Does Economic Growth Equal Inflation?

Something that's been bothering me a long tie is the way the that economic growth, in terms of the Gross Domestic Product (GDP) is measured. Clearly, I'm not an economist, but it appears to me that GDP growth is measured purely in dollars spent in a geographical location. The "growth"measured by GDP includes growth in government spending (done at a deficit) growth in consumer consumption (thanks to credit), so-called investment (purchases is speculative instruments, a polite form of gambling) and the difference between exports and imports.

So how does economic growth differ from inflation, if at all? If everybody charges more for their good and services, that is economic growth, more dollars are changing consumption hands. But it doesn't mean that farmers are growing more wheat, manufacturers are making more widgets or doctors are working more hours. They're just charging more. The dual role of the Fed in fighting inflation and promoting growth (or employment, depending on who you ask) would seem to self contradictory, which is why they don't so much fight inflation as target low inflation.

So this post is basically just a note to myself to read up on how the GDP is currently calculated and whether an adjustment for inflation is made before growth is compared to inflation. If it turns out that growth equals inflation, wouldn't that be a zinger.

Thar's Gold In Them StreetTracks GLD ETF Shares

A month or so ago I held my nose and bought gold at $720 an ounce, or rather, I bought the StreetTracks gold tracking ETF GLD at $72 a share. Today GLD topped $82 a share, up 15% from where I bought it. Why in the world would anybody buy gold at $820 an ounce when it can surely be extracted from the earth for less than that, not to mention existing reserves at central banks and in jewelery?

Simple. Everybody in the world now knows that the dollar is a joke and is looking for a safe haven. If it was easy to buy bulk gold and bury it in the back yard, I might be doing that, but the recent housing bubble prevented me from acquiring a back yard or a cellar. The GLD ETF gives me an easy and highly liquid way of moving in and out of gold, though so far, I've mainly stuck with in.

People who buy gold aren't generally stupid, and it's not a popular investment with the automated 401K stock market inflation scheme. Gold is mainly bought by rich individuals and institutions, as a hedge against inflation and monetary uncertainty. Today, the US economy has both, in spades. The big banks who gave anybody and his uncle money in order to pay themselves big bonuses are now being forced to write-down some of their alleged assets. If you think they all came clean with their handfuls of billion recently, you're on a different page than I am.

Inflation, of course, is what this blog is all about. In real estate, it's all about location, location, location. In investing, it's all about inflation, inflation, inflation. The only thing that gives the dollar value is the full faith of the US government that the Federal Reserve will act in such a way to preserve the value of the dollar. But the Fed has a different agenda, as does the government. It's called postponing pain as long as possible. I wouldn't be surprised if they all take happy pills, but the only thing making me happy these days is my investment in GLD. If you don't want to take it from me, give this guy a listen:

Energy Price Inflation

There was a funny article in the WSJ this morning talking about energy pricing in the context of bio-fuel. Anybody who has been following the alternative fuel or tertiary oil recovery industry for years knows that these alternatives to "regular" oil always come with a "cost effective" break even point, in terms of the cost of a barrel of oil. The WSJ article lamented the fact that palm oil, once thought to be a cost effective oil replacement at $50 a barrel, is now estimated to be cost effective at $130 per barrel. Somehow, the economies of scale for alternative energy keep getting pushed back.

Around 20 years ago, I worked on a Department of Energy SBIR contract for tertiary oil recovery. The idea was using RF transmitted by bore hole antennas to heat heavy oil underground. lower the viscosity and recover it. Ignoring equipment cost, the main cost (assuming we did all the science right:-) was the electricity to generate the RF field. That electricity could be purchased from the grid in some locations, and would have to be produced by diesel generators in other locations. It took a lot of hand waving based on a small scale model, but I think I put the break-even point at between $50 and $80 per barrel, or well beyond what made economic sense in the late 80's.

Fast forward to 2007 and oil is well over $80 a barrel, so is the RF assisted heavy oil recovery now cost effective? Unfortunately, both electricity and diesel fuel cost more than twice as much as they did in the late 80's not to mention the cost of equipment, environmental compliance, etc. In other words, that $50 to $80 break even cost would now be $100 to $160, all other things being equal. And that's the trick with energy inflation, it's the great equalizer. While there are some arbitrage opportunities in BTU's, such as playing locally (to North America) produced gas against imported oil, energy costs from all sources tend to move in the same direction at the same time. Inflation hits solar voltaic panel manufacturers just like it hits windmill generator manufacturers. Nothing stands still.

Well, I take that back. The only thing that stands still is the Fed's outlook on inflation, ex-food, ex-energy. By ignoring the cost increases of the two commodities most necessary to human beings, the Fed can keep inflation numbers in check. Inflation numbers, not inflation itself.

Hedonic CPI Disinflation

Statistics can be abused with the best of intentions, but the art of hedonics takes inflation jiggering to a new level. I'm not a statistician, if you want to read the underlying mathematical justification for adjusting down "apparent" inflation in textbooks, it's on the BLS website. The way I read it, the logic goes something like this.

Student A pays $30 for a textbook in 1980. Student B pays $150 for a textbook for the same course in 2007. An idiot like me would look at a 5X price increase and say, "That's inflation." But the statisticians introduce a hedonic adjustment. Rather than allowing that the required course text is a necessary expense for both students A and B that can't be avoided, the statistician tries to look at the intrinsic value of both textbooks. If the 2007 textbook has more pages, uses color illustrations, includes links to a website, it may be judged to be twice as valuable as that 1980 textbook. So, the rise in price is no longer 5X over 27 years, it's 2.5X.

The hedonic adjustments to the CPI components offer yet ivory tower look at inflation, or disinflation, which they tend to produce. Anybody who has purchased a washing machine in the past ten years can tell you that they are no longer built to last ten years, but frequently drop dead within a few months of the warranty expiring. But a smart statistician would be more inclined to look at the energy and water savings, and the computerized controls, and declare that the new washing machine is intrinsically more valuable than the old washing machine.

Bill Gross of Pimco claims that hedonic adjustments affect nearly 50% of the CPI components. As a fixed income man, Gross has every reason to care more about CPI disinflation than your average fund manager. He also has the resources to have had some smart people study the problem. Personally, I don't buy the whole concept of hedonic revaluation. A person who needs a car to drive to work needs a car to drive to work. If that person buys the minimum (lowest cost) car available, and is forced to pay more due to computer controls, air bags, and other modern improvements, the difference between the cost of the first car and the second car is inflation. If that person's wages are going up slower than these hedonic adjustments, that person is losing money.

This is where Greenspan, Bernanke and various politicians get up on the soap box and talk about education. It seems to be the responsibility of every American to become an over-educated policy wonk, a sort of a hedonic improvement in humanity, in order to earn a higher salary. Ergo, the solution to inflation is for all of us to become economists. I can't see any flaws in the argument, but I may be losing my reason along with my money.

PowerShares ETF Inverse QQQQ Tacking Failure?

Just a short note about PowerShares tracking today. The WSJ online reports the DOW closed down 362.14 at 13567.87, or a loss of -2.60% for the day. My DOG, the Short Dow30 ProShares closed up +2.65%, which I would call excellent tracking.

Unfortunately, while the NASDAQ closed down -64.29 at 2794.83 or -2.25% on the day, and the QQQQ NASDAQ 100 Powershares tracking shares closed down 1.87%, the PowerShares PSQ, which is supposed to invert the QQQQ only closed up 1.65% (.22% short of the goal) and the QID 2X inverse of the QQQQ only closed up 2.76%, or a full percentage point short of what I would have expected.

It may be that I misunderstood the product, or it could be that their tracking broke down under heavy volume as they couldn't find people to take the other side of the bet. Either way, I'm unhappy:-)

PSQ and QID ETFs To Short NASDAQ QQQ

I bought a chunk of QID, the ProShares Ultra Short of the NASDAQ 100 last month, and I'm down over 17%, even with being a percent up today. The QID ETF is designed to double the inverse of QQQ, so if the NASDAQ 100 go up 1%, the QID ETF goes down 2%. It's a bit frustrating for a couple reasons. One, I bet the wrong way and I'm losing money hand-over-fist. Two, the NASDAQ 100 has recently outperformed the NASDAQ as a whole, as companies like Microsoft have blown away earnings. Typically, my biggest position this year was in Microsoft, and I sold right before it began its 20% rise. I thought I'd waited long enough for the Vista benefit, but I was wrong, wrong, wrong.

If I had my wits about me, I would have bought the PSQ ETF, which is designed to simply invert the QQQ, so if the NASDAQ 100 go up 1%, the PSQ go down 1%. You might notice that in both examples, I pick the NASDAQ to go up, with myself on the wrong side of the bet. That's called being realistic. I've used these ProShares short ETFs to go against the market several times now, and I've lost every time.

I suppose I could make the argument that tech is the only thing the US economy really has going for it at the moment. Our other exports, cheap to EU, middle eastern and Asian customers because the fall of the dollar, are third world in nature, like food staples and commodities. I'm not enthusiastic about America raising our exports by becoming the economic equivalent of a banana republic.

But despite the fact that our tech exports are real, I'm utterly convinced that the stock evaluations are way overblown. The QQQ includes all of those companies with whacko earnings expectation that will eventually fall to earth, the problem is one of timing, So, if you want to short the NASDAQ, the PSQ and QID ETF's are an easy way to do it, with the QID shares moving twice as much as the PSQ shares in the counter QQQ direction. Just don't blame me if you lose money, losing money is what I'm good at.