Oiled Down CPI

Adam Hamilton    September 22, 2000    4072 Words


In dry rural environments around the countryside, dust is a perpetual nuisance for homeowners.  Dust is pervasive, ubiquitous, and seems to magically spawn out of thin air almost as rapidly as global fiat currency growth.  Trying to keep one’s house dust-free while living in the country is a never-ending task, similar to the challenge faced by the legendary Sisyphus.  In ancient Greek mythology, Sisyphus was the son of Aeolus and the ruler of the great city of Corinth, in classical Greece.  As a punishment for his Machiavellian trickery during his life, the Greek gods doomed Sisyphus to a hopeless and taxing task for all of eternity.  Sisyphus was commanded to roll a great boulder to the top of a large and steep mountain.  He was told by the gods that when he was finally able to wrestle the large stone to the summit, he would be released from his torment.  Sisyphus would labor and toil and eventually, through sheer force of will, push the great rock near the apex of the mountain of Tartarus (ancient Greek “hell of hells, the deepest, darkest pit of hell”).  As soon as he neared the end of his task, however, the immense boulder would slip and bounce and roll back down to the base of the mountain.  He would trudge back down the rocky slopes, put his weary hands on the rock, and begin once again to push it to the top.  Each time he almost finished this Herculean task, the rock would escape and roll back down, and he was doomed to repeat this punishment through all eternity.  Dusting a house can seem similarly hopeless!


The task is even MORE difficult in rural environments, where country roads are made of dirt or crushed (almost powdered) rock, which throws up billowing clouds of dust when someone walks on it, let alone when a vehicle or farm truck passes.  The clouds of dust thrown off the roads envelope houses, and soon everything inside is covered with a fine layer of dust, and the dust can never be eradicated.  One guerilla tactic that has been developed to combat this plague is the oiling of the dusty roads.  Used motor oil is spread on the dusty roads to make the loose dirt more sticky, so when vehicles pass, very little or no dust is thrown up to engulf the houses.  The tactic can be very effective, although the great protector of the spotted hairy green-backed yellow-striped large-eyed miniature racing snail of rural ditches, the Environmental Protection Agency, would love to throw all these dangerous social miscreants who are desecrating our pristine and natural dusty roads into prison.  Nevertheless, oil is still spread on rural roads with excellent and cost-effective dust suppression results.


The ever popular measure of inflation known as the Consumer Price Index, like dusty rural roads, also appears to have been oiled down lately.  The market bulls KNOW, of course, that there is no inflation, prices are stable, the economy is booming, and the long promised era of perpetual wealth and prosperity for all is just over the horizon.  The battle-hardened statistical special ops folks down in the restricted access subbasement of the Bureau of Labor Statistics recently deployed their widely heralded August 2000 CPI report, and all the markets rejoiced.  The full report is available at http://www.bls.gov/news.release/cpi.nr0.htm, and is interesting reading.  The first paragraph began, “The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1 percent in August, before seasonal adjustment, to a level of 172.7 (1982-84=100), the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  For the 12-month period ended in August, the CPI-U increased 3.4 percent.”  And all the bulls exclaimed, “Hallelujah!”  3.4% inflation in America!  A 0.1% increase in the CPI in August 2000 is a stellar number, and tremendously bullish for US equity markets.  After all, with trivial inflation in the States, all must be well in our economy and **l (that dark, black censored dirty word … oil) is not adversely affecting the “record economic expansion”. 


But just as things seemingly couldn’t get ANY better, the third paragraph of the BLS CPI report delivered the coup de grace for any lingering concerns of inflationary pressures in America…  “On a seasonally adjusted basis, the CPI-U declined 0.1 percent in August after increasing 0.2 percent in July. The energy index, which rose 0.1 percent in July, fell 2.9 percent in August.  The indexes for petroleum-based energy and for energy services declined 5.5 and 0.2 percent, respectively.  The food index rose 0.2 percent in August.  The index for food at home increased 0.3 percent after advancing 0.7 percent in July, with each of the major food at home groups except fruits and vegetables contributing to the deceleration.  Excluding food and energy, the CPI-U rose 0.2 percent in August, the same as in each of the previous four months.”  Holy cow!  Consumer prices DECLINED in August?  That is fantastic news, and it is the FIRST monthly decline in the CPI in over 14 years!  Our leaders are geniuses, our economy is sound, all bow before the alter Wall Street, and please pass the caviar!  Even better, energy prices fell 2.9% in August (35% annualized), and PETROLEUM-BASED energy services plummeted an incredible 5.5% (66% annualized)!  Our economy has reached the pinnacle of western civilization, inflation is down, energy prices are down, and food is more affordable except for those pesky fruits and vegetables (who needs ‘em anyway?)…  life is good!  Thank goodness frozen pizza prices aren’t rising.


Are you getting uncomfortable yet?  Do you feel something is not quite kosher?  Don’t you believe there is no inflation, oil prices are falling, and the grass is red?  In this essay we will briefly explore the historical CPI and its relationship with **l.  Before we begin, a definition of the CPI is in order.  In the past the CPI has stood for the Consumer Price Index, but rumor has it the BLS has officially changed its name in 2000 to the CPI … Committee to re-elect vice President and Incumbent Al Gore.  Is the CPI an acceptable measure of consumer inflation, or has it been oiled down and suppressed like a dusty rural road?


As always, a great place to begin our look at the CPI is modern history.  History is like your best college professor morphed with the best story-teller you ever had the privilege of hearing.  He is a great teacher, his wisdom is virtually boundless, and he never tires of telling his story.  He rewards many priceless gems of wisdom to those who will sit at his feet and listen to his tales.


We will begin with a look at almost 54 years of monthly CPI data.  As the US media decided to use the bullish seasonally adjusted (SA) CPI numbers over the non-seasonally adjusted (NSA) flavor while reporting August 2000 results, we will use the SA data throughout this essay.  Over the long run, the differences between the SA and NSA versions of the CPI are ultimately immaterial and trivial.  How common are down months in the CPI historically?



In this graph, the green dots represent a month in which the CPI actually DROPPED, indicating declining inflation or disinflation.  Disinflation can be defined as a slowing of the rate of inflation over time, while deflation is a general DROP in price levels (negative inflation, in effect) over time.  With the blue line of CPI marching happily and perpetually northward, it is more accurate to refer to the rare down months in the CPI as temporary disinflation, and not outright deflation.  And how rare are these down months for the CPI?  Very.  From January 1947 to August 2000, there were 644 months, and only 29 (4.5%) showed actual monthly declines in the CPI.  Intriguingly, they are NOT distributed anywhere near randomly or evenly over this time period.  72% of these down months (21) occurred in the late 1940s and early 1950s, and another was not seen until 1963.  In August of 1971, an earth-shattering financial event occurred that altered the course of US inflation forever, as can be observed in the sharp slope steepening of the CPI line in the graph above.


Although private gold ownership for US citizens had been outlawed in 1933 by the authoritarian socialist President Franklin Roosevelt, foreign holders of US dollars were still granted the important privilege US citizens had been denied…  converting US dollars into gold on demand.  This important fact was widely known by foreign holders of US dollars at the time, that the dollar was “as good as gold”, and contributed mightily to incredible world economic growth and a very strong dollar, which was indispensable for American economic hegemony.  Having the dollar directly tied to gold imposed a semblance of discipline over unrestrained fiat currency growth in America.  Technically (although it wasn’t followed very well), no new dollars could be printed until a certain amount of gold was acquired by the USA to fully back the dollar.  This system would have worked fantastically in restraining fiat currency growth, but the politicians of the time could not live within the discipline of limited money growth.  In order to finance guns AND butter, war and social welfare state handouts, they needed MORE fiat money, even if there was no gold to back it.  As the money supply grew, gold became increasingly undervalued, and it was artificially pegged at prices between $20 and $35 per ounce between 1933 and 1971.  With the gold price locked down by decree, and the dollar supply blooming like a mushroom cloud, shrewd international speculators and investors began to realize gold was a great bargain.  They started to buy cheap gold with inflated US dollars, threatening to push up the gold price, and hence devalue the dollar relative to the ONLY currency that has ever worked over a long period of time, gold.  The US initially fought the speculators, dumping gold on the open market to suppress the price of gold.  (anyone else have Déjà Vu here?)  Eventually, running out of physical gold available to dump as the metal fled from US shores at lightning speeds, President Richard Nixon, on August 15, 1971, officially declared defeat and defaulted on the US government’s promise to foreign dollar holders to redeem their dollars for gold on demand.  The US was officially bankrupt, reneging on its contractual promises to the world.  That date, one of the most important economic events of the last century, is marked on the graph above with a vertical red dotted line.  Note the slope of CPI growth before 1971 (green arrow) and AFTER 1971 (red arrow).  Without the quasi-gold standard that was in place before 1971, politicians after that date could simply order up UNLIMITED amounts of fiat currency backed by absolutely nothing.  This worthless fiat currency is not without cost, however, as it eventually filters down to the common populace and results in more money chasing relatively fewer goods … the TRUE definition of inflation.


From 1947 to 1971, only 7.7% of months experienced an actual decline in the CPI.  Not a good record.  From 1972 to 2000, however, down CPI months became a veritable endangered species, with only five sightings before the wonderful numbers of August 2000!  The sixth confirmed sighting of the elusive Yeti of CPI goodness made for a dismal record of 1.7% down months for the CPI since the dollar gold relationship was unceremoniously severed.  A mere 6 months out of 344!?!  The impact of reckless and imprudent fiat currency storms cascading through the US economy after the 1971 gold default is very difficult to dispute in light of the prominent CPI slope change in 1971 in the graph above.  Something fundamentally crucial DID change that year, and US consumers have been bearing an ever increasing price for that fateful decision ever since.


We digress, however.  Back to the task at hand, let’s take a closer look at the CPI since 1970 relative to the price of crude oil…



The CPI data from the first graph is shown here with the nominal price of crude oil superimposed.  The six down CPI months where the index actually shrunk are noted by the green dots.  Interestingly, the five previous down months in the CPI since 1970 ALL occurred when the oil price was DROPPING dramatically.  Hmmm…  We would expect, in order to follow precedent, that oil prices must have dropped dramatically in August 2000, right?  After all, the intrepid Bureau of Labor Statistics officially said the “petroleum-based energy index declined 5.5% in August”.  Looking at the graph above, oil jumped in price from $11 per barrel in 1998 to over $30 in August 2000.  Surely something must be wrong here.  Maybe the oil graph is backwards or something, because certainly the CPI could not drop while oil is rising for the first time in history.  Using a secondary data source, we will examine the daily crude oil prices in August 2000 to clear up this obvious misunderstanding.



As we can see in the above graph, oil dropped dramatically in August 2000, contributing to the rare decline in the August CPI…  er, wait a second.  Whoops!  Crude oil actually ROSE a blistering 19.3% in August!  The dotted green line is the monthly trend for oil, which, unless you turn your monitor upside down, is decidedly bullish in orientation.  There were only two significant daily drops in the price of oil during the month, and they were quickly trampled underfoot by the relentless marching of the oil bulls on parade.  SO, oil is up 19.3% in August, and the BLS reports “petroleum-based energy index declined 5.5% in August”.  Anyone else experiencing some cognitive dissonance here?  It IS important to remember that the CPI is a backward looking indicator, AND it takes a while for spot commodity prices to filter into the economy, but something STILL smells rotten in Denmark.  We decided to take a look at historic monthly oil and CPI data, and the results are MOST interesting.


August’s 19.3% monthly increase in crude is the NINTH biggest monthly increase in the price of crude since 1970, competing with the Arab oil embargo against the West in 1973 as well as the early 1980s commodities boom for the largest month over month price increase in almost 31 years.  From January 1970 to August 2000, there were 368 months of CPI and oil data.  ONLY 12 of those months, or 3.3%, saw oil rocket up greater than 15% in a single calendar month.  And what was the CPI doing, pray tell, when oil was exploding?  During those 12 months (not including the surreal August 2000 numbers), the CPI saw an AVERAGE gain of 8.2% (annualized) in a single month!  The monthly CPI NEVER declined when oil rose over 15% in the same month in over 30 years of historical data.  The experiment was run again, this time with 10% gains in crude oil in a single month as the selection criteria.  29 of the 368 months, or 7.9% of the data, saw 10% month over month gains in crude.  When the CPI index results for those months were analyzed, the AVERAGE increase in the CPI was an incredible 7.0% (annualized) in a SINGLE month.  NONE of the months saw a decline in the CPI!  As one final conservative test of the data, all months with crude oil gains greater than 5% in a single month were reviewed, yielding 65 of 368 months, or 17.7% of the data.  During these months, the CPI had an average monthly gain of 6.1% (annualized).  NOT A SINGLE month exists in history where crude oil leapt up greater than 5% in a single month and the CPI actually declined!  Until this virtual reality known as August 2000, that is.  Apparently, this time it IS different!


This quick and dirty historical analysis indicates that the BLS’s strange August 2000 CPI results are deviant at best from historical precedent.  The thesis that something massive is very awry can be buttressed if the fundamental case can be built that oil IS an important part of the economy and rising crude oil pushes other prices higher.  Since the oil price spike in March, an endless parade of pundits has been paraded on bubblevision to convince the American people that the oil price is not important anymore and the economy is not dependent on oil.  Really?  Although beyond the scope of this essay to thoroughly and fundamentally dispute this ridiculous assertion, it is a straw man and is easily knocked down.  Oil is CRUCIAL to the US economy, and EVERYTHING we consume reflects some oil prices.  Anything that is driven, taken on a train, carried on a marine freighter, or flown is dependent on the cost of oil.  Surcharges are springing up like groundhogs in early February all over the country, and higher costs are being passed on to the US consumer on a multitude of fronts.  In addition to the cost of everything being dependent in some way on crude oil prices, there are many primary products we need, some for survival, that are manufactured directly from crude oil.  The easy ones, of course, are gasoline, diesel fuel, and heating oil.  If oil doesn’t matter, no one should care about walking (gasoline growing too expensive to drive) to an empty grocery store (truckers going on strike like in Europe because they can’t make money with diesel so high, hence food deliveries slow) to disappointingly returning to a cold house in the middle of winter (heating oil grows too expensive to keep the thermostat above 55).  The assertion that oil is not important to our economy is illogical at best and intentionally deceptive at worse.  There is nothing more important than oil to modern human existence except air, water, and food.  Expensive oil (as in 1973 or in Europe RIGHT NOW) can lead to catastrophic reverberations throughout a modern first world economy and cause massive dislocations and hardship.  In addition to the obvious distillates made from crude, many other important products are heavily dependent on crude oil.  A very short list of these includes plastics, fertilizer and pesticide for agriculture, synthetic fabrics, cosmetics, shampoo, tires, detergents, electrical and thermal insulation, industrial gases, jet fuel, mechanical lubricants, some electricity generation, etc.  The list of petroleum dependent products is truly vast, and it accentuates the far reaching and pervasive implications of a general rise in the price in crude oil for consumer prices.


If oil no longer affects consumer prices, the burden of proof for that interesting assertion lies squarely on the shoulders of the BLS.  Their own historical data as well as simple logical fundamentals would seem to indicate that oil would have a tremendous influence on consumer prices.  What the heck is going on deep in the bowels of the BLS?


Before we conclude, a better representation of true inflation is in order.  As mentioned above, inflation IS ultimately the result of undisciplined fiat currency growth, as relatively more dollars chase relatively fewer goods, driving up general price levels.  The graph below shows the CPI graphed next to the US M3 money supply, or the broadest measure of the US fiat currency blight our economy currently faces.



Interestingly, true fiat currency inflation in America has been a consistent 8.1%, at an annually compounded growth rate since 1970.  The CPI over this entire period has shown a compound annual growth rate of 5.1%.  Provocatively, take a look at the green M3 line on the graph above since 1995.  The M3 money supply went nearly vertical compared to historical precedent in 1995, and one would expect the CPI to follow, as the previous 25 years the CPI and M3 lines have had very similar slopes even though M3 has grown faster than the CPI.  Incredibly, the CPI growth rate DECLINED to a reported 2.4% during the last five and a half years, weighing in at less than HALF its historical levels, even though M3 growth accelerated tremendously.  Something is VERY wrong here, friends!!


We have briefly taken a look at oil and the CPI, outlining how absurd a drop in the CPI seems during one of the biggest bull months for oil in history.  We also looked at money supply growth, and observed it increasing dramatically (which yielded our stock market bubble, please see "S&P Perpetual Motion" for elaboration on this point) yet the CPI stubbornly has hovered at less than half of recent historical levels.  And we did not even have a chance to discuss the mystical world of hedonics statistical wizardry, where the BLS claims the quality of goods is increasing and offsetting price increases, so we are getting better goods for higher prices so the price per unit of quality is dropping, hence dragging down the CPI, even though prices are rising.  (for a more detailed discussion of the surreal world of hedonics, please see "Lies, Damn Lies, and CPI")  On a little hedonics sidenote, the BLS in its current CPI report proudly proclaims the extension of hedonic price deflation methodology to the critical consumer staples of washing machines and clothes dryers.  First, who cares about large consumer durables in the CPI?  These machines last for DECADES.  What is important to American consumers is inflation in everyday items we buy all the time, from gasoline to milk, from food to toilet paper.  The CPI should track items we all need to purchase every week to survive and weight them accordingly, not big-ticket items we buy once a decade or less.  Second, rather than working on filtering out the all important food and energy price increases we are seeing on the street, and wasting its time on hedonics mumbo jumbo, why isn’t the BLS focusing on improving its measurement of inflation that affects real people?  The plot thickens…


The Department of Labor’s Bureau of Labor Statistics appears to have a great deal to answer for to the American people.  In the United States, government bureaucrats are employees of the citizens, and should work for the best interest of the US populace.  The BLS serves an incredibly valuable and important function in monitoring inflation growth that is so dangerous for working class Americans.  It is truly sad that the BLS’s reporting lately has defied logic and reality, and it certainly has all the appearances of being systematically and persistently manipulated downward to hide fiat currency excesses.  Who DOES the BLS work for?  The Clinton administration?  Wall Street?  Or the American people?  IF the CPI is being understated, the millions of Americans dependent on government handouts tied to inflation (COLAs, cost of living adjustments) are being cheated out of hundreds of billions of dollars they have been promised.  Is that how a great nation like the United States treats its military veterans, widows, and orphans?  In addition, if the bull market is built on a dangerously false premise of a low inflation environment, and that is not really the case, the market could implode at any moment as it is not girded in a foundation of truth but in deception.  The projected budget “surplus” the politicians have been fighting over would vaporize in 2 seconds if the CPI has been dramatically understated for at least five years, as projected government payments tied to inflation (welfare state handouts AND interest expense on the national debt) would rise dramatically.  Interest rates may be too low if inflation is being consistently understated, and higher rates may be necessary to compensate bond holders for fiat inflation and stave off a liquidity crisis.  The implications of suspicious CPI reporting are vast, and they NEED to be addressed before they lead to catastrophic consequences.


US citizens, especially those on fixed incomes or dependent on COLA adjusted checks from the government, should be outraged, and should aggressively contact their representatives in Congress if they believe the CPI is being manipulated downward to their detriment.  Every market and every citizen benefits from honest, unbiased reporting of inflation data.  If political pressure is being applied to the BLS to lowball the data, this is an important issue for the future of our nation that must be resolved.


In the professional world, appearance IS almost as importance as substance.  For instance in accounting, one must be independent in fact (substance) AND in appearance, otherwise people could get the wrong idea about an accountant’s motivations and integrity.  From the perspectives of history and logic, it sure APPEARS that the BLS has been oiling down the inflation numbers…


Adam Hamilton, CPA     September 22, 2000