No Inflation to See Here!

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By The Daily Reckoning Australia | November 8, 2012 3:31 PM EST

It's a big week. The race that stops the nation will stop us from coming into our St Kilda headquarters tomorrow. We used to try working on Melbourne Cup day. But we gave up when we realised most people really do take the day off. But don't worry. We've queued up a special US election preview presentation for your enjoyment. Watch out for it.

In the meantime, there is a fair bit to get to today. In today's Daily Reckoning we'll figure out what the RBA is going to do tomorrow with interest rates. We'll give you a red hot tip for Tuesday's biggest race of all, the US election! And finally, some reader mail about the end of the world, misleading and/or deceptive advertising, transparency, and more.

First off, there is the usual anticipation about tomorrow's Reserve Bank of Australia meeting. Will they or won't they? Well, a lot depends on what the bank defines as inflation, and then what it tells us inflation is doing. Consumer price inflation will be the big factor.

Consumer prices jumped 1.4% in the September quarter, according to the bank's own numbers. But you have to wonder where those numbers are coming from. When we were up in Sydney for the Gold Symposium, we paid $28 for a hotel breakfast that consisted of breakfast cereal and stale coffee. For the full buffet we would have paid $35.

Australia has become an incredibly expensive place to live and breathe, even if you throw out over-priced hotel breakfasts. But then, you can see from the chart below that according to the RBA's data, the cost of things you use every day is actually going down, once you exclude those things from your cost calculations. Funny how that works.

No Inflation to See Here!

 Source: Reserve Bank of Australia

Not to get too wonky, but the RBA breaks down consumer goods into two categories, tradeable and non-tradeable. Non-tradeable goods tend to be services, or goods you cannot import easily. In other words, you can substitute one barber for another, but a haircut is going to cost you pretty much the same. The value of the Aussie dollar and imports don't affect the price of the good or service.

All the consumer price inflation is in non-tradeable goods, according to the RBA. You'll just have to cop it. Meanwhile, the bank says tradeable goods prices - things like cars, clothing, and oil - are actually falling. The fall is a combination of a strong Aussie dollar (more purchasing power so you can buy goods from overseas) and global competition driving down prices (computers and electronics).

Our completely non-scientific, non-statistical analysis is that this methodology for calculating consumer price inflation is bogus. At the very least, it's wrong. Look around you. Does life seem cheaper or more expensive? Are the assumptions in the methodology right?

One of the assumptions behind cheaper tradeable goods prices is that you can always substitute a cheaper good for a more expensive one. But cheaper isn't always better. This is another way of saying that in order to avoid inflation, consumers can opt for a lower quality of life. But that's not an improvement, is it?

In any event, the share market may not care too much about the intricacies of inflation definitions. A lot of eyes are on the US Presidential election. Our own view is that the 12.5% rise in the S&P 500 year-to-date is the Romney Rally. The market has baked a change in leadership into the cake.

That's certain to surprise you if you get all your election news from the Australian media. In fact, outside the US, there's little reporting of how close the election actually is. We won't steal the thunder from our presentation tomorrow, but expect it to be close. Our prediction: Romney wins the popular vote and wins in a squeaker in the Electoral College.

Regards,

Dan Denning

for The Daily Reckoning Australia

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The article was first published by The Daily Reckoning Australia

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