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Mamdani’s Effect on the CPI
Surprising no one, and yet shocking many, avowed socialist Zohran Mamdani won the election yesterday to become Mayor of the largest city in the United States.[1]
Probably the main reason for Mamdani’s victory is that he pursued the tried-and-true method of giving out free stuff, and a whole generation of Americans who have systematically been poorly educated in history and economics said “that sounds awesome.” So, now we will see whether socialism will work for the first time ever.
This is an inflation blog, so I want to review briefly the effects of price controls on inflation – and indirectly, on inflation instruments. It’s interesting because we actually have some direct and recent experience with what were effectively price controls: the Biden Administration’s ‘eviction moratorium’ during COVID, that prevented landlords from tossing out renters who weren’t paying their rent. Really, it’s a pretty amazing thing that says a lot about Americans that the vast majority of renters continued to pay rent anyway.[2] An ancillary effect, though, was that landlords had no leverage to raise rents and therefore, rents stopped going up. Unsurprisingly (and here is where the lesson should have been learned), when the eviction moratorium was lifted rents re-accelerated. In the chart below, note how in 2021 effective rents declined while asking rents went up – but the red line eventually rebounded and exceeded the prior trend.
I actually haven’t looked at that chart in a little while. It’s fascinating to me that ‘asking rents’ (which come from the Census department) have maintained their divergence from ‘effective rents’ (sourced from Reis Inc). I wonder if some of that is the effect of the LA wildfires. In any case, not today’s article. The point is that the effective price controls on rents did have an effect on measured rents, but it didn’t change the economics and eventually prices caught up.
Back in 2022, I produced an excellent podcast episode entitled Ep. 37: Bad Idea of the Year – Wage and Price Controls. In it, I discussed some of the trial balloons that had been floated by the Administration and some of the really bad economics that was being used to support the idea. This is a part of the transcript (from Turboscribe.ai), and I still love the analogy:
“But the basics of how it works are very simple to visualize. Price is a teeter-totter, okay? It’s a seesaw. On one side of the seesaw sits all of the buyers. On the other side sits all of the sellers. If there are lots more buyers jumping onto one side, then the teeter-totter drops on that side, and the fulcrum, in order to make everything balance, the fulcrum has to move. And if you move the fulcrum, then you can get that to balance even with more buyers and fewer sellers.
It just means that the fulcrum, which is price, has to move in one direction. If then people, those buyers drop off, then the fulcrum moves back the other direction. If more sellers jump onto the teeter-totter, the fulcrum moves the other direction as well.
So it’s a simple way to visualize it…and yes, there are all kinds of complexities in the real world. There’s behavioral, there’s stickiness that happens, but that’s the fundamental theory of price, is what I’ve just given you, is that price is the fulcrum that balances the buyers and sellers.
So what price controls say is that, well, we don’t like where this balanced. We have too many buyers, not enough sellers, and the fulcrum has moved way over to one side and we don’t think it should be there. So we’re going to take the fulcrum and we’re going to move it to where we like it. And guess what happens? There’s no balance. All of a sudden, if you move the fulcrum away, then all of a sudden, the side with all the buyers goes down and goes thunk on the ground. There’s no balance.
“How do you then balance it? If you say that the fulcrum has to be in this location, how do you balance the teeter-totter? Well, you have to take buyers away. And you take buyers away by making a shortage. And so those buyers can’t buy anything. And then voila. So if you force the price, then the quantity has to change. And if you let both things happen, then it will magically go and balance. If it’s truly a free market and there’s good information and all that stuff.
“So does this solve the problem to push the fulcrum to one side and say, oh, there’s no inflation and to make it balanced, we shove everybody off the teeter-totter by creating a shortage? It doesn’t solve the problem. And furthermore, the people that you’ve pushed off the teeter-totter who can’t get access to the thing anymore are pretty upset. They should be upset because before they had a way to get what they wanted and what they were willing to pay for. And now they can’t because you’ve shoved them off the teeter-totter. You’ve created a shortage.”
That was a public service announcement, just to remind you why price controls don’t work. That doesn’t mean they aren’t really good politics, especially if you can leave the removal of the controls to the next guy who ‘causes’ the inflation when they come off. And it’s the politics, not the economics, that leads to this dumb idea being tried over and over despite a roughly 0% record of success.[3]
Because can price controls affect price indices? You betcha. If you make it illegal to move prices, then at least official prices will not move. So let’s consider the potential impact of Mamdani freezing rents and grocery prices, for example.
New York City is about 7% of the CPI sample. Technically, it’s New York-Newark-Jersey City but we know most of that is NYC. In the New York consumption basket, Rent of Primary Residence is about 11%, 28% is Owners’ Equivalent Rent, and 8% is Food at Home. So, if rents and grocery prices were frozen, about 19% of the NY CPI would go to zero month/month right away (at least officially – the best tomatoes will be sold on the black market for a premium of course and the best catch of the day will be sold in NJ…[4]) And since OER is based on a survey of primary rents, eventually 47% or so of the NY CPI basket will go to zero price change. I’m ignoring the quality adjustments in the housing stock, which have the effect of increasing OER inflation slightly.[5]
The effect of this on the national CPI: if 47% of the NY basket goes from, say, 4% inflation to 0%, and NY is 7% of the national CPI, then the really-rough effect on the US CPI would be 47% x -4% x 7% = -13bps per year. Obviously that’s extremely rough, but I’m just aiming for an order of magnitude calculation. 13bps is small, but noticeable. Probably not tradeable.
But here is something that’s interesting and potentially tradeable. New York City is about 30% of the Case-Shiller 10-City Home Price Index. Let’s suppose that home prices in New York over the next year drop, say, 10%.[6] That move would cause the nationwide Case-Shiller (10-city) index to drop 3%, or to rise 3% less than it otherwise would. Here’s what is interesting. The chart below shows the February 2027 NYC Metro Case-Shiller futures contract, which trades on the CME (and settles to the index for December 2026, which is released in February 2027).
There has been exactly zero price effect of the Mamdani victory. To be sure, open interest in the NYC contract – in all of the Case-Shiller contracts, for that matter – is extremely low but there is an active market-maker and the current price as I write this is 344.40 bid/351.60 offer. The last print of the S&P Cotality Case-Shiller New York Home Price NSA Index, for August 2025, was 334.08. On the bid side, then, the market is paying 3.1% higher prices than the current index. That seems sporty to me. Why would home prices rise if rents are frozen? Why would they rise if people are leaving the city?
As always, my musings here are not trade recommendations; do your own research. Disclosure: I do not currently have a position either long or short in any housing futures contract, nor does any account or fund that I or Enduring Investments manages, nor do I currently have plans to initiate any position.
[1] New York, at least for now.
[2] At the time, we worried about what would happen with the CPI since a renter paying zero rent is not skipped but the rent goes into the calculation as a zero. So you could in theory have had 10% of the basket going to zero, which would have destroyed the inflation market.
[3] If you listen to the episode: I also love my thermometer analogy.
[4] Also, though rents will stop rising the quality of the apartments will deteriorate since landlords will skimp on maintenance. Mamdani has a plan for that, though – he has said the city will order maintenance to be done and if it isn’t, the city will seize the property. Just in case there was any question who really owns any property that you can’t pick up and transport elsewhere.
[5] N.b. – the increase in the CPI nationally from the owned-housing quality adjustment almost exactly cancels the decrease from quality/hedonic adjustments in other parts of the CPI. Yet another reason that the whining about hedonic adjustment being used to ‘manipulate CPI lower’ makes no sense.
[6] You can easily make a case for a much steeper drop if the city increases property taxes to make up for declining income tax collections, not to mention if the exodus from the city looks anything like the 9% of the population who claim they’d move if Mamdani won, or if the finance industry continues to relocate to Dallas and Miami.
Inflation After 100 Days
It is hard to believe that a third of the year is already past. Some people, of course, would say that it seems like a hundred years have passed in the first hundred days of Trump’s second term, but to me it seems like a blink.
Here’s a quick mark-to-market summary of where I think we stand with respect to inflation and the economy generally…after which I actually have another point for this column:
Uncertainty. That’s the watchword, of course. One place this shows up is in the huge spread between survey data and hard data. The survey data is tinted with fear of uncertainty, and is very negative (and likely influenced by the media deciding that Trump’s Administration signals the End of Days); the hard data is clearly softening but not dramatically so – and frankly, that was already under way in some ways since at least 2023 when the Unemployment Rate started heading slowly higher. In my view the softening of the hard data won’t ever get to be dramatic in this recession, and this will end up being more like a garden-variety recession we used to have pre-2000.
Inflation will be higher than it would otherwise be, because of tariffs, but lower than many people think because people greatly exaggerate the effect of tariffs. Tariffs only affect goods, and only significantly if they are goods facing inelastic demand. There will be some shortages in the near-term, and unlike during COVID when many of the shortages were caused by too much demand induced by money-drops to consumers, in this case it really will be supply constraints. Look out for things like ibuprofen, which is 90% sourced from China which makes it hard to completely switch supply to domestic suppliers. But these are short-run or in some case medium-run disruptions as supply chains shift. As domestic or lesser-tariffed countries replace the highly-tariffed suppliers, the supplies will respond and prices will come back down – not all the way to where they were, but it will feel like deflation in some cases because we mentally refer to the most-recent price, not to the year-ago price.
But either way, the tariffs are a jump-discontinuity, a one-time effect. The uncertainty, less so but that will fade (as an aside, and as I’ve noted previously, the high uncertainty had the effect in Q1 of causing money velocity to decline very slightly for the first time in a couple of years). By the end of the year, things will be much more settled and inflation will be stabilizing again…but the story continues to be that inflation will stabilize in the high 3s, low 4s, not at 2%. This probably means the Fed will not be easing much, although if there is a significant slowdown not caused from net trade – the Q1 drag was significantly from the surge in imports due to front-running tariffs – the Fed will ease even if inflation hasn’t come down. They’ll point to tariffs being transitory, although I sincerely doubt they will use that word! And they’ll be right, but they’ll also be wrong. Money supply growth is still too fast to accommodate 2% inflation especially in a deglobalizing world.
We’ll talk more about all of these things in columns here and in my podcasts over the next few months. But today I am still very preoccupied with getting USDi[1] launched, getting investors involved, talking to crypto ecosystem providers, etc. And I want to address one question I get routinely these days – not just about USDi, which exactly tracks CPI but adds nothing on top, but about the underlying investment strategy that I’ve been running/marketing for 3.5 years. The question is, “why should I buy something that returns CPI when inflation is at 3% and I can buy Tbills and earn 4.25%?” Here are two important pieces of the answer – and they’re just as important to investors who operate wholly in the traditional finance world as it is to people operating in the crypto world.
The first part of the answer is that while Tbills are above inflation now, that is not exactly guaranteed. In fact, for the last quarter-century it has been fairly unusual.
Sure, if you go back to the 1980s and early 1990s, when inflation was high and coming down and the Fed was following inflation down, you can find a lengthy period when Tbill rates were above inflation. Is the current period, with inflation where it is, comparable to the period when inflation was descending from double-digits and the FOMC was dominated by hawks? Do you think Trump will replace Chairman Powell and other Fed governors whose terms expire, with hawks? It doesn’t seem that way to me. I think it’s important to realize that is the bet you’re making, if you hold short cash instruments as an inflation hedge.
The second part of the answer is that holding a cash instrument does not protect you during an inflation spike because the Fed cannot respond fast enough, and a cash instrument in nominal space does not protect you from a dollar crisis. Almost nothing does, in fact, as stocks and bonds both do poorly in those cases as do ‘inflation hedge’ products based on equities or bonds. Here is a chart of the recent inflation spike. How well did your Tbills, or short-duration bonds (VTIP) or long-duration inflation bonds (TIP), keep up? Did they ever catch up?
To me, any allocation to low-risk securities that is meant to serve as a volatility buffer for a portfolio, but does not hold inflation beta, is completely missing the value of that beta in certain scenarios where very little else is helpful. When inflation spikes, stocks and bonds become correlated (down). You can (and should) add commodity allocations to your portfolio, but those consume part of your risk budget and push out the equities, hedge funds, private equity, and other higher risk asset classes. If you can get the inflation beta from a very low-risk part of your portfolio, you ought.
The foregoing is, transparently, partly self-serving. But the products I’ve been involved with developing have never been developed because they produce big fees or are easy to sell.[2] I’ve developed them because they’re useful to investors. And, parenthetically, I do think that the worker is worthy of his wages.
If you want to find out more about USDi, I urge you to visit the home page https://usdicoin.com, where you can see the current value of the coin increasing minute-by-minute with inflation. If you’re a denizen of the crypto world, then you might also be interested in joining the Telegram read-only group for the USDiCoin, available at https://t.me/USDi_Coin. That group is where we will make announcements about the coin, post the price of the coin periodically (at least daily; automation in process), post the monthly reports confirming the collateralization of the coin, announce new market-makers and markets…and also post some inflation-related charts, such as I used to do on Twitter on CPI morning, when Twitter allowed such automation. If you’re at all interested in inflation and/or the inflation-linked coin, hop on.
[1] If you don’t know what USDi is yet, read my prior article https://inflationguy.blog/2025/04/15/announcing-usdi-inflation-linked-cash/
[2] Understatement of the century.
The Effect of Time on Trump’s Win Likelihood
Not everybody is an options trader, but during an election year there is at least one binary option that most of us care quite a bit about and that’s the option on the US Presidency. There are ways to trade the binary option, but my interest here is not in valuation.
People generally understand that if an option with a payoff of $1 or $0 (depending on the outcome of the event) is trading at $0.60, it means that the market is pricing a 60% chance that the event will occur. (Because 60% chance of $1 + 40% chance of $0 has an expected value, if we ignore discounting, of $0.60). But what I think many people don’t naturally understand is how the 60% chance changes over time even if nothing changes in the underlying circumstances.
If you’re not an options trader, this might be confusing. If Trump has a 60% chance of winning based on the current circumstances on July 31st, then if the exact same circumstances prevail on October 31st shouldn’t the odds of him winning still be 60% (and therefore, the price wouldn’t change)? The answer is nope, not at all.
Let’s suppose that we can summarize “the current circumstances” with one metric, that being the national polling margin.[1] Trump currently polls about 2 points ahead of Harris nationally according to the RealClearPolitics average. If that’s still true on November 5th, Trump will win (again, pretending that the winner of the popular vote automatically wins the election). The odds of him winning would be, of course, 100%. If he only drew 49% of the vote, his odds of winning would be 0%. That’s on the day of expiry, when the odds have to collapse to 100% or 0%.
Prior to the last day, time and volatility work in favor of the challenger and against the leader. If I am the leader, then I want nothing to change. Good things will help me, but won’t change the situation (I’m still expected to win), but bad things might change my expected win to an expected loss. The more volatility there is, the more crazy things happen, the more chances there are that my victory will turn to a loss. If I am behind, I want chaos, and the closer I get to ‘expiration’ the more I am willing to risk to get the chaos. Think about pulling the goalie in an elimination round in hockey or soccer…if the team is behind by 1 goal with 1 minute left, then the opposition scoring on an open goal doesn’t change anything – but having an extra man forward has a chance to change the outcome.
Key point: volatility helps the out-of-the-money option. Higher volatility raises the delta (loosely thought of as the chance of ending up in-the-money) of an out-of-the-money option. Similarly, higher volatility lowers the delta of the in-the-money option. This is why there are October surprises.
Time works on options pricing similarly to volatility (fun fact – doubling the implied volatility has the same effect as quadrupling the time to maturity, I the Black-Scholes world). As the expiry of the option approaches, the delta of an in-the-money option gradually rises until it gets to 1.0 at expiry; the delta of an out-of-the-money option gradually declines to 0.0. It’s the same reasoning. With more time to play, there are more chances for good (outcome-changing) accidents to happen to the person who is trailing, and more chances for bad accidents to happen to the person who is leading.
In the context of the election, here’s what this means. (Note: remember this is just an illustration, not a prediction. It’s a pricing model where I’ve made lots of assumptions so as to be able to show this point).
If Trump still has a similar lead in the national polls in two months, his odds of winning will rise – to something like 70%, versus 60% now. After that, it will rapidly go to 100% over the ensuing weeks. And so event contracts will behave likewise…Trump contracts should gradually rise, even if nothing changes, as the opportunities for changes in the race get narrower.
Two more caveats.
One: the option here is not really a European exercise that is determined on November 5th. Since there is such a thing as early voting, the effective expiry is closer. If Trump is leading on October 15th, he’s accumulating actual votes. So it’s really like some kind of weighted average-price exotic option. But the point is, the delta decay will happen faster than I’ve modeled, for that reason.
Two: I’ve assumed volatility is constant. It most assuredly is not constant. Implied volatility ought to rise as we get closer to expiry (October surprise!). That will tend to offset the delta decay that I have modeled.
In summary – don’t take this as trading advice, but as a hopefully useful insight into how deltas (and binary contracts) evolve over time. I hope you found this interesting.
[1] Obviously, we know that’s not right because the US elects Presidents based on the Electoral College process, which is the result of a compromise between those who wanted the President selected by Congress and those who wanted the President selected by popular vote. In recent years, the winner of the popular vote hasn’t always won the Presidency because the most-populous state, California, has overwhelmingly voted Democrat and skewed the popular vote numbers.
Understanding Biden’s Poll Numbers Despite a ‘Strong Economy’
The Biden team keeps talking about how they can’t believe how underwater the President’s poll numbers are, when the economy is so frickin’ good. “As soon as people figure out how frickin’ good it is, they’ll come running to vote for him.”
At some level, one can be sympathetic with that view. Inflation is down to only 3.1%, the Unemployment Rate is still sub 4% even with the most-recent rise, well below the levels when he took office; Average Earnings are up and gasoline prices are down around $3 after being above $5. What’s not to like? Moreover, put this record next to Trump’s record! When Trump came into office, Unemployment was 4.7% and when he left it was 6.7%!
The problem that the Biden team has – and, frankly, the one it has always had – is that they have no idea how actual people experience the economy, and no idea how actual people think.
Americans, on average, tend to be fair. When people think about the Trump years, they recognize that it isn’t quite fair to saddle him with COVID. While they don’t think this explicitly, their memories about the 2016-2020 period fall into “pre-COVID” and “post-COVID” zones. In other words, if in mid-March 2020 a particular consumer was positively disposed towards the Trump economy, then that’s what their memory is. When COVID hit, it started a new time period in their memory. So to the normal person, they remember Trump coming in with a 4.7% Unemployment Rate and watching as it fell to 3.5% in February 2020. “Then COVID hit.” This works against Trump in little ways too; no one gives him credit for the disinflation that happened between March 2020 and the end of his term.
So this is the way that normal people see Trump’s record:
Now, the best part of Biden’s record is that Unemployment fell from 6.7% when he took office to 3.7% as of January. Other than that, though, his record in the minds of Americans looks unimpressive. (Of note is – and folks, don’t shoot the messenger; I’m just showing the data – that the Biden team persistently claims that real earnings have risen during his Administration, while it isn’t so.)
And so now, let’s put them side by side. Inflation is higher under Biden, gasoline prices have risen under Biden, real earnings are down under Biden, and food costs are up (a lot) under Biden. The unemployment rate has fallen more, but is now higher than it was pre-COVID under Trump!
If you realize that Americans are not going to blame Trump for COVID, then it gets very easy to understand why Trump polls better on the economy.
What Happens if CPI Isn’t Released?
One thing I’ve stopped worrying very much about is a government shutdown. It could even be a good thing, given the bloated deficit, except for the fact that the government basically keeps spending anyway. The federal government employs about 4.5mm workers, and no more than 800k have every been furloughed – moreover, many of those furloughed workers often receive back pay. Social Security gets paid, Treasuries get paid, and the wheel keeps turning. That’s not a guarantee, of course – it’s possible that an extended shutdown could cause Treasuries interest to not be paid, but we all know that before that happens, the Fed would just print the money and make sure the checks go out. At worst, there could be a one-day technical default, if important people had given the heads-up to insiders to get really long CDS.
But my cynicism is getting the better of me so let’s turn to what could happen in a shutdown that impacts the inflation markets: in the past, some data releases of federal agencies have been delayed (or their quality impacted), and if the delay was long enough then it could affect TIPS. Lots of people are asking about this, so I thought I’d lay out what would happen and how.
First of all, the quality of the CPI data could potentially be impacted. That has happened in the past, because data collection agents are not ‘essential workers’ so if the government shuts down, a lot of the data collection stops. This is less of a problem than it has been in the past, though, because a lot more of the data is collected electronically than in the past. For example, the new cars sample is no longer collected by hand but is sourced from J.D. Power. Prescription drugs data is partly supplied by one large firm that didn’t want to allow data collectors to collect data in store. A similar story applies to apparel. Many of these ‘big data’ changes are discussed in this BLS white paper, but the point is that these changes also mean that the quality of the data won’t be impacted as much as would be the case if data collection was entirely done by hand as it once was.
The bigger potential problem is that the CPI report could be delayed.[1] The NSA CPI is used almost exclusively as the index in inflation swaps, and is the index that determines escalation of TIPS principals. Other subindices are used in contract arrangements (for example, in long-term airplane purchase contracts), but those applications are generally less urgent.
If the BLS is unable to release the CPI on October 12th, what happens? The first thing to know is that the September CPI (which is what is released in October) is only relevant to swap payments and TIPS accruals in November and December. For each day in November, the inflation index is interpolated between the August and September prints; for each day in December, the inflation index is interpolated between the September and October prints. Ergo, missing the September print would make it impossible to settle inflation swaps payments – but more importantly, every TIPS trade that settles in November or December would be impossible to settle because the invoice price couldn’t be calculated.
Fortunately, the Treasury thought about that a very long time ago. Title 31 of the Code of Federal Regulations (CFR) spells out what would happen if the BLS didn’t report a CPI by the end of October (it also spells out what happens if the BLS makes a large change to the CPI, or stops calculating it). In a nutshell, the Treasury would use the August CPI index, inflated by the decompounded year-over-year inflation rate from August 2022-August 2023:
I’ll do the math for you. If the CPI isn’t released, the figure for September will be 307.94834, which is +0.3004% on the month. While that sounds very convenient, since economists are forecasting a +0.3% m/m change for this data point, remember that the economists’ +0.3% is seasonally adjusted while the +0.3004% change is NSA. The difference is that 0.3004% NSA is about 0.50% SA this month.
Naturally, this wouldn’t matter very much in the long run; once the October CPI was released at the proper level the artificial change from Sep-Oct would wash out the artificial change for Aug-Sep.
Except, that is, for one pain-in-the-ass way, and that is the second part of the code snippet shown above: the Treasury would never adjust the official number back to match the BLS back-dated release of September CPI. Forever after, if you ran the sequence of monthly Treasury CPI Index numbers and the BLS CPI numbers, they would be exactly the same except for the one data point. The economic significance of that approaches zero, but the Inflation-Guy-Irritation figure on that approaches infinity.
So let’s hope cooler heads prevail.
[1] How likely is this? Kalshi has a market for this as well as markets on the probability of a government shutdown and the length of a government shutdown. As of this writing, Kalshi traders are saying there is an 18% chance that the CPI data will not be released in October.
Summary of My Post-CPI Tweets (October 2022)
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast! Note that this month and going forward, I will be delaying the drop of this tweet summary and the podcast until the afternoon rather than dropping it late morning. So subscribe if you want it live!
- It’s CPI Day – and here we go again!
- A reminder to subscribers of the path here: At 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
- Afterwards (hopefully 9:15ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
- Thanks again for subscribing! And now for the walkup.
- The chance of more-lasting inflation just went up a lot. With the much-narrower-than-expected margins for the Republicans in the House – and perhaps no margin at all in the Senate – this is “divided government” IN NAME ONLY.
- Republicans are notoriously bad at whipping their vote, and with a narrow margin it will be very easy to pick off a couple of votes with well-chosen pork to pass large stimulus measures if the Democrats want it. And they probably want it.
- And why shouldn’t they want it? The Republican message in the midterms was “Biden caused this inflation and we voted against the Inflation Redution Act.” The Democrat message was “Putin caused this inflation and we PASSED the Inflation Reduction Act.” Evidently, that resonated.
- Politicians will keep pushing MMT as long as the populace allows them to get away with it. And with such a narrow majority, Republicans can probably not ‘hold the line.’ Ergo, there will be more stimulus ahead.
- To say nothing of other continuing pressures, on resources & a need to shorten supply chains as the world fractures the post-Berlin-wall detente. To say nothing of demographic challenges. To say nothing of the fact that prices still have far to go to catch aggregate M2 growth.
- Those are not stories for the October CPI, but they are the backdrop.
- I was at a conference the last 2 days and several mainstream economists stated (it was barely phrased as an opinion) that core inflation will definitely be around 3% by middle of next year and low 2s by end of 2023.
- This seems ignorant of the composition of the CPI. EVEN IF you think inflation pressures in a macro sense are ebbing, we haven’t yet seen any signs of that in the data. Y/Y median CPI has accelerated 14 months in a row. Rents remain buoyant.
- Rents will eventually slow, but it will be a while before they slow very much. So far they are still accelerating! And core-services ex-rents is my recent focus. As a reminder, that’s where you find the wage-price feedback loops. And it has recently started spiking higher.
- But there is a potential fly in the ointment in that group this month, and that’s the question about the CPI for health insurance. Here is the issue that some people are worried about.
- Medical care is paid for by consumers directly, and indirectly for consumers by insurance companies. It is straightforward (if complex) to measure the part of medical care paid directly to providers – just ask doctors and hospitals.
- The problem is that there is a difference between what insurance companies receive from consumers (which is part of consumers’ cost) and what they pay to doctors. That is, profit.
- That’s still a cost to consumers but not captured if you just ask doctors. It shows up in the “Health Insurance” part of Medical Care CPI. So, periodically (because it’s not at all straightforward) the BLS tries to figure out this difference and adjust for it.
- It tends to happen roughly this time of year, which is why people were looking for it last month and still looking for it this month. Here’s the problem – it isn’t always important.
- You can see in the m/m changes in Health Insurance that sometimes there’s a discontinuity in the monthly figures, and sometimes not. Here’s the salient point, though – the adjustment doesn’t really matter.
- If it’s done right, then the overall inflation in Medical Care will be about right. Could be seasonal issues, so any given month it could be wacky, but the REAL question is: is inflation in Medical Care overall accelerating/decelerating? Sure looks to me like it’s accelerating.
- So I don’t pay a lot of attention to this nuance but be aware that it COULD have an impact potentially today.
- Last month, big drivers were Rents again (primary=0.74%, OER=0.71%), Medical Care (0.68%, with Hospital Services 0.78% m/m and y/y Prescription Drugs at 3.2%, highest since 2018). Oh, and “Other” at +0.73%.
- Inflation is of course very broad, and that means it is going to keep being pretty resilient. Until one day it starts narrowing and being less resilient. There’s no good way to say when rents will roll over. They will eventually. Probably not today.
- But breakeven market is being very optimistic generally about this eventual occurrence! There’s almost no penalty to betting inflation will NOT go back to its old level. Or at least, a pretty small one.
- Used cars this month will again be heavy, but probably not as heavy as last month’s -1.1%. Used car prices have retreated (in the Black Book survey) about 12% from the highs but remain up about 35% since end of 2020. That’s about the same as M2, so it’s roughly “right”.
- Of course not everything will be up the same amount as the general price level, but that’s a decent touchstone. On average, once velocity finishes correcting back, the aggregate price level should be +30%-+35% (based on current M2) from 2020. Currently +15%. Long way to go.
- Markets since last month: breakevens are up a bit, but real yields close to unchanged. Reals are pretty close to a long-term fair level. They’ll go higher if nominals go higher but they’re a pretty decent deal esp relative to nominals given the long term breakevens.
- …and the nominal auction yesterday was pretty ugly, so I don’t know that the fixed-income bears are done. I suspect the Fed is getting close, though. My guess for terminal rate is currently 5%.
- Econ consensus for today’s CPI is 0.62% m/m on the headline and 0.47% m/m on core, bringing y/y core to 6.52%. With the medical insurance issue I’m reluctant to hazard a guess but 0.47% seems optimistic. Avg for last 6 months has been 0.56%. But interbank is LOWER than 0.47%.
- In any event, good luck! Auto charts will follow the print fairly quickly. I don’t know how many months I will be doing this before I stop being nervous about the automation. But I throttle those charts still to make sure that if something looks wrong it isn’t followed by 9 more.
- m/m CPI: 0.438% m/m Core CPI: 0.272%
- OK now let’s look at these. Obviously the core figure was a disappointment but I can already see it’s not something I’m terribly worried about and not likely to signal that we’re done. That said, it should be a nice rally number.
- Last 12 core CPI figures
- Primary Rents: 7.52% y/y OER: 6.89% y/y
- Further: Primary Rents 0.69% M/M, 7.52% Y/Y (7.21% last) OER 0.62% M/M, 6.89% Y/Y (6.68% last) Lodging Away From Home 4.9% M/M, 5.9% Y/Y (2.9% last)
- Well, 0.69% m/m is better than last month’s 0.84% on primary rents, but not exactly the deflation that people are expecting to happen ‘soon.’ Soon, it seems, is still a bit far away.
- M/M, Y/Y, and prior Y/Y for 8 major subgroups
- Immediate observation – huge decline in Apparel (yes, a small weight) and in Medical Care (which I suspect is the technical adjustment). Housing, Food, Other, Recreation, all high.
- Here is my early and automated guess at Median CPI for this month: 0.613%
- Median: definitely better than recently! but a 7.6% compounded annual median rate isn’t GOOD news. And it suggests that most of the miss was in a few categories, not the main body of the distribution.
- By the way, a little asterisk on my median calculation – I have the median category as West Urban OER. Since the individual components of OER are seasonally-adjusted (but we don’t know the seasonals), my estimate will be slightly off.
- Core Goods: 5.08% y/y Core Services: 6.74% y/y
- And you can see the effect of Apparel (and Used Cars, which was down more than I expected it would be and more than Black Book suggested it would be) on core goods. This is partly a delayed dollar effect, and some supply-side relaxation, and not surprising in a macro sense.
- Some ‘COVID’ Categories: Airfares -1.1% M/M (0.84% Last) Lodging Away from Home 4.85% M/M (-1.04% Last) Used Cars/Trucks -2.42% M/M (-1.07% Last) New Cars/Trucks 0.37% M/M (0.67% Last)
- So Used Car prices are coming down, and New Cars still going up. Remember in mid-2021 Used Car prices in some cases exceeded New Car prices b/c New weren’t available. They are now, so this is the convergence. Used is correcting, New is trending.
- Used cars on top, New Cars on bottom, since day 1 of COVID. New have another 10% to go higher, Used another 15% lower, is my guess.
- Piece 1: Food & Energy: 13.3% y/y
- Piece 2: Core Commodities: 5.08% y/y
- Piece 3: Core Services less Rent of Shelter: 6.42% y/y
- The y/y for health insurance went from 28.1% to 20.6%. Obviously, those numbers are way too high. But it caused the y/y for Medical Care to drop from 6% y/y to 5% y/y. This seems exaggerated.
- Now, to be sure Medicare is dropping the amount that it is reimbursing health care providers. But Medicare is not in CPI and a squeeze on Medicare reimbursements may make the consumer part of health care more resilient. Got to pay health care providers somehow.
- Piece 4: Rent of Shelter: 6.99% y/y
- No sign of any slowdown in rents yet. And without that, we’re not getting 2% inflation next year, period.
- That really was an amazing adjustment to health insurance. I applaud those who decided it was going to be huge. Again, though, it’s just a question of how Medical Care inflation gets allocated. And it’s a one-off thing.
- Outside of food and energy, the biggest monthly decliners were Infants and Toddler’s Apparel (-32% annualized), Jewelry and Watches (-30%), Used Cars and Trucks (-25%), and Footwear (-13%). No services. OTOH…
- Biggest gainers were Lodging Away from Home (+77% annualized), Misc Personal Goods (+26%), Vehicle Insurance (+23%), and Food Away from Home (+11.8%). That last one is obviously Food & Energy but it’s also a wages indicator.
- Looking at Median some more, probably the lowest it could be (if my West Urban OER seasonal is way off) is 0.55%. And could also be higher than my estimate.
- Core inflation ex-housing fell to 5.9% from 6.7%. That’s the lowest it has been since 11/2021. And it’s a good sign. A lot of that is goods.
- The deceleration in goods inflation is completely real. But that doesn’t mean goods prices are going to go DOWN, which is what consumers are expecting. Some places where there were overshoots like in Used Cars will go down, but in most cases we’re talking small.
- Here’s the challenge on the Fed question. I wouldn’t take a victory lap even though this is the lowest core m/m in more than a year. Median has still not obviously peaked! Next core comps are 0.52%, 0.56%, 0.58%, 0.50% before 0.32% in March.
- That means we are probably looking at core which will be steady to declining slowly, but not coming down rapidly. There aren’t 0.6s or 0.7s to roll off until May. So it will look like a peak but not a rapid drop. Unless of course rents roll over and drop like a stone.
- OR, suddenly workers start getting wage cuts. Keep in mind that the Social Security adjustment for next year will flush a lot more money into the system. There’s just a lot of bad feedback loops that are in play.
- By the way, Lodging Away from Home was high (+4.9% m/m) this month. That’s a volatile category but surprised me. Hospitality is having difficulty with finding workers though and so this is another one of those pass-throughs I suspect.
- Here’s the distribution of lower-level price changes y/y. It’s an interesting tale. The lower tail are mostly goods (insurance won’t be there for a long while), upper tail has some foods and some services. The middle part is still 7-9%.
- Having said that, this is starting to look more like a disinflationary distribution where the mean is below the median because long tails start showing up to the lower side. I think we’ve likely seen the peak, although Median will take a bit yet.
- I mean we still have 65% of the distribution above 6%…
- That health care insurance adjustment is odd. Normally the BLS smears the adjustment over 12 months roughly equally. I can’t imagine this is going to be 4% PER MONTH for a year. That would be really weird. Something to dive deeper on. For now I’m treating it as one-off.
- Last chart. I didn’t run this last month because of tech issues. The EI Inflation Diffusion Index remains high but dropped to 41. It’s not yet really signaling a peak in pressures but if we get down to 30 or 35 I’ll feel better that the peak is real.
- OK, let’s try the conference call for anyone who wants to hear this verbally. 🙂 [REDACTED] Access Code [REDACTED] Let’s say 9:35, 5 minutes from now.
The number today made a lot of folks very happy, but it is a trifle early to declare victory over inflation yet. Core goods remains in deceleration mode. This is no surprise; the extended strength of the dollar helps depress core goods prices with a lag. The sharp drop in apparel prices is sort of the poster child for this effect. But the dollar will not be strong forever, and when it goes back to something like fair value – when the Fed stops hiking aggressively relative to the rest of the world – then there will be a little payback in this category. That doesn’t mean 10% core goods inflation but neither does it mean that we’re going back to the old normal of -1% inflation in core goods year after year. Given the re-onshoring trend and the general unsettled nature of geopolitics, I suspect core goods will end up oscillating around low-positive numbers. Think 1-2%, not -1% to -2%.
Rents remain strong, and there is no sign that they’ve rolled over yet. They will eventually, but it takes a long time for rents to reflect changes in home prices and even longer for asking rents to be fully reflected in rent CPI and OER. Rents will decelerate from here, but not for a while. And they’re also not going back to 2%.
Core services ex-rents is in a continued uptrend. There was a small correction this month, but the feedback loop has been triggered. Next year’s Social Security adjustment will throw more fuel on the fire, and even if unemployment rises so that real median wages decelerate nominal wages are going to keep climbing faster than they have historically. Core services ex-rents…and we saw similar effects in Lodging Away from Home and Food Away from Home, both of which have a big wage component…is going to stay strong for a while.
By the way, on Medical Insurance…that 4% per month drag over the next year is going to add up to 0.3% on headline and a bit more than that on core. But only if this isn’t offset elsewhere in the medical care category. This is bean-counting: insurance in the CPI doesn’t really measure the cost of insurance premiums but insurance company profits. If our estimate of profits declines it’s either because people are paying less for insurance (not likely) or because insurance companies are paying more out to doctors, which means the inflation should just show up there instead. So it will be a consistent drag that is mostly irrelevant in a practical sense.
All of which is to say that while core CPI has likely peaked, and median inflation will probably peak in a few months, the folks who are looking for it to drop to 2% next year are going to be terribly disappointed. I’m sticking with my view that we will be at high-4%, low-5% for 2023.
The Fed, though, will take the peak in Core as a reason to step down to 50bps at the next meeting, then probably 25bps, and ending at around 5%. If rates are at 5% and median inflation is around the same level late next year, it isn’t clear that much higher rates would be called for especially in a recession. But neither will much lower rates. So I think overnight rates get to 5% and then stay stuck there for a while. If you found this useful, and would like to get it in real time during next month’s CPI report, go to https://inflationguy.blog/shop/ and subscribe to my private Twitter feed. You can also subscribe to my quarterly, or purchase a single issue of the Quarterly Inflation Outlook (either current or historical). Thanks a lot for your support.
Inflation is a Tax
We all have heard it said before: “inflation is a tax.” It seems that when most people say it, they seem to mean that it’s painful, like a tax is. That both inflation and taxes hurt the little guy, more than the big guy. That the other political party is responsible for bad things, and these are both bad things, so they imply the same thing: vote for me!
When Milton Friedman said it, he meant inflation is a tax.
We recently have seen in an uncommonly explicit way just what this means. It isn’t something vague but an actual tax. It takes money from you, but it doesn’t stop there – it transfers that money to government coffers. I thought of this recently when I saw a headline about how government receipts were breaking records. The headline seemed to think this was great news, but I am a taxpayer so my natural reaction was: dang it. Indeed, receipts at all levels of government are way up for a bunch of reasons. Incomes are higher, so income taxes are higher. Corporate earnings are higher, so corporate taxes are higher. Retail prices are higher, so sales tax collections are higher. And real estate prices are higher, so real estate taxes are higher. To the extent that these things are higher because of higher real activity, it isn’t a bad thing – but at least part of the increase in receipts is due to inflation. Buy the same item today as you did last year and the price is going to be roughly 8-9% higher on average, which means that your sales tax will also be 8-9% higher. If your restaurant bill is 10% higher this year; so is the tax…and the tip, which is income. So it shouldn’t be a terrible surprise that overall federal receipts over the last twelve months are up. By about 27%, actually, compared to the twelve months ended in March 2021.
To be sure, the 12 months ended in March 2021 included a lot of the shutdown, although you can see in the chart that the shutdown didn’t really hurt receipts that much. But to make a better comparison: the first three months of 2022, compared to the first three months of 2021, federal receipts were +18.8%. It’s good to be the king, in inflationary times. At least until the rabble figures out where their money is going.
How much of the overall increase in tax collections is inflation? Over a long period of time, most of it although you are correct in your visceral sense that the pound of flesh has become more like 2.5 pounds of flesh over time.
The chart above shows rolling 12-month tax receipts, indexed to 12/31/1980. The red line is nominal receipts; the blue line is taxes adjusted for inflation. Since 1980, taxes have still gone up about 150% in real terms, about 2.25% per year. That’s not far from what the real growth rate of the economy has been, although to be fair about 22% of that is since the beginning of 2021.
[As an aside: if the “inflation truthers” are right about inflation really being about 5-6% higher per year than the government admits to, since the early 1980s, then either tax burdens have been going dramatically lower in real terms or the government is also lying about government receipts which must actually be orders of magnitude higher. You see how absurd this argument gets?]
So the government gets more revenue when you produce more, but it also gets more just because prices go up. Inflation is a tax.
While it isn’t directly illustrated in the charts above, this is one way that inflation contributes to inequality. It takes more from the less-well-off than it does from the well-heeled. Inflation is not only a tax – it is also a very regressive tax.
The Political Temptation Posed by “Price Gouging”
The arc of explanations about the rise in inflation and the end of the disinflationary era was foreordained:
- There’s no inflation.
- What you’re calling inflation is just a series of one-offs.
- This is just a ‘transitory’ phenomenon, a one-off at the broad economy level, and will soon fade.
- “It’s actually okay.” (NY Times: Inflation Could Stay High Next Year, and That’s OK)
- It’s greedy manufacturers and vendors that are price-gouging. Where is my pitchfork?
In the current arc, we are already easing past level 3, as “transitory” is starting to be stretched a bit to “well, not past 2022” (Former Fed Chair Ben Bernanke opined yesterday at an online event that inflation would “moderate” in 2022). And we’ve seen signs of #4, and even some #5. The blame game is heating up, and with an Administration under pressure for its handling of…well, everything…I suspect we will move sooner rather than later into the full-blown level 5, complete with price controls in some industries and possibly economy-wide. Yes, there’s a very clear lesson from history that price controls don’t work to restrain inflation, but (a) today’s politicians don’t seem to really know much history, and (b) price controls need not be about restraining inflation – for some, it’s worth the political points.
Since it’s a term we will hear more of, I thought I’d try and put a little more structure around the accusation of “price gouging.” It is an easy term to throw around, but what does it mean?
Developed economies are still mostly free markets, in that buyers and sellers are given wide latitude to negotiate on price and quantity. In certain markets, where there are limitations on competition (electric utilities being a classic example) or vast differences in negotiating power or information (health insurance?) there are limits on the terms of trade but for the most part, if you want to buy an apple from the apple vendor you can strike whatever deal suits you both. In a free market, either the buyer or the seller can choose not to transact at the proffered price; ergo, economists assume that if a transaction occurs then both buyer and seller made themselves better off or at least not worse off. Unlike many economist assumptions, this one doesn’t seem like a bad one, at least in most cases.
If the price is “too high” for the buyer, then the buyer can complain but the buyer can always choose to not transact. So there’s only two senses in which “price gouging” might mean something:
- The price is egregiously high because the seller knows you really have no alternative, as the buyer, other than to buy. If there is a mandate to buy insurance or lose your liberty, but no cap on the price of insurance, then the insurance provider can charge any price it wants. This is infrequent. Arguably, in the aftermath of hurricanes it might apply to building materials, but even in that case I would argue #2 below is a more-accurate sense of the word.
- The price is, in some sense, “unfair.”
What is “unfair?” We do, as social animals, have some innate sense of fairness. A classic result from “the ultimatum game,” where one person is endowed with money that he/she chooses unilaterally how to split with a second person who can in turn accept the split or reject it (in which case both parties get nothing) is that under experimental conditions splits that are worse than 70:30 tend to be rejected by the responding party – in other words, the respondent would rather get zero than 30%, if it feels “unfair.” It is in that context that “price-gouging” accusations could be related to “anchored” inflation expectations. If a vendor is charging a very high price, but the buyer expects price changes to be large, volatile, and generally not in the buyer’s favor, then an accusation of “price gouging” is less likely than if the buyer expects price changes to be low and random. So, it might be that accusations of price gouging simply means that the buyers have not adjusted to a new inflation/pricing paradigm, and perceive the price increases as unfair even if they are objectively fair.
If that’s the case, then the buyer is going to lose in cases where the higher prices are a result of changes in the supply/demand balance. Higher prices are how limited supply gets rationed among the buyers – it is a feature, not a bug, of the capitalist system. In the case where a surge in demand (caused by, say, massive government transfers to consumers) causes stock-outs and rising prices, then accusations of price gouging are just sour grapes. Rising prices in this case are simply normal inflation happening in an environment that has not adapted to normal inflation again. (Listen to the Inflation Guy Podcast, episode 2, where I point out that “supply chain problems” is exactly what inflation caused by too much money looks like.)
Nevertheless, where the “price gouging” accusation is code for “this feels unfair,” it is a terrific opportunity for a political lever. Politicians will feel that they can make people happy by instituting price controls, and blaming the wealthy industrialist, even though economics and history tell us that this isn’t the right answer. But it is a siren song, and I think that we are very likely to start hearing this more and more.
Once price controls are instituted, what follows is that the stock market craters (since the difference between input costs and consumer prices is some part profit), a black market develops in the restricted goods and services, and many products get impossible to acquire or rationed by a lengthening waitlist rather than by price.
Can you really control prices in the Internet age? It hardly matters. Politicians don’t really care about controlling prices after all; they merely want to appear as if they’re on the side of the voters. Bashing suppliers is one easy way to do that. I don’t think it will be long now. Keep the torches and pitchforks at the ready.
Drug Prices and Most-Favored-Nation Clauses: Considerations
A potentially important development in the market for pharmaceuticals – and in the pricing of the 1.6% of the Consumer Price Index that Medicinal Drugs represents – is the President’s move towards a “most-favored-nation” clause in the pricing of pharmaceuticals. The concept of a favored-nations clause is not new, although this is the first time it has been applied broadly to the pharmaceutical industry. In the investment management industry, it is not uncommon for very large investors (state pension funds, for example) to demand such a clause in their investment management agreements. Essentially, what such a clause does is guarantee to the customer that no other customer will get better pricing.[1] In the context of pharmaceuticals, the “problem” that the President is addressing is the fact that Americans buying a drug will often pay many times what a customer in another country will pay the pharmaceutical company for that same drug.
The optics are terrific for the President, but the economics not as much so. The argument is that demanding such a clause will force pharmaceutical companies to lower prices for American consumers drastically, to something approximating the price of those same products purchased abroad. The reality, though, is not so clear.
This is a story about price elasticity of demand. As I do often, I pause here and give thanks that I studied economics at a university that had a fantastic econ faculty. Economics is a great field of study, because done right it teaches a person to ask the right questions rather than jumping to what seems to be the apparent answer. (Incidentally, I feel the same way about Street research: done right, the value of that research is in guiding the questions, rather than handing us the answers.)
So let’s start at the ‘free market’ version of the pharmaceutical company’s profit-maximization problem. Let’s start by assuming that the marginal cost of production of a little pill is close to zero, or at least that it’s no different for the pill sold in one country versus the pill sold in another country. Then, the firm’s profit-maximizing linear programming problem is to maximize, independently for each country, the price where the marginal revenue is essentially zero – where in order to sell additional units, the price must be lowered enough that selling those additional units costs more in lost profit on the other units than it does on the incremental units. (If I sell 10 units at $10, and in order to sell the 11th unit I have to lower the price to $9, then I go from $100 in revenue to $99 in revenue and so if I am a profit-maximizer I won’t do this).
This point will be different in each country, and depends on the demand elasticity for that drug in that country. If the demand for a drug is very elastic, then that market will tend to clear at a lower price since each incremental decline in price will produce a relatively large increase in incremental quantity demanded. On the other hand, if the demand for the drug is very inelastic, then that market will tend to clear at a higher price since each additional increase in price will result in the loss of relatively few units of quantity sold. Now, every country and every drug will have different price elasticities. A lifestyle drug like the little blue pill will face fairly elastic demand in a Third World country, while a malarial drug probably does not.[2]
As an aside, one of the things which creates a more-elastic demand curve is the availability of substitutes. So, if the FDA makes it more difficult for a new statin drug to be approved than does the equivalent agency in Italy, then demand for a particular statin drug (all else equal) will be more elastic in Italy, where it faces more competition, than in the US. If you want lower prices, promote competition. But back to our story:
Now the Trump Administration adds a constraint to the drug company’s linear programming problem, such that the maximization is now joint; the problems are no longer independent maximization problems but the company must find the price that maximizes revenue across all markets collectively. If the free market has found a perfect and efficient equilibrium, then any such constraint must lower the value of the revenue stream to the drug company because if it did not, then it implies the company would already have be operating at that single-price solution. Constrained solutions can never be more valuable than unconstrained solutions, if both are in equilibrium.
What the drug company most assuredly will not do, though, is immediately lower the price to the American consumer to the lowest price charged to any other country. What it will do instead is take the highest price, and then add the incremental market that has the most inelastic demand, and see how much total revenue will increase if they have to lower the universal price to induce demand in that market. Note that this outcome may lower the price in the high-priced country, but it will also raise the price in the low-priced country. Since the lower-priced countries probably have more-elastic demand than the high-priced country…which is suggested by the fact that they had lower prices when they were being separately optimized…it is easy to imagine a scenario where the drug company ends up only supplying the high-priced country because the large increases in price for other countries essentially eliminate that demand. And that outcome, or indeed as I said any constrained outcome, is likely to be bad for the drug company. But what it will almost certainly not do is cause drug prices in the USA to drop 70%, or a massive decline in the Medicinal Drugs portion of CPI.
It may cause a decline in US drug prices, but that is not as certain as it appears. If the optimal strategy is to supply the drug only in the United States, then prices need not change at all (the US would then be the Most Favored Nation because it’s the only customer). In fact, the drug company might need to increase prices in the US. That happens because when you allow price discrimination, any customer who pays more than the variable cost of the product (which we assume here is close to zero) contributes something to the fixed overhead of the company;[3] therefore, a company that understands cost accounting will sometimes sell a product below the total cost per unit as long as it is above the variable cost per unit. When a US company, then, sells a pill to Norway at a really low price but above the cost of production, it defrays some of its overhead. If a most-favored-nation clause prevents a company from doing this, it will need to raise the price of the product in its remaining markets in order to cover the overhead that is not being covered any longer by those customers.
OK, so that’s just one iteration. I suspect that most pharmaceutical companies will end up lowering prices a little bit in the US and in other countries where prices are similar, and only selling them in countries that now pay a very low price to the extent that those foreign countries and/or international charities subsidize those purchases. But then we get into the financial and legal engineering part of this: what happens if Pfizer now licenses the formula for a particular drug to an Indian company that is legally distinct and doesn’t sell to the United States? Does the licensing agreement also fall under the MFN clause? What if Pfizer spins off its South American operations, sharing the intellectual property with its spinoff? For that matter, it might be the case that for some drugs, it is optimal to sell it everywhere in the world except the US, because the value of the unconstrained-non-US portion of the business is greater than the constrained-US portion of the business.
Now wouldn’t that be a kick in the head, to see pharmaceutical companies leave the US and refuse to sell to the US consumer because it makes them subject to the MFN clause? In the end, it seems to me that this is a great political gesture but it will be very difficult to get the results the President and his team wants.
[1] As an aside, in investment management this has caused the universe of strategies available to institutions demanding this clause to be reduced, hurting their investors. There are many circumstances in which an investment manager will offer outstanding, and sometimes outlandish, terms to investors who are the first in a new strategy, or who are low-touch easy/sophisticated customers, etc; a later entry by a large, high-maintenance customer may not be economic under the same terms.
[2] I am not at all an expert on how drug price elasticity behaves in this riot of market/product combinations, so readers who are should give me a break! I’m just illustrating a point.
[3] Cleverly called “variable contribution.”
How Not to Do Income-Disparity Statistics
I am a statistics snob. It unfortunately means that I end up sounding like a cynic most of the time, because I am naturally skeptical about every statistic I hear. One gets used to the fact that most stats you see are poorly measured, poorly presented, poorly collected, or poorly contexted. I actually play a game with my kids (because I want them to be shunned as sad, cynical people as well) that I call “what could be wrong with that statistic.” In this game, they have to come up with reasons that the claimed implication of some statistic is misleading because of some detail that the person showing the chart hasn’t mentioned (not necessarily nefariously; most users of statistics simply don’t understand).
But mostly, bad statistics are harmless. I have it on good authority that 85% of all statistics are made up, including that one, and another 12.223% are presented with false precision, including that one. As a result, the only statistic that anyone believes completely is the one they are citing themselves. So, normally, I just roll my eyes and move on.
Some statistics, though, because they are widely distributed or widely re-distributed and have dramatic implications and are associated with a draconian prescription for action, deserve special scrutiny. I saw one of these recently, and it is reproduced below (original source is Ray Dalio, who really ought to know better, although I got it from John Mauldin’s Thoughts from the Frontline).
Now, Mr. Dalio is not the first person to lament how the rich are getting richer and the poor are getting poorer, or some version of the socialist lament. Thomas Piketty wrote an entire book based on bad statistics and baseless assertions, after all. I don’t have time to tackle an entire book, and anyway such a work automatically attracts its own swarm of critics. But Mr. Dalio is widely respected/feared, and as such a simple chart from him carries the anti-capitalist message a lot further.[1]
I quickly identified at least four problems with this chart. One of them is just persnickety: the axis obviously should be in log scale, since we care about the percentage deviation and not the dollar deviation. But that is relatively minor. Here are three others:
- I suspect that over the time frame covered by this chart, the average age of the people in the top group has increased relative to the average age of the people in the bottom group. In any income distribution, the top end tends to be more populated with older people than the bottom end, since younger people tend to start out being lower-paid. Ergo, the bottom rung consists of both young people, and of older people who haven’t advanced, while the top rung is mostly older people who have Since society as a whole is older now than it was in the 1970s, it is likely that the average age of the top earners has risen by more than the average age of the bottom earners. But that means the comparison has changed since the people at the top now have more time to earn, relative to the bottom rung, than they did before. Dalio lessens this effect a little bit by choosing 35-to-64-year-olds, so new graduates are not in the mix, but the point is valid.
- If your point is that the super-wealthy are even more super-wealthier than they were before, that the CEO makes a bigger multiple of the line worker’s salary than before, then the 40th percentile versus 60th percentile would be a bad way to measure it. So I assume that is not Dalio’s point but rather than there is generally greater dispersion to real earnings than there was before. If that is the argument, then you don’t really want the 40th versus the 60th percentile either. You want the bottom 40% versus the top 40 percent except for the top 1%. That’s because the bottom of the distribution is bounded by zero (actually by something above zero since this chart only shows “earners”) and the top of the chart has no bound. As a result, the upper end can be significantly impacted by the length of the upper tail. So if the top 1%, which used to be centi-millionaires, are now centi-billionaires, that will make the entire top 40% line move higher…which isn’t fair if the argument is that the top group (but not the tippy-top group, which we all agree are in a category by themselves) is improving its lot more than the bottom group. As with point 1., this will tend to exaggerate the spread. I don’t know how much, but I know the direction.
- This one is the most insidious because it will occur to almost nobody except for an inflation geek. The chart shows “real household income,” which is nominal income (in current dollars) deflated by a price index (presumably CPI). Here is the issue: is it fair to use the same price index to deflate the incomes of the top 40% as we use to deflate the income of the bottom 40%? I would argue that it isn’t, because they have different consumption baskets (and more and more different, as you go higher and higher up the income ladder). If the folks at the top are making more money, but their cost of living is also going up faster, then using the average cost of living increase to deflate both baskets will exaggerate how much better the high-earners are doing than the low-earners. This is potentially a very large effect over this long a time frame. Consider just two categories: food, and shelter. The weights in the CPI tell us that on average, Americans spend about 13% of their income on food and 33% on shelter (these percentages of course shift over time; these are current weights). I suspect that very low earners spend a higher proportion of their budget on food than 13%…probably also more than 33% on shelter, but I suspect that their expenditures are more heavily-weighted towards food than 1:3. But food prices in real terms (deflated by the CPI) are basically unchanged over the last 50 years, while real shelter prices are up about 37%. So, if I am right about the relative expenditure weights of low-earners compared to high-earners, the ‘high-earner’ food/shelter consumption basket has risen by more than the ‘low-earner’ food/shelter consumption basket. Moreover, I think that there are a lot of categories that low-earners essentially consume zero of, or very small amounts of, which have risen in price substantially. Tuition springs to mind. Below I show a chart of CPI-Food, CPI-Shelter, and CPI-College Tuition and Fees, deflated by the general CPI in each case.
The point being that if you look only at incomes, then you are getting an impression from Dalio’s chart – even if my objection #1 and #2 are unimportant – that the lifestyles of the top 40% are improving by lots more than the lifestyles of the bottom 40%. But there is an implicit assumption that these two groups consume the same things, or that the prices of their relative lifestyles are changing similarly. I think that would be a hard argument. What should happen to this chart, then, is that each of these lines should be deflated by a price index appropriate to that group. We would find that the lines, again, would be closer together.
None of these objections means that there isn’t a growing disparity between the haves and the have-nots in our country. My point is simply that the disparity, and moreover the change in the disparity, is almost certainly less than it is generally purported to be with the weakly-assembled statistics we are presented with.
[1] Mr. Mauldin gamely tried to object, but the best he could do was say that capitalists aren’t good at figuring out how to share the wealth. Of course, this isn’t a function of capitalists. The people who decide how to distribute the wealth in capitalism are the consumers, who vote with their dollars. Bill Gates is not uber-rich because he decided to keep hundreds of billions of dollars away from the huddling masses; he is uber-rich because consumers decided to pay hundreds of billions of dollars for what he provided.
