Another Bias in Time

Is CPI An Inappropriate Backward-Looking Indicator Right Now?

For several months now, I’ve wondered if there are people who just want to drive the economy into a recession. They say that the price of food is too high, the price of homes is too high, and the price of energy is too high. They point to the annual CPI (Consumer Price Index) to show that year-over-year inflation was too high.

I’m going to suggest here that while they are right, they are also wrong. This is another bias that was caused by actions taken by the federal government during the height of the COVID pandemic. But the important thing to understand is that these were not necessarily long-term trends, but merely spikes. If there were spikes in costs, then a backward-looking year-over-year analysis can give the wrong impression. I am going to suggest that this is the case below, so keep reading.

During the height of the COVID pandemic, two things occurred that pumped a large amount of money into the economy at the same time people were staying at home and spending less money. First, there the Federal government issued several stimulus checks to Americans during the pandemic. At the same time, people were ‘afraid’ to go out and risk exposure to Covid, so they ‘banked’ the money in many cases instead of going out to spend it. Why did they bank it?

Initially, the government and the CDC warned people that it could take years to find a vaccine for Covid and that the lockdowns and mask requirements could last equally as long. People in office jobs were told to work from home to minimize their exposure to others who might be carrying the Covid virus. As people set up offices in their homes, they did spend some of the money to buy electronic equipment such as computers, printers, better Wi-Fi, etc. And remember the run on toilet paper, paper towels, cleaning supplies, and other things. Some people even decided that if they could work from home, they could work from anywhere. Thus, many abandoned the major cities to move further out to the suburbs and rural areas driving up the prices of homes and putting pressure on the construction of new homes (which temporarily drove up the price of lumber). Also, when they moved out of the city, they found that they now needed a car to get around because they no longer had access to public transportation, driving up the price of used cars. Why buy a used car? Simply because new cars were getting harder to make because of chip shortages due to issues with imports. Do you remember the problems with ships sitting out at sea because they could not dock to unload?

While all of this was going on, the Federal government decided to raise the minimum wage of government workers to $15 per hour. This was estimated to raise nearly 1 million people out of poverty. While on the surface that sounds good, it does not consider the ripple effects of non-government workers now also demanding at least $15 per hour. Then that wage increase begins to ripple up through the higher wage earners, earners who may have greater skills that they either learned on the job over many years or paid for through technical training. Obviously, they could not earn the same amount as before if others with less training or education were getting a bump in their earnings. So, they too demanded more, or they jumped jobs to other companies who were willing to pay them more. Free enterprise, right?

As more workers demanded greater salaries, the costs faced by companies to provide services or products also increased. Their costs also increased because of supply issues. Remember the problems at the ports? To maintain their profit margins, they were forced to raise prices. Many companies resisted such increases if they could but eventually, they all had to increase prices. Small businesses were especially hard hit. Many businesses closed and are still closing today. Others, like restaurants, raised their prices by as much as 30-40% as they struggled to attract and keep staff. As prices rose though, fewer people went out to eat. Many mid-range restaurants saw their full dining rooms start to empty. To cover their fixed costs, they had to raise their prices as well.

Finally, the Federal Reserve stepped in to try to lower inflation which by the beginning of 2022 had started to spike at over 1% month over month which if it continued for a year would imply over a 12% annual increase in prices (See the chart in Figure 1 below which lists the CPI (Consumer Price Index) values by month and shows what an annualized rate would be based on that month’s increase (which is a bias that assumes that what is true today will be true going forward) and what the increase over the prior year (year-to-year, a backward-looking bias) was. Of course, this is a lagging indicator. The sudden jumps in the monthly CPI due to the factors mentioned above as well as others gave the impression of runaway inflation. This continued as you can see through June 2022. Table 1 below shows the monthly CPI Index from the US Department of Labor. The next column shows the rate of increase from the previous month. The reported annual rate of inflation from the same month the prior year. Finally, the last column shows the monthly rate of change in the CPI multiplied by 12 which shows the inflation if the entire year going forward had the same rate as the current month.

Figure 1: Monthly CPI numbers from the US Dept of Labor Bureau of Labor Statistics

The Federal Reserve only has a single tool to fight inflation, which is to raise interest rates. So, inflation rates quickly rose 75 basis points each month for several months. (There are 100 basis points in 1%. Therefore, they were raising interest rates by 0.75% each month.) This interest rate is the amount that commercial banks can charge each other overnight for funds loaned to each other. Of course, this influences other interest rates from mortgages, to CDs, and even the Federal Treasury bond market. The way that this slows the economy and inflation is by making it harder for companies to borrow money to expand, to pay for raw materials, to pay rent, and even to pay salaries. While the Federal Reserve hopes that rising interest rates cool the economy by forcing companies to cut back on salaries and growth plans, it can also drive small businesses to close. This is where much of the fear of recession enters the picture as small privately held companies cannot obtain funds to help cover their expenditures as higher product prices discourage buyers of those products.

The result of this will be a shrinking of the economy, a consolidation of smaller businesses either directly or indirectly into larger businesses, increased unemployment, a slowing of wage increases, and in the extreme case a reduction in wages by those who just want to keep their jobs. How much will this affect the price of goods at the store? I don’t know other than some prices will retreat at least a bit. However, I have no hope for prices to fall back to what they were at the start of 2020.

Okay, for those of you who understand all of this, you are probably thinking that you are glad that you are not responsible for setting fiscal policy. I agree. But these were exceptional circumstances that started with what history may label ill-advised stimulus payments combined with what we hope was a rare health emergency. Of course, that is looking backward too. Perhaps if it had been foreseen that the Covid pandemic would not be as bad as many feared (on a percentage basis, the 1917-1918 Spanish Flu was far worse. See my post: Worse than the Spanish Flu?) or that vaccines would have been developed as quickly as they were, then a slower more cautionary approach to the situation might have been prudent.

While what was done is done, we may want to be sure that we do not overreact again as the inflationary spike falls back down. The fact is, for the last 6 months, the month-over-month CPI has retreated substantially and has recently dipped into negative territory. At the same time, the annual CPI number (which remember is backward looking) is dropping those high monthly CPI increases from the end of 2021 and the beginning of 2022. This tells us that the annual CPI number which the news constantly throws out as an indication that inflation is still too high is not only wrong but counterproductive. The important measure when there is a spike in any number is to look at the rate of change over a brief period of time. For this reason, I do not fear inflation at this point. Rather, we will experience some level of recession as the numbers settle back down due to FED policies as long as those who only watch the economy in their rear-view mirror do not overreact again and there are no more major bumps.

Monetary vs Fiscal Stimulus

Because I have an MBA (in addition to working in SQL Server and Power BI and because I am interested in the financial analysis side of things), a few people have asked me to explain the difference between Monetary and Fiscal stimulus when it comes to the way the federal government is fighting to keep our economy from falling into a depression at this time of the Coronavirus. So, let me give it my best shot.

Monetary stimulus is often associated by changes by the U.S. Federal Reserve to the interest rates charged to banks for loans. The theory being that as interest rates are lowered by the Federal Reserve, those banks in turn will make more money available to business, especially small business at lower rates. If this occurs as expected, it may help to keep small businesses which our country relies on from going out of business because they cannot otherwise pay their debts, their employees, and the cost of materials they need to conduct business. The Federal Reserve, I believe, can even now buy corporate debt to help those businesses survive.

Fiscal stimulus on the other hand consists of tax cuts, unemployment benefits, credits, government spending on infrastructure (which we could probably use) and even direct payments to individuals and families such as those checks many of you have recently received. This is money directly to individuals, not businesses. This is an entirely different tool than Monetary stimulus.

Still don’t see the difference? Think of it this way, Fiscal stimulus is the direct transfer of money from the federal government to the public through one or more different methods with no expectation of getting that money back. Yes, this increases our national debt and will someday in some way have to be repaid. If the economy soars, this can be done through normal fiscal methods without undo taxing of businesses and individuals would could hurt the economy. Only the spending on infrastructure has some ‘public’ return in the form of perhaps better roads, repaired bridges, and updated water and sewer lines. The rest of the fiscal stimulus is simply a hand out of money in the hope that people will pump it back into the economy to buy goods and services that they might not have bought before. If people just put it in their savings accounts, it will not help at all which is why most fiscal stimulus plans phase out as individual or family income rises.

On the other hand, Monetary stimulus does not simply hand out money. It is effectively money used for loans to business which the government expects to paid back at some time in the future. Even when the Federal Reserve buys corporate debt, they expect that debt to be paid back at some time in the future. Monetary stimulus also does not apply typically to individuals the way Fiscal stimulus does.

So, I hope that helps you understand a little about what is going on in the news these days. This will eventually all pass and we can get back into Power BI features and capabilities.

Serving as Executor

Over the last year I’ve had to serve as executor to two estates, my father-in-law’s estate and my wife’s estate.  But these were not my first experiences at this task.  I had to close out my parent’s estates both in 2003.  It’s challenging.  It’s frustrating.  It gives you no time to grieve for the one you lost.  Attorneys are constantly asking for this information or that information. In the meantime you have to sift through years of paperwork, discover accounts, locate documents, and try to figure out where everything was stored.  There is no time for anything. No time to relax.  No time to watch a little television.  Then if you have to sell off a house or other property, the workload increases dramatically with having to clean out a house filled with decades of accumulated things, trash the junk and the worthless, sell off the better stuff for pennies on the dollar, list the house for sale, deal with realtors who only really care about turning over the house as fast as possible, negotiate the final sale, file all the necessary paperwork and file final taxes.  Multiply the complexity of having to deal with estates from a different state than the one you live in with each state wanting a piece of your pie and it is at times enough to make you go crazy.

Even working with an attorney can be a massive drain on your energy and your well being. Then friends and relatives (if you still have any) begin to wonder why you have changed.  You never seem to have time for them.  You never have time to go out, to go to the movies, or to one of the parks.  And when you do go, they think that you are insensitive about the loss of your loved one.  It’s kind do mind numbing.  People may say ‘Can we help?’ But what can they really do? Trips to the courthouse, lunchtime meetings with banks and attorneys, going to the post office to send registered mail, and countless phone calls that you must take during work because these other people do not work evenings or weekends even though you boss is angry with you for taking personal calls while you are at work.  Dealing with insurance firms and investments who require a dozen different documents to prove the other person is really dead and you have the rights to handle the estate.  Paying expenses out of your own pocket until the estate can free up some accounts and give you access to them.  Balancing other peoples checkbooks.  The list goes on and on and sometimes you just wish that you had gone first and no one understands why you seem so worn out and down.  After all, it has been 3 months since the other person died.  But estates can take months if not years to completely resolve and close.  Perhaps for the dead, it is one final cruel joke to play on the living to account for all the things you should have done while they were alive but didn’t.

Eventually you get close to finishing everything and you just want to sit back or lay down, rest, and do nothing.  But others tasks have been pilling up.  You want to take time to grieve but it has been so long that the feelings of loss have dulled. maybe it is also from all the aggregation of closing the estate.  So while you feel an emptiness, maybe even a bit of loneliness, the pain of your loss is mostly gone.  You tend to remember more of the good times, not the bad times.  You begin to plan on how to move forward again.  How to find meaning in each day again. This is another time that relatives may call you cold and uncaring, and that hurts more than your loss because you have made peace with your loss. You have worked through your feelings while you struggled to close the estate. You want to move on but they don’t want to let you.  They keep trying to pull you back to a state of grief that you have already left behind. They don’t understand that it is over.  That it is time for a new chapter.

Sure executors get paid for handling the estate.  A whopping 2% which unless you are executor for a large estate ode an estate with many heirs is nothing.  Certainly not considering the stress and aggregation. And especially not if you are the only one to inherit the estate anyway.  Especially not if the work places your job/career in danger.  Did I tell you about the judge who almost wanted me to post a bond so I would not steal money from myself?

So another year is about to start.  I’m close to closing these two estates.  I don’t know for sure what the new year will bring.  There are some bright spots to focus on. My final recommendation to you the reader is that if anyone asks you to be their executor for their estate, try if at all possible to avoid it.  And if you must do it because there is no one else, find a good attorney who will guide you through the legal morass of estate law. Perhaps even consider some estate planning for yourself now like making sure all of your investments have beneficiaries or you could set up revocable trusts in your beneficiaries names while still retaining control.  Perhaps that could be a New Year’s resolution.

C’ya later.

Personally Identifiable Information – Beyond SSN

It seems that most people are now aware that collecting SSN information from people and storing it a computer system is a risk to that person’s identity protection.  However, the risk does not stop with SSN.  There are other types of information that you should carefully secure after it is collected and furthermore, you should only collect it if there is a real valid reason why it must be collected.  Collecting information just because you can or just because you might one day need to use it is not an excuse when doing so could result in that person suffering at some point from identity theft.

So what else should be protected?  What about email address.  It seems like everyone wants to collect email addresses these days.  You can hardly log into a site on the web without them asking for your email address.  Some people live their lives happily with only one or two email addresses and they use that email address for everything ranging from securing their phones or other mobile devices, accounts on-line, contact lists, etc.  Now even Windows 8 allows you to use a Hotmail (or Outlook) email address as your desktop login.  How can you protect your email address when you don’t know if the programmers are encrypting that information the same way they encrypt (or should encrypt) SSN values?  Simply go out and get a throwaway email address that you use for logging into web sites.  You can get extra email accounts from many places, but I recommend either Hotmail (Outlook) or Google because you get not only an email address from these two, but you also get a fair amount of online storage where you can store files and documents.  Furthermore, Hotmail (Outlook) also allows you to create alias accounts associated with the main account.  The real advantage of these alias accounts is that you can create rules to redirect all email to these accounts directly to the trash if you have the account only as an email address for sites that require one.  (It is a great way to avoid spam too!)

There are other things that should also be protected such as phone numbers and addresses.  Why do you need to include an address when you register with a web site?  It is not as if they are going to actually send you physical mail is it?  After all, that is one of the reasons why the post office will be stopping Saturday deliveries later this year.  Total mail volume is down.  (You thought not getting all of that junk mail was a good thing!) Junk mail paid for a major portion of the post office expenses.  But it is not just that.  People don’t send letters or cards anymore.  They use email message, instant messages, texting, and e-cards.  Many people don’t get physical magazines either because they read most magazines online and not have to guess what is missing from the torn pages of magazines that get shredded during the delivery process.  People also pay bills online rather than sending checks.  And the list goes on.  So why ask for an address that really isn’t needed, but could be used to locate where a person lives.   Imagine a fictitious criminal organization that buys customer information including email addresses from high-end online sales companies so they can target which communities and even homes are more likely to have valuable stuff that their contracted thugs can burglarize.

Phone numbers to some extent fall into that same category.  It is one thing perhaps for the company on whose site you registered to give you a call about their products or services.  However, it is quite another when they sell that information to information brokers to make a few extra bucks because you didn’t buy anything anyway (or even if you did).

Ok, so we are not going to solve all the privacy problems here.  However, I still would encourage those of you who develop databases or who manage databases to consider encrypting more than just the SSN and passwords of people from whom you collect personal information.  Also, please consider if you are collecting that information because it is something that you or your organization will actually act on or whether you are merely collecting it because you just threw it into the pot along with the kitchen sink.

Do You Have A Goal For Your Excel Data?

As it gets closer to the holidays, I’m looking forward to some time off so I’m going to cover some quick Excel analysis tips I’ve run across during the past year during these last few weeks of the year.  When I come back in January, I will be starting a series on Project Crescent in SQL Server 2012.

Solving for a goal in Excel

A common thing that we have been looking at as we prepare for a new budget year is evaluating which of several projects should we take on.  One way to evaluate projects is to calculate the Net Present Value (NPV).  This technique looks at a future stream of expenses and revenues and adjusts them for time to determine what that stream would represent in today’s dollars.  To do this, you have to begin by calculating the expected expenditures and revenues over the next several years as shown in the following table for a simple 5 year project:

	A	B	C	D	E	F
1	Project: Widget Upgrade
2		Year 1	Year 2	Year 3	Year 4	Year 5
3	Expenses	$275,000.00	$77,250.00	$79,567.50	$81,954.53	$84,413.16
4	Revenue	$120,000.00	$126,000.00	$132,300.00	$138,915.00	$145,860.75
5	Net	-$155,000.00	$48,750.00	$52,732.50	$56,960.48	$61,447.59

If you just sum each year’s net return, you would be saying that a dollar five years from now is the same as a dollar today.  However, that simply is not true.  Even if inflation were 0%, a future dollar is not worth a current dollar if for no other reason than you can invest a current dollar and have more than a dollar in 5 years (yes, even with the low interest rates banks are currently paying).   In fact, unless you can earn more from your project than the bean counters in finance can earn by investing that dollar somewhere else, your project doesn’t stand a chance.  How much more you must earn is a function of anticipated inflation and risk.  So if you could invest your dollar and earn 5% a year, but expect inflation to be 2% and the project is moderately risky, you may need to earn at least 9 or 10%.

Most projects, such as the one in the above table have fairly high expenses in the first year or two but have moderate operating expenses in subsequent years, at least compared to the expected revenues.  In this example, the first year of the project costs $155,000 more than it brings in.  But in subsequent years, revenue exceeds expenses by about $50,000 or more each year.

Suppose you just added the year net returns together.  You might think that by spending the $275,000 this year, you can cover all expenses and have an additional $64,890.56 in revenue.  That sounds like a good deal right?

The problem is that merely summing the net returns does not take into account the time value of money.  Let’s look at a simple example of the time value of money.  Suppose you could invest the $275,000 and earn 5% per year for each of the next five years?  In year 2 you would have $275,000 * 1.05 or $288,750.  In other words, you would earn $13,750 on your investment.  In year two you would have $288,750 * 1.05 or $303,187.50 earning another $14,437.50.  In fact, over the five years you would earn $59,264.22

So how do we take into account the time value of money in our example?  Well, in the first year, we have expenses of $275,000 but only revenue of $120,000 for a net loss of $155,000.  In the second year, we have expenses of $77,250.00 with revenues of $126,000 for a net gain of $48,750.  Can we simply take that $48,750 and credit it against the first year loss of $155,000?  No, that $48,750 is not worth that much in today’s dollars.  In fact, if you only consider the alternative investment rate of 5%, those second year dollars are only worth $48,750/1.05 or $46,428.57 today.  Why?  Because if you invest $46.428.57 today at 5%, you will have $48,750 a year from today.

Using similar logic, you would discount each of the future year net returns by 5% per year and then sum the results to get $39,016.19.   So you would still make about 39 thousand dollars more by doing this project.  Anything that returns a positive amount is potentially a good project.

NPV	$39,016.19		=B5+C5/B8+D5/B8^2+E5/B8^3+F5/B8^4
%	1.05

But wait a minute, we did not yet account for inflation or risk.  Suppose you said that you really need to discount future year net proceeds by 10% to account not only for alternative investment, but also for inflation and risk.  Performing these calculations and summing the results still yields us a positive $17,663.54.

NPV	$17,663.54		=B5+C5/B8+D5/B8^2+E5/B8^3+F5/B8^4
%	1.1

So at what interest rate would we become indifferent to this project?  By definition, that is the interest rate that make NPV equal to $0.00.  We could continue to guess at different interest rates, but there are some easier ways in Excel.

The first way is to use a feature called Goal Seek in Excel.  Goal Seek is great when you are trying to force a specific cell’s calculated value by changing one and only one other cell.  In this case, I set up the equation to calculate NPV in cell B7 and the discount interest rate in B8.  Then I opened the Tools menu in Excel 2011 (for the Mac)  and clicked on Goal Seek.  This opens the dialog shown below:

(Note: if you are using Excel 2010 for the PC, you can find Goal Seek by clicking on the Data –> Data Tools –> What-If Analysis.)

First you have to set the cell that you want to force to a specific value. This is the cell that holds the NPV calculation, B7.  In the second text box, I want to force the set cell to have a value of 0.00.  To do this, I want to change the contents of cell B8.

When you click OK, Excel does the hard work of trying different values in cell B8 until it gets a value of 0.00 in B7.  It does this by performing a series of iterations and projections to quickly narrow down to a correct result.  In this example, it gets a value of 1.148540228.  In other words, this project has a rate of return of just under 15%.  Another way to look at this result is that if the cost of money (opportunity cost, inflation, and risk) were greater than 15%, you would not do this project.

Of course, in this case Excel has another way to calculate this rate, known as the Internal Rate of Return (IRR) for the project by using the IRR() function found in the financial set of functions.

=IRR(B5:F5,1)

The IRR function has two parameters, the first is the range of cells containing the net returns for a project.  The second parameter is an initial guess at the rate of return which I usually start at 1.00 or 0%.  Upon pressing the Enter or Tab key, this function performs the same goal seek analysis to determine the rate of return that results in a value of zero when you sum the values in the referenced set of cells.

Note however that while the IRR() function may be a lot easier to use than setting up a Goal Seek, this function is only good for a specific financial calculation.  On the other hand, Goal Seek can be used for any set of calculations in which the final result must converge to a specific value.

What if your problem has more than one parameter that can vary?  There is another technique within What-If analysis using an add-in tool called Solver which I will cover next time.