Inflation


This post was originally published on July 31, 2013. It was updated on November 11, 2013, August 3, 2014, and again on August 2, 2016 to reflect the new GDP numbers. Extending our research on the use of the Big Mac Index, as created by The Economist, we applied the rise in the price of a Big Mac in relation to the economy. While Big Mac prices rose over the last three months, the price overall declined in the past 12 months. The burger, as a representation of GDP, may be stealing more than calories from consumers. The Bureau of Economic Analysis (BEA) reported that in 2015, the economy grew 1.2%. This was far below economists’ expectations reported by Briefing.com. As the BEA indicated in the press release “The increase in real GDP in the second quarter reflected positive contributions from personal consumption expenditures (PCE) and exports that were partly offset by negative contributions from private inventory investments, nonresidential fixed investments, residential fixed investments, and state and local government spending. Imports, which are a subtraction in the calculation of GDP, decreased.” The deflator used for inflation was up 2.2%, which was far higher than the Consumer Price Index (CPI) of 0.8%. Under estimating inflation results in correspondingly optimistic growth rates. This resulted in the GDP number being significantly higher than it would otherwise be if the CPI was used. Odds and Ends The BEA defines gross domestic product, the measure of economic growth as: GDP = private consumption + gross private investment + government spending + (exports – imports) Taking it one step further, we can break this down to by private consumption into service and actual goods and investment into fixed investment (machinery) and inventories. When looking at GDP with all its components, we can see that real final sales was the strongest, but all other components have weakened over the course of the last 12 months. Doug Short graphically represents the components of GDP. Burger Blues Inflation boosts the growth rate of each of the components of GDP. When the price of food or gasoline increases, GDP increases. This is more accurately called “real” GDP. Thanks to The Economist, we have come to look at the price of the Big Mac as a good indication of inflation. The Big Mac includes beef, dairy (cheese), wheat (bun), cost of labor, and the cost of real estate. As a result, I believe it is a good representation of inflation. However, our analysis indicates that the price of the Big Mac has continued to escalate much faster in recent quarters than the official government rate of inflation (CPI-U). Consequently, here...

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The consumer-price index in July increased 1.8% from a year ago. This represents the core CPI. This upsurge was driven by an increase in medical and housing prices increasing.  This post has been updated from our previous post on May 8, 2015. Continuing our research using the Big Mac as a gauge of inflation, we build on past posts but use our own research to draw conclusions. In previous articles, we have relied solely on The Economist’s calculation of the Big Mac price. The Economist has been conducting the research sporadically since 1986. However, it was not until a few years ago that they began updating their research periodically in January and July. Believing this span is too great, we have compiled our own look at the price of the Big Mac in the United States. Thanks to my assistant, Geraldine Garcia, we have surveyed 30 McDonald’s restaurants throughout the nation to obtain the average price and compare that to the trend. From our research, we have determined that currently, the average price of a Big Mac is $4.79, down $0.01 from $4.80 in July 2014. Clearly this indicates little or no inflation over the last year. As stated in previous posts, I believe that the Big Mac provides a better indication of price movements than the government compiled Consumer Price Index (CPI). Many of us can neither follow nor actually experience what the CPI means or how it moves. Conversely, the Big Mac is consumed constantly, and we shell out hard-earned dollars to purchase the sandwich. Thus, it is a real-time metric of our economy. The CPI was reported to have decreased 1.8% over 12 months. Food and gas prices saw an increase of 0.2%; however, the Big Mac increased significantly more. This under-reporting of inflation impacts savers, investors, retirees and individuals receiving Social Security, just to name a few. Just recently, Placed Insights surveyed the eating habits of Americans to determine that individuals eat 17 Big Macs per second. This means Big Macs are eaten at a rate of 1,200 a minute, 61,200 an hour, 1,468,800 each day and 536,112,000 a year. These numbers prove that people experience the change in the price of the Big Mac daily. It is tangible. Consequently, it is a good way to view inflation. While we have just observed why the Big Mac makes for a good inflation gauge, it is also important to relate it to the financial advisor profession, and how we communicate the impact of inflation to individual clients. Bet on the Big Mac Ed Easterling, the founder of Crestmont Research, believes that the level of inflation –...

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Last month, the Social Security Administration (SSA) announced the expansion of Social Security benefits due to the cost-of-living adjustment (COLA). Unfortunately, if you are living off your Social Security benefits, you have probably realized it is not enough to keep up with food prices. With the SSA announcing the COLA for 2015, we thought it would be a good time to see how Social Security benefits are actually stacking up to the inflation we are experiencing. As I have said in a previous Big Mac post (updated October 24, 2014), I believe that the Big Mac provides a better indication of price movements than the government compiled CPI. Many of us can neither follow nor actually experience what the CPI means or how it moves. Conversely, the Big Mac is consumed constantly, and we shell out hard-earned dollars to purchase the sandwich. Thus, it is a real-time metric of our economy. Let’s take a look at the last 14 years of COLA adjustments.   The first few years in the 2000s, Big Mac prices increased at a lower rate than COLA; however, since 2003, Big Mac prices have increased at a much faster clip. This would suggest that if you are living off of Big Macs for your sustenance, you are buying significantly fewer today than you were back in 2000. The lack of funds in the Social Security trust is well-publicized. To date, there has not been a revamp of the benefit calculation to account for the trust’s potential of being illiquid by 2030. However, the SSA is combating the lack of funds in one very crucial way: under-reporting inflation! By reporting a COLA that is lower than the actual rate of inflation, people are receiving fewer dollars than they may have put in, or would expect to receive if COLA tracked the rise in prices of the Big Mac. Completing this analysis, we can see a significant decrease in the number of Big Macs one can purchase. In 2000, the average Social Security benefit was reported at $785. Today, accounting for the COLA increases reported by the SSA, the average benefit would reach $1,149 per month. At an average price of a Big Mac at $2.44 in 2000, and the average price now residing at $4.80, as reported by the Economist in July 2014, an individual could purchase 90 fewer hamburgers. This is almost one-third fewer hamburgers! No wonder why Congress and the SSA have not changed the benefit calculation — they don’t have to! By reporting lower inflation, the SSA can reduce the benefit payout without lifting a pen or bringing the decision to a vote...

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Note: I’ve updated my periodic look at the Consumer Price Index (CPI) versus the Big Mac Index to coincide with The Economist’s bi-annual update of the Big Mac Index used for currency values and the most recent CPI for August 2014 (which was released on August 19, 2014) . What are we to believe? The change in the price of the Big Mac says one thing while the Bureau of Labor Statistics is telling us another. On Tuesday, August 19, the Consumer Price Index (CPI) was released by the Bureau of Labor Statistics, stating that “Over the last 12 months, all the items in the index increased 2.0 percent before seasonal adjustment.” The rise in the price of a Big Mac has risen faster than the official rise in consumer prices and has been doing so since the late ’90s. In 1998, the average price of a Big Mac was about $2.50. As of July 24, 2014, The Economist reports that the price of a Big Mac is $4.80. If we were using the Consumer Price Index (CPI), the price of a Big Mac today should be about $3.67. Believe it or not, the price hikes represented by the Big Mac will impact you more than the saturated fats in popular burger. By understanding the price disparities, you can make better decisions for you and your clients. The rise in the price of the Big Mac foreshadows how the printing of money is eroding the financial system’s arterial walls. The impact is broad based: Each dollar we own is buying less. For individuals relying on Social Security, the compensation for inflation is not keeping up with the prices people actually pay. The price of bonds should be much lower if interest rates fully accounted for the rise of inflation based on the Big Mac. The official economic growth rate would be lower now if prices were based on the Big Mac index. Using the Big Mac Index to Measure Inflation The Economist created the Big Mac Index in 1986. The Big Mac Index was created to compare the price of currencies between different countries. The index is based on a theory called purchasing power parity. This theory looks at the same basket of goods in each country and then adjusts for the interest rate one would pay for a loan or get for a savings account. This adjustment for interest rates makes the price of a Big Mac comparable in each country. The Big Mac Index just has one item. However, since the one item contains beef, dairy (cheese), wheat (bun), cost of labor, and the cost of real...

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In May, the Consumer Price Index (CPI) rose at its fastest pace in more than a year. This may be an indication inflation has bottomed, or it was just a momentary spike. Whatever inflation does, it is a good time to measure stock market valuation and inflation. This post has been updated from our original post on December 18, 2013. In previous posts, I have argued why using the Big Mac Index may be a good alternative to measure inflation rather than using the Consumer Price Index (CPI). In this post, I extend the research further to include a comparison with valuations in the stock market. Expanding on work from Ed Easterling and Doug Short, I compare the price-to-earning ratio 10 year (P/E10) to inflation as measured by the Big Mac Index. I have chosen to use the P/E10, or cyclically adjusted price earnings ratio (CAPE), because this valuation metric is more highly correlated to movements in the market than the normal P/E ratio that uses forward earnings. “Y Curve” To begin, let’s start with Ed Easterling’s work with in P/E Ratios and Inflation. In Easterling’s work there are two notable findings: P/E ratios increase when inflation is near 1% This increase is consistent with the dividend discount model valuations The P/E relationship to inflation is predicated on stable prices. That is, when inflation as measured by CPI is around 1%, P/E ratios are at their highest. P/E ratios decline when there is deflation. They also decline when there is greater inflation, above 1%, which Easterling has coined as the “Y Curve.” Easterling believes that this is consistent with the dividend discount model or discounted cash flows, because dividends and earnings decline with inflation. With higher inflation, company’s profit margins are not as strong, because it is difficult to raise prices as fast as the underlying commodities’ price increases. Earnings are also not as strong in an environment when prices are increasing. Therefore, a stable price environment benefits stock price valuations. Inflation Sweet Spot Short dug into this work and noted a “sweet spot”—the range that has supported the highest valuations—is between approximately 1.4% and 3%. As Short noted in his most recent update, “The latest P/E10 valuation is 24.9 at a 1.9% year-over-year inflation rate, which is in the sweet spot mentioned above.” So, there is clear evidence that higher valuations are supported by stable and relatively low inflation. Big Mac “Y Curve” Replacing the use of the CPI with the Big Mac, we come up with similar results but with some key differences. In the graph above, the CPI is indicated by dark blue circles, and the...

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Originally posted on October 2013, this blog entry has been updated with new data through the end of April 2014. Continuing our research into using the Big Mac as a gauge of inflation, we build on past posts but use our own research to draw conclusions (see, for example, our analysis here and here). In previous articles, we have relied solely on The Economist’s calculation of the Big Mac price. The Economist has been conducting the research sporadically since 1986. However, it was not until a few years ago that they began regular updates to their research in both January and July.  Believing this span is too great, we have compiled our own look at the price of the Big Mac in the United States. Thanks to my assistant Geraldine Garcia, we have surveyed 30 McDonald’s restaurants throughout the nation to obtain the average price and compare that to the trend. From our research, we have determined that the average price of a Big Mac is $4.45 (the range was $3.78 to $5.28), an increase of $0.09, or 2.0% from what we obtained in January. While it increased during the past three months, annualized, this a decline of 2.4% over the last 12 months. This compares to the Consumer Price Index (CPI) reported today by the Bureau of Labor Statistics. The CPI increased 2.0% year-over-year. We are seeing a reverse of what we saw last year. Big Mac prices rose more than CPI last year. This year the reverse is true–CPI is rising more than the price of a Big Mac. As stated in previous posts, I believe that the Big Mac provides a better indication of price movements than the government compiled CPI. Many of us can neither follow nor actually experience what the CPI means or how it moves. Conversely, the Big Mac is consumed constantly, and we shell out hard-earned dollars to purchase the sandwich. Thus, it is a real-time metric of our economy. Just recently, Placed Insights surveyed the eating habits of Americans to determine that individuals eat 17 Big Macs a second. This means Big Macs are eaten at a rate of 1,200 a minute, 61,200 an hour, 1,468,800 each day and 536,112,000 a year.  At $4.45, the current average price of a Big Mac generated $2.4 billion in revenue for McDonald’s from Big Macs sold in the U.S. alone. My point is that people experience the change in the price of the Big Mac daily.  It is tangible. Consequently, it is a good way to view inflation. While we have just observed why the Big Mac makes for a good inflation gauge, it also is important to relate...

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