There was great relief in financial markets today when today’s CPI reading came in. While the overall monthly increase of 0.5% was somewhat higher then expected, that only reflected higher food and energy prices and they apparently don’t count. The core index was unchanged after having risen 0.7% over the previous two months. But this reading highly underestimate price inflation.A illustration of this was given in a San Francisco Chronicle article.
In San Francisco house prices has risen some 36% over the last 2 years.
But home buyers need not worry. Because the government says that the cost of living in a San Fransisco home has in fact fallen. That’s right the U.S. government statisticians try to have us believe that it is really cheaper now to live in a San Francisco home than 2 years ago, even though you have to pay 36% more for it. The explanation for this curious phenonema is that the government calculate the cost of living in a home you own by looking at the cost of renting a home
and since rents have fallen this means that the government will claim that it is cheaper to buy a home now.
The government tries to justify this absurdity by arguing that they do not wish to include the asset value of homes. But even leaving aside the question of why asset price inflation should not be considered inflation, it should be noted that houses are assets whose fundamental value reflect the consumption services they provide, unlike other assets like stocks or bonds whose fundamental value reflect the future cash flow they will provide for the holder. And that accordingly, any price increase will make the consumption service of living in a house much more expensive. Trying to measure the cost of living in a house you own through the cost of renting the house is like trying to measure car prices by the cost of transport through a bus or taxi.
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“The government tries to justify this absurdity by arguing that they do not wish to include the asset value of homes…“
If I’m reading this paragraph correctly, it appears to be asserting that the government wants to base the value of home assets on the income approach, and not replacement/market value.
While it’s a more “objective” approach, it ignores that there is greater subjective value to the owners who utilize their homes, and would value it above the income-capitalization price, or otherwise they would be renting their homes to others.
IMO, the biggest problem in using rent equivalents to substitute for actual house prices is that the two have grossly different sensitivities to changes in interest and discount rates. Rentals are current goods and have relatively little sensitivity to interest rates. Houses, OTOH, are primarily future goods and the net present value of the future shelter they provide shoots up whenever the FED is in its interest rate suppression mode.
Regards, Don
The use of rental equivalents was implemented during the 70′s while there was a great deal of home price inflation. IMO the government did this SPECIFICALLY to “game” the numbers and produce lower inflation numbers for political purposes.
During “normal” inflationary times the use of rental equivalents drives down CPI from what would be reported if home prices were used. In today’s times, with the proliferation of “interest-only” mortgages, it has an inverse affect, for the short term at least.
The easy availability of “interest-only” purchase mortgages make the cost of entry into homeownership (for the balloon period, anyway) smaller than renting, even as it drives the purchase price UP. The landlords must then drop the rent to keep tenants. Hence the rental equivalent falls while the purchase prices go up. What about the balloon period? Mister tenant-turned-homeowner doesn’t care, because “house prices always go up” and they will refinance or sell when the balloon pops, provided the housing bubble doesn’t pop first, in which case they will default.
Balloons are for clowns. LOL!
Correction. Owners’ Equivalent Rents was implemented in Jan 1983. See under the “hedonic adjustment” thread a more complete post.
The problem is that inflation data was shown sustainable lie ( 2001-2003, 3 years ) to hide Fed’s action of print big amount of greenbacks, and sustainable correction to tell people the truth. it takes period of 6 years. US economic data of each month, even each quater never try to be true, because they can’t acurately to calculate 0.5% increase or decrease, it is only provide a data for the balance of economy, politics and special interest group, market then make judgement or follow the data, but if the data are wrong consecutively too many times without correction something will happen. Crisis!!! US will lose power to Japan or EuroZ.
…uh…folks….oil hits…$60.00 and likely will go higher…and there’s no effect on inflation? Get ready homeowners…The Government is lying. Prediction….inflation goes wild…housing prices “correct” and welcome to the oil crisis 1970′s style! Bad times ahead.
Ed.
The reason “some price inflation is worse than others” is the ability of the rich to avoid the losses on their investments. If inflation is centered in financial assets, no problem. If inflation is centered in housing, no problem. But if inflation is centered in consumption goods which can’t be stored — big problem.
But even worse than all those is DEFLATION. Why? Because rich people have many assets they can buy. They take the riches gained from one inflationary cycle and buy the non-inflating assets. If the Fed successfully offsets a boom with another boom (thereby repairing the relative price offset), even when holding the losses in the correcting boom asset, the non-boom assets then rise in price. So money goes to X first, then Y, then Z, and those that can borrow and invest in X and Y and Z proportionally, grow richer each cycle.
It’s when CASH and the concomittant destruction of leveraged positions occurs (price deflation) that leveraged rich people really get hit. Cash is only a small fraction of their portfolio and they take a loss on (for example) 80% of their positions. So I’d bet on inflation as long as there’s a group of people that can be fooled by “money = wealth”.
Surely, we may enter deflation if the market balks at making the mountains of public credit private (turing public credit into US treasuries by the deficit-spend-monetize cycle), but until that point is reached when EVERYONE is going long the inflation (and there’s no more profit for the insiders to make), it will go on. There is still a group of people that are being fooled (witness the Asian countries outstanding determination to hold to the dollar in the face of unbelievable trillions of new private US credit) that will buy the “worthless debt”.
More important, perhaps, is how YOUR OWN INCOME is tied to the rolling booms and busts — if you’re at ground zero for the correction (like telecomm in the 90s), you’d better offset your risk by holding cash. As long as the boom continues, you earn income and make more by leveraging into a hard resource mutual fund. But when it turns, it will likely all turn at once. And that is when the scramble for liquidity begins. Your objective is to last “longer than your neighbors”.
CHEAP ENERGY..the bottom line is really simple….and out of the fed’s hands…there are so many varibles at hand that one can get lost in them. So, I’m a bottom line guy. The high price of oil = getting your products(distribution)to the market more expensive and so much more but certainly inflation..with fast inflation (Greenspan’s worst fear and rightly so) comes fast rate hikes…the fed HAS to keep ahead of inflation so rates go to say 17% prime.(think about that for a long minute)….which most definately cools the ecomony(worldwide)…housing prices fall/collapse taking out X number of lending institutes that have overlent from overpriced real estate(that period will be referred to as the good old days when money was cheap and abundant)..and the rest is history… BIG recession and then a period of long stagflation as we all lick our wounds and then,slowly,the whole damned thing starts again. This is the end of a cicle. The bottom line is energy. Cheap energy in ANY form is gone,at least for some time to come and IMO will be the challenge of all world ecomonies.I cannot believe how complex this simple equasion has become. Advice to new home buyers…..DON’T DO IT! The numbers government are plainly inaccurate.
Ed.
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