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The paper was authored by Brodie Gay, Brad Lookabaugh, and Rayan Rafay.
A scale is a sacred symbol. It represents balance, justice, and accuracy. Over
thousands of years, societies have come up with agreed-upon units and measures
for concepts as varied as temperature, weight, and space. While economic
measures have benefited from the high regard in which society holds balances
and measures, economic measures are not like measurements of time or weight.
Economic measures are subject to significant judgment, discretion, and errors in
No economic measure should be relied upon for business or political decisions if the measure, its
strengths, and its weaknesses are not appropriately understood. Since it was first uncovered in 2008,
the LIBOR scandal has resulted in $5B in fines. Though more assets are sensitive to LIBOR than to any
other economic measure in the world, it—and the risks associated with its pricing—are rarely
understood outside of a small inner circle of the financial sector. LIBOR was manipulated because the
incentives to do so were in place, and the incentives for its manipulation continue to remain in place.
Despite the scandal, which Andrew Lo of MIT claimed “dwarfs by orders of magnitude any financial scam
in the history of markets,” most investors still do not understand how LIBOR is tabulated and set.
Second to LIBOR, there is perhaps no more important financial measure in the world today than the
Consumer Price Index (CPI), which is the measure of inflation. The most important inflation benchmark
in the world is the US CPI-U (U for urban consumers). Despite the fact that pension plans, endowments,
foundations, unions, and governments are impacted by inflation, CPI’s strengths and weaknesses are not
well understood. The opacity of CPI’s relationship to inflation, the control policy makers have over CPI’s
construction, and the incentive to achieve a low and stable rate of inflation commingle to produce a moral
hazard. After all, an agent who controls the measure of his own success will never fail.
While we believe that all economic measures should be well understood by investors, we place a
particular importance on understanding CPI. This paper addresses the largest component of inflation
(housing), how inflation as a whole is calculated, and how changes to CPI are not necessarily driven by
intellectual vigor or accurate measure.
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