books deal with different approaches to understand and manage complex systems. I have found my economics training to be inadequate for understanding these issues, likely due to its preoccupation with understanding the implications of so-called rational behavior of the individual. I have had much more success studying complex adaptive systems, an inherently multi-disciplinary approach associated with the Santa Fe Institute.
In any case, I will be shifting the focus of my writing to understanding and helping investors protect capital from the rising tide of tribal conflict. Stay tuned.
The views and opinions expressed in this article are those of Dr. John Rutledge. Assumptions made in the analysis are not reflective of the position of any entity other than Dr. Rutledge’s. The information contained in this document does not constitute a solicitation, offer or recommendation to purchase or sell any particular security or investment product, or to engage in any particular strategy or in any transaction. You should not rely on any information contained herein in making a decision with respect to an investment. You should not construe the contents of this document as legal, business or tax advice and should consult with your own attorney, business advisor and tax advisor as to the legal, business, tax and related matters related hereto.