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Joining the political dots!

By Richard Cluver

Politics is a dirty game they say and, from my perspective as a young newspaperman who recognised that the road to the top required that one immerse yourself in it if one ever hoped that an editorship lay at the end, I took a conscious decision to walk a better path.

Recognising one of the great truths of the day was that if you wanted to understand anything happening around you, you needed to follow the money trail, I chose instead to make it my mission to understand economics.

It was a route which soon taught me to be wary of leaders promising salvation through following their “putting the people first” policies. It did not take much scratching to unearth the gravy train lurking beneath so many political campaigns. Fundamental to all the major stories making headlines in the Sunday papers back then – and still today – is that people aspiring to be our leaders are on the whole greedy scavengers of limelight.

Meanwhile the financial world, which so often carries the can for the wrongs of our society, has on the whole been largely innocent of the shenanigans which taint the politicians….because it has to be. With so many investors watching over their transactions, it’s the rare few which really manage to shock us…like Enron, Steinhoff and Tongaat Hulett….. simply because they are the very few.

So this month I am going to tell you an old fashioned fairy tale with a happy ending for everyone: one which could be closer to the truth than any of us imagine. I am going to sketch out for you a situation shaping up before our eyes which could potentially make beyond-eye-watering amounts of money for those who are currently shaping the hopes and dreams of millions of South Africans….and yet might well leave us all grateful for a happy ending to the seemingly intransigent political conundrum currently facing this country.

I start with something that has been puzzling me for a long time and which came into sharp focus last week when SARS moved against Economic Freedom Fighter first lieutenant Floyd Shivambu. On March 17 the Daily Maverick reported how Floyd Shivambu’s front company Grand Azania (Pty) Ltd “….stuffed with VBS millions and more money from business benefactors,” was ordered to be provisionally wound up because it couldn’t pay its R11,5-million dues to SARS. 

The report added that SARS’s Criminal and Illicit Economic Activities Division had succeeded in closing down one of Floyd Shivambu’s front companies. In a High Court of Pretoria ruling on Friday, 10 March 2023, Judge Ronel Tolmay ordered that if anyone involved with Grand Azania (Pty) Ltd could not motivate by 24 April why the company should not be wound up, the court order would become permanent. Scorpio had further proved that, “…the bank card linked to Grand Azania followed Floyd around southern Africa and paid for his 1 January 2017 birthday celebrations at the Royal Livingstone Hotel in Zambia.”

The report added that, “Scorpio has also been informed by various sources that Shivambu and EFF President Julius Malema now tend to hide their hand in business operations and prefer cash in tog bags in the boots of expensive cars.” And then it added that, “The fight can be expected to be taken elsewhere – most probably the Hawks and NPA, who have made no moves to bring justice to Shivambu and Malema.”

What has puzzled me for so long is why an ANC, which has long been troubled by the antics of the EFF leadership, has not used the evidence it obviously possesses to put the two behind bars. Since most political observers believe that the EFF is a cult which would collapse like a popped paper bag if its two leaders were silenced, a conviction would obviously bar them from Parliament and leave the way ahead safe in the assumption that disaffected EFF followers would probably, with the right inducements, return to the ANC fold and give them the election victory they so desperately need next year. 

But what if the threat of such a prosecution were the leash that is keeping the EFF in the control of the ANC leadership? What, furthermore could such an advantage mean to the mendacious ANC leadership if untold billions of Rands could be legally culled from such a situation…more than Julius, Floyd, Cyril, Gwede and a handful of other leaders have ever dreamed might be possible?

The thing is, if you are in a position to know the outcome of events ahead of everyone else, you might be able to turn that knowledge into one of the world’s legendary fortunes. Ask the Rothschild family which owes its economic dominance of the financial world to having had prior knowledge of Nelson’s victory at Waterloo.

Rumour has, furthermore, long held it that Osama bin Laden took out futures positions on Wall Street just before his al Qaeda followers hijacked four airplanes and carried out suicide attacks against the twin towers of the World Trade Center in New York City and the Pentagon in Arlington, Virginia in September 2001…and raked in fabled riches as Wall Street shares tanked.

All of which brings me to the current banking crisis which, regular readers will fully understand because I have written countless articles about the world’s debt mountain which was allowed to grow to uncontrollable levels because a flood of cheap consumer goods from China during the late 20^th century masked the normal inflationary effects. Because billions of Chinese peasants were giving up lives as subsistence farmers and pouring their cheap labour into the new factories of the Far East, the West effectively exported its manufacturing capacity to China and consumer prices fell everywhere for nearly 30 years, dampening the inflationary effects of monetary inflation.

But that benefit could not last forever. 

The graph above, courtesy of the Federal Reserve of Dallas, illustrates how the central banks of the world’s major economies have played fast and loose with money supply over the past two decades, in 2008 to ward of the “Sub Prime” recession and, although they used the excuse of Covid-19, the money printing spree from 2018 onwards was actually used to lower the debt-burden of over-borrowed governments.

So, in my next graph from Refinitiv Datastream, look what has been consequentially happening to global inflation rates since 2017. While governments around the world have been reassuring their citizens that concerted central bank action hasbeen bringing down inflation, the reality is that they have only been tinkering with it. That US Inflation currently stands at six percent while the asking price for a US ten-year sovereign bond is 3.554 percent highlights the fact that you can still borrow money for free!

Meanwhile, the current generation of bankers has, courtesy of the Chinese phenomenon, had no practical experience of inflation nor, more importantly, of the devastating effects of rising interest rates upon the value of government bonds which have built up a debt pile of an unimaginable $120-trillion in recent years.

Playing out before our eyes is the misery of millions of investors fearing they might have lost their life savings as bank shares tank all over the world amid the contagion of the Silicon Bank collapse which is spreading its dark tentacles into the lives of ordinary hard-working people who have saved all of their lives in the seeming safety of big corporate banks towards a comfortable retirement which might now be no more!

Investors were still digesting the Silicon Bank story when Signature Bank customers, spooked by the sudden collapse of Silicon Valley Bank withdrew more than $10 billion in deposits. That run quickly led to the third-largest bank failure in U.S. history and regulators were obliged to take over Signature to protect its depositors and the stability of the U.S. financial system. Next, troubled Swiss giant Credit Suisse tumbled 30 percent before the Swiss Government stepped in to stabilise things and sell the bankrupt shell to UBS.

Even here in South Africa where our banking system is one of the world’s best-regulated, the best of them, FNB, took a nine percent knock, Standard shares fell 11.27 percent and Capitec 11.6.

In an uncomfortable play back of a similar shock in 1929 when, as the dominoes fell and took almost the whole world into the “Great Depression.” Silicon Bank was one of the biggest providers in the world of loans to incubator companies: almost half of all US start-up-ventures which are estimated to collectively employ more than a quarter of a million workers. If they and other SVB customers suffer cash crunches or cut back expansion plans, rent payments in many parts of the world may be delayed and staff may no longer buy coffees and lunches at the corner deli.

After Signature Bank became the second failure in days, consternation understandably gripped the monetary world and bewildered investors began to panic. It was a classic repeat of 1929; an event we thought could never again happen. Signature, a New York-based institution with deep ties to the real estate and legal industries had, according to a regulatory filing, assets of $110.36-billion and deposits of $88.59-billion at the end of 2022. How could this be happening in this era of monetary sophistication?

Well, if the Great Depression was the direct result of the US Federal Reserve printing more money than it had gold reserves to back its currency, then that exercise pales into insignificance compared to what has been happening in recent years. That, so early in the struggle central banks have been waging to try and counter the recent inflationary effects of their 30 years of money-printing irresponsibility, they are now being forced to curtail their activities to head off a pandemic of banking failures, implies that they have just lost the first battle in a protracted war.

Yet, if we cannot stabilize the global monetary system, western civilization and the very concept of democracy is arguably at stake. So you can expect many localised skirmishes in what could arguably prove to be the Third World War. It will be fought with weapons which never existed before in mankind’s history; with things like Internet hackers using personal data-harvesting in order to fire up “bots” to re-shape political outcomes. And a major salvo is what we are now watching in the banking system which will have a direct bearing on the ability of the current generation of workers to both receive their promised pension benefits and enjoy a peaceful retirement.

Here, note the ongoing riots in Paris over the fact that the French Government has had no option but to raise the pensionable age by two years in order to try and stave off the collapse of that system. And exactly the same potential exists in South Africa where our RSA bonds represent an altogether too attractive opportunity for mendacious politicians, one which in comparison would make the asset-stripping of Eskom look like the mere holdup of a township spaza shop!

To understand bonds, you need to appreciate that they are traded by yield. Thus if you have an AAA grade economy you are able to attract investors at a lower interest rate than if they are issued by an over-borrowed country like South Africa which is currently borrowing a billion Rands a day to meet the gap between its tax revenue and its spending and has to thus offer lenders 10.1 percent compared with the 3.554 percent the US Government has to pay.

However, Governments borrow very long with redemption dates as far away as 30 years from now and accordingly locking in their taxpayers for whole generations having to foot the bill. A benchmark 10-year US sovereign bond, arguably however, provides the best picture of what has happened lately. As, courtesy of the US St Louis Federal Reserve, the graph on the right so aptly illustrates, back in July 2020 the US was able to place 10-year notes at a yield of 0.62 percent while in February this year they were having to offer 3.75 percent. In simple terms, the cost of US debt has thus risen over six times.

Put that the other way around; if the Silicon Valley Bank was lending money to the US Government back in July 2020, the bonds they bought then are currently worth only 16 percent of the price the bank paid. They have LOST 84 percent of their value and, were investors to demand repayment of the money they lodged with the bank, it is simply clear the bank would be unable to pay. That’s why the bank collapsed…..and why it is not alone!

So now central banks have another problem on their hands. Inflation remains steadfastly high. But if they keep raising interest rates in order to counter inflation they risk a domino effect which could collapse countless global banks and bring on another Great Depression. One might accordingly conclude that global interest rates are thus at, or close to a peak. So, precisely the issue which sank the Silicon Valley Bank could massively enrich speculators who have to courage to buy bonds now. For example, if the demand for high-yielding bonds like South Africa’s RSA series were such that the yield were to subsequently fall from 10 percent to 5 because of a change in local political sentiment, speculators would double their money.

Now, of course, with Julius Malema sensing a killing at the forthcoming general election a year from now if the ANC gets below 40 percent of the vote and needs a coalition partner like the EFF in order to retain power, Julius’s top manifesto demands currently include the immediate nationalisation and re-distribution of ALL South African property to his followers. Bearing that fact in mind, you would obviously be deeply foolish to invest in RSA bonds if you thought Julius had even a remote chance of coming to power!

But now consider why, with SARS having already moved on Malema’s first lieutenant Floyd Shivambo for his part in the VBS bank plunder, maybe President Cyril Ramaphosa has Julius on a tight rein. If Julius were to drop his demands in return for a vice-presidency, maybe the VBS matter might remain buried in the background….just saying!

Now I personally do not think that the ANC retaining power in this manner might fill overseas investors with any sense of optimism, but then that’s what makes bond speculation so interesting.

Then, to take things further, you do not actually have to buy bonds in order to go along for the ride. If you KNEW the above scenario were actually going to happen, you could buy bond futures for a tenth of the physical bond’s face value.

So let’s speculate that Julius and Cyril secretly got together to use some of that seemingly inexhaustible supply of Phala Phala dollars to take a future position on RSA bonds and then opted to do what the world’s best economists have been advising the ANC throughout its period in power, to turn its back on the unworkable socialist experiment of the past and instead take South Africa on a growth path like that achieved by the Chinese in the 1990’s. Given the current unhappiness of the South African voting public, with the strong oratory Julius is famous for and some realistic growth milestones, I would wager the average citizen would be happy to exchange government handouts for a real job with growth prospects.

In such a scenario it is not impossible to imagine the yield on an RSA bond falling from 10.1 percent to five and then Julius and Cyril, if they held bond futures positions could make a 20-fold gain.

So, to go back to my comments about the Rothschild trillions and the fabled Osama bin Laden futures positions on Wall Street just before his assault on the Twin Towers, I sense another money trail. But hey, who in South Africa would complain if our political leaders could achieve a unanimous mutual dream of really building a better future for us all?

I cannot see many of our millions of unemployed complaining if they were offered a genuine opportunity to roll up their sleeves and work; if we could all see clear milestones towards prosperity instead of the current state of play where everyone is now witness to a privileged politically-connected few feasting on the now sun-bleached bones of what was once one of the world’s most promising economies.

If such a dream could restore RSA bonds to their once favoured prime position among global sovereigns where the current yield of 10.1 could fall to rival the US current yield of 3.554 percent….and even more optimistically in a world similarly recovering to an old-fashioned “believable” monetary system….where a futures ten-fold multiplier could be heaped upon a plus-minus ten-fold bond yield gain…..who would have time to notice Cyril, Julius and a few others strolling off into a sunset where they might take their places among those remembered for their greatness in leading South Africa into global prosperity and political stability……even if they had collected a few billions along the way?

I think we would all be too happy to notice. But then who ever said that politics was not a dirty game?

Thought: Is the century of despotic leaders coming to an end in this new interconnected world where ordinary people have finally found their voice? From Joseph Stalin to Adolph Hitler and more recently Osama bin Laden, Donald Trump, Vladimir Putin, and locally Jacob Zuma together with a long string of lesser figures whose dreams of self-aggrandisement left the world in deep initial pain, it seems that ordinary people have decided that enough is enough.

When bin Laden enacted the 9/11 horror he believed it would result in the US pulling out of the Middle East and raise him to apex middle-eastern leadership, but instead the US presence there massively expanded. Where Putin massively miscalculated by dreaming the world would stand idly by when he re-entered the Ukraine as a prelude to re-taking control of the entire former Soviet Union, he succeeded only in uniting the major part of the world against him culminating in a warrant for his arrest as a war criminal.

And here at home this month when Julius Malema thought he could cripple South Africa in fear that the authorities would again stand idle in the face of an impending re-run of the July 2021 riots, his damp-squib demonstration proved to ordinary South Africans that our police and army are not as effete as many feared.

Finally, in the US, Donald Trump thought that he could resist arrest by unleashing a re-creation of the January 2022 ‘storming of the Capitol’. He, like Julius Malema, has just squandered much of what remains of his political capital with major long-term consequences for his country’s political future.

Can a new era be dawning when the decency of ordinary citizens takes precedence?

The SA Budget re-visited

By JP Landman

It is useful to start with what was expected by many commentators, but then did not actually materialise in the 2023 budget.

There were no income tax increases. On the contrary, taxes were reduced, largely paid for by the usual culprits, sin taxes and the fuel levy, and this year joined by carbon taxes. Even more, R40 billion of tax increases over four years flagged by the Finance Minister last year, were withdrawn. Clearly there is an acceptance that higher taxes is not the way forward.

 Also, no wealth tax to pay for Covid-19. No caving into expenditure demands for further Covid-19 allowances or a basic income grant. No squandering of the R100-billion better-than-expected tax collection. No abandonment of the strong stance on controlling public service salary increases. No increases in dividend tax and from next year the company tax rate is actually reduced by 1%. No large-scale extension of the Covid-19 grant and social grant increases limited to well below inflation. All these things were widely expected and predicted.

Glaringly obvious from all the ‘not-happens’ is that the Finance Minister’s political position is not nearly as isolated as suggested by some in the chattering classes. Politically-speaking this was a tough budget. Social welfare beneficiaries got an increase less than the inflation rate. The Minister of Finance is clearly strong enough and sufficiently supported to do all these tough ‘no’ items.

What DID happen? 

The budget does provide for free Covid-19 treatment for everyone (more than R10 billion with more in a contingency reserve). That settles the who-pays-for-vaccinations question.

It also provides money to employ more people in social job programmes, also called public employment. This must not be confused with civil service employment. The employed earn a stipend of R3 500 per month and these job programmes pull a lot of people into the labour market, teaching them some basic skills. It gives effect to President Ramaphosa’s goal to employ 800 000 people in public employment programmes – about 630 000 of whom have so far been recruited.

As a direct result of all the things that did not happen, the budget does provide a clear road back to fiscal sustainability. The numbers are still horrible, but the way out is clear. Of course, occurrences like another Covid-19 pandemic or some other ‘Black Swan’ event can upset the most carefully laid plans. But the intent is clear. A lot hinges on the freeze in salary increases for civil servants. Again, the one thing that did not happen is that government did not yield on this issue over the past year and is unlikely to do so despite all the dire warnings. As a prominent economist put it “so far so good”.

What may very well happen  

When Covid-19 struck in 2020, we had already experienced five years of declining per capita incomes. Covid-19 was then merely the final nail in the coffin. The budget assumes 3,3% economic growth this year, which is lower than the consensus and indicates a conservative approach. That is double the population growth rate of 1,6%.

One swallow does not make a summer. The crucial question is whether economic growth in 2022 and beyond can remain above population growth. That entirely depends on how much structural reform is achieved. By structural reform we simply mean changes that remove constraints on the economy and improve productivity and stimulate investment. One can also use the very loaded term “supply side” measures. Energy, spectrum, infrastructure and ease of doing business come to mind.

The budget quite religiously followed the State of the Nation (SONA) speech in committing government to pursue such reforms. So much for the narrative that the President and Finance Minister are on different pages. The political and economic lesson from the budget is clear: growth will be pursued through structural reform. It will not be pursued through fiscal policies, and there is no political pressure on the Reserve Bank to pursue it through monetary policy. As a colleague has observed, the ANC’s commitment of a decade ago to pursue growth through anti-cyclical policies (spend more money when times are tough, as Biden is now doing in the US) has been jettisoned. For the US anti-cyclical policies are possible, but in post-downgrade South Africa it is not. Downgrades limit one’s maneuvering space.

Last year I published four notes on structural reform and electricity. Suffice to say that the political commitment to structural reform is very strong. But we also know how difficult implementation is. I am building a dataset on structural reform and intend to publish a first comprehensive report on the state of play at the end of March.

So what?

The widely articulated horror expectations of the budget did not materialise. What did materialise was a realistic road back to fiscal sustainability.

The budget indicates that the Finance Minister is strong enough to do what is required and enjoys the political support he needs to pull it forward. South Africa’s road back to growth can only come from structural reform, particularly in electricity, spectrum and infrastructure. All the ‘did-not-happens’ in the budget confirm that the political will is clearly there. Now for the results.

Grasping the Future

Professor Brian Kantor

Nostalgia has its comforts. But looking ahead rather than behind may be the better way to live our lives. This is especially true for those with the responsibility of directing a business enterprise.

They should move on from the mistakes they have made, in business or life, and not throw good money after bad. Rather do that than sell off the best divisions in order to sustain the underperformers with capital that could be better deployed elsewhere. 

Do as Woolworths did with David Jones – but do it faster. And when you have a seriously erring CEO, change the CEO (and the board members who supported them), sooner rather than later. Furthermore, don’t encumber your stronger operating managers with having to service the capital that was once wasted overpaying for acquisitions. The poor deals and the waste of shareholders’ capital were not their mistakes.

Your stronger managers may do well operating the plant and equipment entrusted to them and therefore need the requisite recognition and encouragement.  To do this, the firm should accurately estimate the current market value of the plant and equipment they are held responsible for and reward them when they achieve returns on this capital that exceed the required returns (calculated as the opportunity cost of the capital employed). The investors who value the business will, as managers should, look forward and estimate expected returns based on current market values – and add or subtract based on expected performance.

The technology for dramatically improving the productivity of capital is available to the firm and its competitors.

The future is for every business and every individual to prepare for. The outcomes will be knowledge and technology-driven. The technology for dramatically improving the productivity of capital is available to the firm and its competitors. The future will belong to those who succeed best or at least better than their rivals in doing so and pass the test of the market.

Frustrated South African customers of the state-owned enterprises are only too aware that they operate to serve other stakeholders, not their customers.  Other key performance indicators seem to be more important, most obviously to serve the interests of their employees or suppliers without regard for the bottom line. What will the future bring for this operating model that so clearly fails to deliver to customers? The obvious solution is to introduce incentives for them, based on the same return on capital criteria that make private businesses so customer-friendly. Is this politically possible?

The accelerating pace of technology

The pace of technology may well be accelerating and its outcomes becoming more uncertain. This pace of change has become a source of ever greater anxiety to bosses and their teams as well as to parents and their children. Ours seems a less happy era and maybe technology is to blame. Yet there is also a business imperative to apply technology to improve resilience and reduce the dissonance of the workforce, in that way enhancing productivity and competitiveness.

The evidence from working from home, made possible by improved technology, suggests a great deal about what the future of work may hold. It suggests that the future will be one of fewer hours worked, including fewer (unproductive) hours getting to and from the workplace. Fewer hours worked because improved technology enables more output produced and therefore more income per (fewer) hours worked required to satisfy the necessities of life, and more time for other important pursuits such as exercise or bringing up children.

Those who prefer to work from home but turn out to be less productive doing so, may be willing to accept lower rewards to work from home.

If collaboration in the workplace is valued – when firms believe it leads to more innovation and competitiveness in serving customers – the firm may therefore have to pay more, as well as give more time off, to get key workers to come to the office. Those who prefer to work from home but turn out to be less productive doing so, may be willing to accept lower rewards to work from home. If working from home makes them more productive however, they could seek enhanced rewards from firms competing for their valuable services. After all, a free life is about choices and trade-offs and the freedom to make them.  And an inescapable responsibility of any business is to evaluate the contribution made by all of it’s workforce, wherever they are.

The larger challenge for all will be to find meaning in life. A strong sense of vocation, of finding purpose and satisfaction in work for its own sake, as well as for what it may buy – including more time off – will remain as helpful and important as ever for true well-being.

¹ I should disclose an interest. I am an investor in a South African start up, Neurozone, that applies neuroscience to improve the well-being of their team members and so the performance of the business.

Adjustments Matter

by John Mauldin

Many of the monthly and quarterly data points we follow—employment, GDP, etc.—are “seasonally adjusted.” What you see isn’t an actual number of new jobs found in the surveys. That’s just the starting point. The raw number is then adjusted to remove “seasonal” effects.

Seasonal effects are real and actually quite common. Retail sales go up around the holidays. Farmers buy more seed at planting time and hire more help at harvest time. Theme parks which cater to families with children get more visitors in the summer. Here in sunny Puerto Rico, our resorts are busier in the winter. Home prices typically rise in summer. All this is normal and expected. But it’s a problem if you are trying to monitor trends over time.

If, for instance, the jobs data shows retailers hired 100,000 new workers last month, what does it mean? Are consumers spending more? Is the economy booming? Maybe, maybe not. We need more context.

If we see that in this same calendar month of recent years, the retail industry added an average of 70,000 new workers, then 100,000 is 30,000 more than “normal.” That’s significant, especially if we see it continue over several months.

In that example, we would say that retail employment grew 100,000, or was up by a seasonally adjusted 30,000. The adjustment highlights the change. (Note: This is a simplified example. The math is actually far more advanced.)

Now, seasonal adjustments have limitations, particularly when things like COVID-19 create huge but temporary distortions. These affect the baseline and can show up in weird seasonal adjustments years later. Statisticians can adjust for that, too, but they can only adjust so much before the numbers become meaningless. That’s one reason data has been so hard to interpret since 2020.

I have said this before, and it bears repeating: Backward-looking data that includes 2020 is going to be skewed for several years, until the extreme volatility of 2020 is basically baked into the long-term cake. We are seeing that in many data releases, not to mention earnings comparisons, and it can make the situation look worse or better than it actually is.

Even in normal times, though, seasonality can obscure underlying trends. That’s important in economic analysis because trends are more important than individual data points. Any given month or quarter can be abnormal for all kinds of reasons. Several abnormal months in a row are more significant. We would be less likely to notice them without seasonal adjustments.

The government agencies that publish economic data normally highlight the seasonally adjusted data for exactly that reason, but they provide unadjusted data, too. Sometimes it helps to look at the numbers both ways.

Let’s look at something as “straightforward” as the unemployment rate (note sarcasm). This first graph shows unemployment since 1980. This is the seasonally adjusted graph and as we mentioned above, it is pretty easy to go back and look at trends. 

Source: FRED

 Now let’s look at the non-seasonally adjusted rate. I chose to start in 1980 because it makes the volatility clearer. These are fairly wide swings. Can you imagine these large swings in the middle of a roaring economic boom being part of the monthly release? It’s crazy enough now. The seasonal adjustments give us context without the extraordinary “noise.” Source: FRED

What if we started in 2008? The data looks even more volatile!

Inflation Basket

 Inflation is another common adjustment. You know about “real” interest rates. That’s simply the nominal interest rate minus the inflation rate. If your mortgage is 5% and inflation is 3%, the real rate is 2%. (I get that for new readers this can be confusing. When they look at their monthly mortgage bill that 5% seems very real to them. But we use the same word, for whatever reason, to describe the effect of inflation on interest rates.)

That adjustment, however, can vary depending on the inflation benchmark you use, of which there are many. And inflation itself is kind of a slippery concept. An inflationary economy has generally rising prices but not everything rises at the same pace. Some prices may even fall (like we have seen for many electronic items over the past few decades). Inflation is a highly personalized phenomenon based on your spending patterns.

The Consumer Price Index measures a “basket” of goods and services thought to represent a typical household’s spending: percentages spent on housing (more on that below), food, furniture, clothing, utilities, and so on. This was in the news recently when the BLS made a methodology change. They used to update the basket weightings every two years; now it will be every year. That makes sense, given that people do change their spending preferences over time, and perhaps more frequently now than in the past. But it further complicates an already complex measurement.

CPI also has its own seasonal adjustments because some prices vary with the calendar. Some food prices fall at harvest time when they become more plentiful—but maybe not always if, for instance, bad weather reduced crop yields. Heating oil typically gets more costly in the winter. The CPI adjusts for these to try and show underlying trends. It is an imperfect but necessary process unless you want to deal with all that noise in the headline data. Here again, the non-seasonally adjusted data is available if you want it.

More controversial are so-called “hedonic” adjustments to account for quality improvements. The new car or computer you buy today is probably better than the one you could have bought 10 years ago. Maybe the price rose, but you also get more for your money. Is that inflation or not? I’ve noticed since the 1980s how prices always seem the same for the typically top-of-the-line computers I buy, no matter how much better and faster. But the BLS assured me that computer prices were dropping like rocks. It has only been in the last few years that sticker prices dropped significantly.

The opposite can happen, too, as in the “shrinkflation” you may notice in your favourite food products. Your preferred brand of cereal has the same price, but the box is smaller. That’s a price increase which should show up in CPI, but making sure it does is hard. (My wife and I typically get shishito peppers when we go to the local sushi restaurant at the Ritz. On Valentine’s Day, I noted that portion size was down by almost 50% while the price was up.)

Then we can add a whole new layer to this by moving beyond CPI to other measures, like the Commerce Department’s Personal Consumption Expenditures (PCE) price index. It is constructed differently from CPI because it’s part of the larger GDP calculation. But even if you stick with CPI, there’s plenty of room to slice and dice the data for different purposes.

You see reports of “core” inflation excluding food and energy. That sounds funny on the surface. Who gets to exclude food and energy from their spending? No one, of course. But food and energy prices are volatile, and they feed into every other price. Excluding their direct impact can help reveal the underlying trends we really want to observe.

Then there’s perhaps the king of adjustments: housing prices. CPI measures the price of housing, not the price of houses. It considers housing a service; you pay someone to put a roof over your head. If you own your home, you’re paying yourself for that service. CPI measures something called “owners’ equivalent rent” (OER), which is basically the amount you could theoretically get by renting your home to a third party, based on market rates in your area. It may or may not match your house payments, and it involves all kinds of adjustments.

We criticize OER but the concept has a kind of logic. When you buy a house, you’re doing two different things. First, you’re buying an asset that will hopefully appreciate, and which you can sell later or leave to your heirs. Separately, you get a place to live without paying rent to someone else. OER isolates that benefit from the investment part of the transaction. Or tries to; as noted, it’s an imperfect science.

Let’s walk down housing price history lane. In 1981 the BLS shifted the measure of housing inflation from home prices to current owners’ equivalent rent. It based the data on 1978 actual rent data and then began to modify it. Because CPI was used to compute wages at that time, it delayed changing the way clerical and regular wage earners calculated inflation until 1985.

And then came the adjustments. The BLS made adjustments the first year, 1983, then in 1987 and 1998.

I have written about this process. You can make arguments either way. But playing “what if,” if actual housing prices were used to calculate inflation, would Greenspan have ignored the significant housing price increases even as OER said there was little housing inflation in terms of rent? What if he had leaned into housing price inflation? The same with Powell in 2021. Housing inflation showed up late in 2021 in terms of OER. OER is a lagging number. It tells you what housing inflation has been over the last 12 months, not what it is doing in real time today. My friend David Bahnsen sent me this chart showing rental prices are now rising just 2.4% a month. If more current data were used, inflation would almost certainly be in 3% territory, and getting closer to the Fed’s 2% target. Would Powell be aggressively raising rates if that were the case?

This shouldn’t be just an academic exercise, though it actually is. Economists fiercely debate these topics, and changes happen slowly. You and I rarely see the actual sausage-producing process, but we have to live with it. Assumptions and adjustments have significant real-world implications to every business in the US.

Not Just Numbers

The assumptions and adjustments that go into CPI don’t just give us data; they have an actual, real-money effect. A CPI sub-index sets the annual “cost of living adjustment” for Social Security recipients, many government employees, some private pension plans, and even some commercial business contracts.

Remember what I said: Inflation is highly individualized. Everyone feels it to different degrees. But everyone in those groups gets the same COLA percentage. This year’s increase was 8.7%, starting in January.

For seniors on fixed incomes, that adjustment was probably a big relief after having to spend more on living expenses in 2022. Others who receive Social Security but don’t depend on it (like me), it’s just a nice bonus. But this adjustment has a giant economic effect. It probably helps explain the surprisingly strong 3% jump in January’s retail sales data. That 3% is not adjusted for inflation, by the way. CPI rose 0.5% from December to January, so in real terms this was a 2.5% jump in retail sales. It was highest in restaurants, bars, auto dealers, and furniture stores.

My friend Samuel Rines pointed to some interesting history. Back in the 2009 recession, Congress passed a stimulus plan which, among other things, gave all Social Security recipients a one-time $250 payment. It was about $13 billion in total. Later studies showed that relatively small amount (in government spending terms) boosted GDP by 0.5% in Q2 2009, creating or saving roughly 125,000 jobs.

Adjusting for inflation, that’s equal to about $340 today. The COLA adjustment that just took effect will give about 70 million people an additional $140 a month ($1,680 a year). Not one time, but every month of 2023. So, other things being equal (and they may not be), it could have roughly 5X the stimulative impact of that 2009 special payment.

But here again your mileage may vary. I have a friend whose lifetime job earnings were at the lower end. She also started taking her Social Security at 62. Her COLA was roughly $60, less than half the average.

(I am personally at the other extreme. I started paying into Social Security in the late ’60s. I have paid the maximum amount since about 1980, and as a self-employed person paid both the employee and the employer portion. I waited until I was 72 to begin to take my Social Security. My COLA was $368, which frankly blew me away. I had no idea. I remember not believing that I would ever get Social Security in the ’80s and ’90s. Now I’m getting $50,000 a year. If my contributions over 52+ years had been put into a simple private plan, 50% stocks and 50% long bonds, the resulting number would afford me a great deal more than $50,000 a year.

I still think that when we get to The Great Reset, they will means test Social Security, as that is one of the few ways to really bring the costs down. There will be a lot of weeping and wailing and gnashing of teeth when those discussions happen.

Now, we could have a separate discussion about whether such stimulus programs are the best way to help both individual Americans and the economy in general. But regardless, they have an effect. In 2009 inflation was very low (in fact, it was below zero for a while) and unemployment very high. That’s the environment in which stimulus payments might make sense.

Now we have the opposite: high inflation and low unemployment. Stimulating consumer demand in this kind of economy isn’t what the doctor ordered. In fact, if you wanted to push inflation up then something like this COLA would probably be part of the plan. It gives cash to people with high propensity to spend.

Again, many Social Security recipients suffered as living costs rose sharply last year. I’m glad they will get some relief. They deserve it. But the structure of this adjustment will give some people more than they need and others not enough. And it may well push inflation higher for everyone, causing the Fed to keep interest rates higher for longer, raising mortgage rates and housing prices.

If so, it would mean the inflation adjustment—much of which is simply statistical inference—will have caused even more inflation. These statistical things aren’t just numbers. They matter and can even take on a life of their own.

I remain convinced the Fed is going to raise short-term rates to at least 5%, if not more, and they are going to stay higher for longer. Unless something seriously untoward happens, rates will be above 5% at the end of the year. While many think that is unconscionably high, looking fondly back on the era of cheap money, the world progressed just fine in the ’80s and ’90s with 5% or higher rates.

We will get back to the disinflationary/deflationary forces as the primary driver in the economy. Just not this year, at least in the data.