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A good recession is like a good marriage. You don’t know the truth of it until you’ve put some time in. It will be summer before we know whether this winter’s discontent qualifies as the start of a recession. But odds are this is the real deal because the right catalysts are definitely in place.
So then what?
If you are worried about losing your job, recession is something to scare you. But for most of us, it’s just a passing nuisance. In the United States we’ve had nine of the things since World War II, and only two of them were particularly bad. The interesting thing about those two recessions is that the Federal Reserve purposely engineered them to put a stop to raging inflation. The worst of these recessions - from 1973-1975 - knocked 4.9 percent off the GDP.
Or was it the worst? Unemployment reached nine percent that time. But in the “milder” 1981-1982 recession, unemployment was worse. It got to nearly 11 percent. But fewer industries were hit.
Now we come to rocks and hard places. It’s why the Fed had to make the situation worse to make it better in the 1970s and 1980s recessions, because inflation is much scarier to government than recession. Inflation and recession call for opposite strategies. But if both threaten, the Fed must choose its poison.
If there’s a recession, the Fed can move to head it off by increasing liquidity. Meaning, among other things, lowering interest rates.
That’s the opposite of the main strategy for halting inflation. With inflation, the Fed wants to slow down spending, so it raises interest rates to discourage borrowing and spending.
Now we have a problem. With the current mortgage market crisis, lenders are sitting on their checkbooks. Liquidity is dry. Recession seems to be lurking. The Fed has been tepidly trying to lower interest rates and get borrowers and lenders moving again. And that would be a simple problem with a simple fix if recession were the only thing the Fed had to worry about.
But now inflation has cast its shadow as well.
And I am here to tell you that this inflation is considerably worse than your local newspaper - or even the mighty Wall Street Journal - is going to tell you.
We are between a rock and hard place, and the Fed is depending on some nice little white lies to keep everyone calm. What lie? The consumer price index … it’s wrong, but not in the ways you’ve been told.
Government’s inflation figures are fairy tales. You know something doesn’t seem right about the numbers. From 2000 through 2007, annual inflation cost us a cumulative 23.5 percent, according to the government. Total.
But if you do the grocery shopping, you know that’s wrong. The groceries you bought for $100 in 2000 can’t be had for a mere $123 today. By the government’s own data, oranges are up 70 percent, while eggs are 60 percent higher. And beyond the grocery cart, gasoline was up 132 percent at the end of 2007, and medical care had risen more than 40 percent. Health insurance - not on the CPI price list - has gone up even more.
This sounds more like reality. An average family is not moderately challenged by inflation. It is severely tested. So how does the government get such tame results with valid numbers?
The final CPI number is a composite of many costs. But among them, food, energy and medical costs come to only one-fourth of the CPI’s weight.
Tell that to an average family. Their food and energy came to a third of their budget. And that’s before adding medical costs. That’s before subtracting for childcare.
So every time the CPI supposedly goes up one lousy percent, the real kick is much harder.
“Core” inflation is even more skewed. It backs out food and energy costs on the ground that they are too volatile, and policy shouldn’t center on them.
We know the truth. It’s an inflationary world out there. And only two groups of people beat inflation. The first is active workers who are advancing in careers and getting raises faster than inflation catches up with them. That doesn’t help for established people or retirees.
The second group is investors. We’ll take S&P data from 1926 to 2006. In that time, bonds averaged 4.86 percent per year. Inflation averaged 3.04 percent. So bonds beat inflation slightly…before taxes. After taxes? Not by much.
Stocks, however, averaged 10.5 percent, more than twice the inflation rate.
The CPI is a charade. Bonds are boring and barely preserve money rather than grow it. It’s stocks you need for the real world. And though they may lose money some years, the same S&P study found that they never lost in any long-term (20-year) periods.
Long-term investing in stocks is how you win over inflation.
Sincerely,
Lynn Carpenter
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