WhatTheyThink.com's Economics and Research Center

Mondays with Dr. Joe:
April 14th, 2008

Did you miss an important event?
Inflation and Its Discontents
U.S. Commercial Printing Shipments Analysis
See You in Two Weeks
Upcoming Dr. Joe Sightings

Did you miss an important event?

On Wednesday, April 9th, Dr. Joe was joined by CEO Advisor and mergers & acquisitions expert Bob Rosen in an important educational web session, Managing Smarter: Magic Numbers to Live By, sponsored by Press-sense. Luckily, WhatTheyThink offers an archive of all of our webinars, and you can still gain from the knowledge, wisdom and insight that these two industry experts shared. Just visit WhatTheyThink.com and click on the Webinars tab at the top of the page.

Inflation and Its Discontents

I am often asked about the adjustment I make to industry data for inflation after my presentations. In a 2005 column, I discussed the process of inflation adjustment, its nuances, and some of the difficult choices that are made in the process. It's time to give it an update.

There are several inflation adjustment tools that can be used. A brief article from CNN.com may be helpful. In the paragraphs below, there are hyperlinks to Wikipedia articles for each method.

The Consumer Price Index (CPI) tracks the changes of a market basket of goods over time. The goods in that basket are revised biannually (every two years) as new products replace old ones, new categories are created, and old ones are deleted. The CPI data are available monthly, and many of the items, of which there are hundreds, are available as individual data series. The CPI has a long history, which makes it useful for multi-decade analyses.

A problem with the CPI relates to substitution of products or changes in demand as prices rise or fall. If prices fall on an item, more will usually be bought. When they rise, less will be bought. The CPI assumes that demand for goods and services does not change for the two-year period. If people stopped buying butter in favor of margarine, the CPI assumes that everyone's still buying butter.

There are many reasons to use the CPI, because it tracks the prices of goods at the end of the value chain, when consumers buy them. They are the prices that you and I pay in the marketplace with our salaries and wages.

The Producer Price Index (PPI) tracks the selling prices of goods at the time of their manufacture. These are tracked by business categories, such as the North American Industrial Classification System (NAICS), which replaced the old Standard Industrial Classification (SIC) system.

Unlike CPI, these goods are generally sold to other businesses and not consumers. That means that other costs, such as transportation, distribution, marketing and additional processing required to bring them to market have not been added to the cost of these goods. In recent years, advances in the costs of bringing products to market have resulted in the PPI being greater than the CPI. Increased manufacturing costs have been absorbed or countered by lower prices somewhere else, making the CPI lower than the PPI.

In the analysis included with this column, we also used the PPI that is calculated specifically for the printing industry. When you see the analysis, it is rather striking how the PPI-adjusted shipments can be quite different than those adjusted using the CPI or the Printing-PPI indices. The basic trendlines have similar shapes, however.

Finally, the Personal Consumption Expenditures Price Index (PCE), sometimes referred to as the GDP deflator, has been the favorite of Fed chairmen like Ben Bernanke and Alan Greenspan. It is generally lower than the CPI because it accounts for product substitutions.

In the calculation, a “chain-weighted approach” is used to adjust for the substitution of goods from period to period as demand for goods and their alternatives changes because of consumer tastes or prices. If the cost of bananas goes up and consumers buy apples instead, then the PCE reflects that. The PCE is considered to better reflect the changes that regularly occur in the economy, and tends to be more consistent. A case could be made that the CPI is better because consumers really want those bananas, and that it is inflation that is changing demand. There are also issues related their differences in tracking housing and medical costs. I say let the academics battle that out in their journals.

The PCE is published every quarter with GDP and other macroeconomic data. That is one of the reasons why we normally do not use it. Printing shipments data are monthly, we can adjust monthly shipments data with the monthly CPI data rather than have to use the same PCE adjustment for the three months in a quarter. In the analysis presented below, however, we did use the PCE.

The Bureau of Economic Analysis, the fine people from our nation's capital who bring you the GDP and other data, have a brief slide presentation outlining the differences between the CPI and PCE.

U.S. Commercial Printing Shipments Analysis

There is no doubt that printing shipments are not what they used to be, and that trying to compare the industry 15 years ago with that of today is fraught with problems. Prices are the best indicator of value, if not the only one, because that is what people are willing to pay for a good or service. Average market prices are actually the result of thousands of transactions and often the decisions of many people for each one of them, all of whom determined that the price was worth paying at that particular time. All of the inflation indices are based on actual sales at the last best price offered, according to the Bureau of Labor Statistics instructions to the companies that participate in their data collection.

The first chart below, shows the different trend lines created by using the various indices. Their shapes are essentially the same, but the peaks are quite different.

The PPI peaks in March 1999, with the 12 months to that date having the industry at $135.3 billion.
Yet, the Printing PPI has it peaking in August 2000, at $114.6 billion. Using this PPI for adjusting industry shipments is rather unwise. It only shows that our own industry prices have not kept up with general inflation. After all, consumers and businesses buy a lot more than printing, and they buy with dollars affected by the entire economy, not just printing industry dollars. If anything, it does show how much the relative price of print has decreased even though demand has been declining. This has been the result of pressures from new media, and this is being amplified now by the growing preferences to avoid print in an effort to minimize environmental impacts and the perceived economic benefit of alternative media.

The CPI's peak is in July 1996, with an industry size of $130.7 billion. The PCE has the peak in 2000, at $126.3 billion. Without inflation adjustment, the peak was May 2001, at $104.1 billion. Note that the unadjusted data (and even the Printing PPI) falsely imply industry growth, especially since March 2004, when we know that it has been otherwise (especially from employment and postal data trends).

So, which one is right, and which ones are wrong? They're all correct in relation to the methodology and definitions used. It's an art, not a science, and judgment is necessary. The most important fact is that inflation adjustment gets you closer to the truth of the past than just doing nothing or guessing.

A Baseline View

Another way to look at this issue is to start with a base year. In this case, the twelve months ending December 1992 calculated at 100.

Here are the highlights through December 2007:

The unadjusted printing shipments are up 26.4% since that time. We know that any rise is just inflation, and not real growth.
CPI adjusted shipments are down -14.5%.
The Printing PPI shipments are flat with 1992, no industry growth at all. But they are down -8.9% with the regular PPI. Perhaps one way to interpret this is that it might be the amount solely due to price erosion. Is it a coincidence that when you add this back to current profit levels, you end up back at the profitability before taxes of the late 1990s? Perhaps. I'm not quite sure, but it's plausible.
The PCE is down -8.8%. Of course. We expected that because of the PCE's reputation for being less than the CPI.

One may think that these results are not all that bad. But it must be remembered that population grows at 1% per year, and GDP around 3%. In that case, real print volume “should” have grown by 16% just from population growth. That's almost nothing over that number of years. To keep up with real GDP, it should have grown by 55%. Unfortunately, we're not even close.

The Bottom Line

I still have a preference for the CPI, though the others have their uses. While some economy watchers prefer the PCE because they feel the CPI overstates inflation, there is also a group of economists who feel that the CPI actually understates it. It was not until the last decade or so, for example, that economists at the Bureau of Labor Statistics have been adjusting for changes in product quality, such as computer speeds and other advances at the same time the prices of those goods have declined. The topic is occasionally contentious.

There is no doubt, however, that inflation is a serious issue that undermines the ability of managers, business owners, and consumers to determine the appropriateness of marketplace prices and costs. It clouds the judging of historical trends and makes assessment of future scenarios confusing.

Still, understanding the trends of the past is an essential management task. The below table shows the multipliers that can be used to adjust any data from 2003 to 2007 dollars. Choose your inflation measure, and multiply the various years’ data by the figures below. If you choose the CPI, for example, take your 2003 data and multiply it by 1.140, your 2004 data by 1.104, and so on. In this way, you will be able to make a more accurate assessment of current performance based on historic trends.

as of Dec. 2007	CPI	PPI	Printing PPI	PCE
2003	1.140	1.211	1.076	1.125
2004	1.104	1.150	1.055	1.089
2005	1.067	1.091	1.036	1.054
2006	1.041	1.062	1.012	1.026
2007	1.000	1.000	1.000	1.000

See You in Two Weeks

Next week, April 21, is a scheduled week off for this column. Watch for blog postings, and especially next week's audio chart of the week which deals with whether digital printing is “greener” than sheetfed offset as part of WhatTheyThink’s Green Week and Earth Day.

Dr. Joe Sightings

Offset & Beyond, April 27-30, Renaissance Hotel, Schaumburg, IL; “Big Picture Industry Trends,” on Sunday April 27 at 2:00pm. The presentation is sponsored by Day International.
Print Services & Distribution Association 2008 Spring Technology Conference, April 30 - May 2, Savannah, GA

Quarterly Economic Webinar, June 18, sponsored by MindFireInc, free, details to be announced
Graph Expo, Chicago, October 28, sponsored by MAN Roland, details to be announced

Recent Sightings (download slides and audio)

Webinar: Managing Smarter: Magic Numbers to Live By, in collaboration with CEO Advisor and Mergers & Acquistions Expert Bob Rosen, April 9, 2008.

Economic Webinar of March 26, 2008, sponsored by MindFireInc. (also read post-event Q&A)

Graph Expo's “Speculative Look at Graphic Arts 2017” event, sponsored by MAN Roland, includes forecasts of the industry and its demographics to 2017. For a special treat, the presentation can also be viewed at SlideShare. The audio will play automatically, but the slides must be advanced manually.

What do you think? Please send feedback to Dr. Joe by emailing him at drjoe@whattheythink.com. To have your question answered in the next column, click here

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