Three charts show why consumers – not the Fed – are right about low prices

Consumers intuitively know something that our central bankers still haven’t quite figured out: lower prices may be a good thing.

The Federal Reserve is confounded in its desire to see annual inflation rise to 2%, which it takes as a sign that the economy is picking up steam. The Consumer Price Index was just 1.4% in January. The Fed considers inflation data when deciding whether or not to raise interest rates.

But instead of taking the view that all prices and quantities move roughly the same way, the Fed should consider the types and quantities of things being consumed, according to Brian Barnier, principal at ValueBridge Advisors and founder of FedDashboard.com.

Barnier looks at three sets of goods he sees as representative of different aspects of the economy. Using data from the U.S. Bureau of Economic Analysis, he charts over half a century of price and quantity, indexed to 2009. Each graph gives a starkly different result.

Source: Brian Barnier, FedDashboard.com
Source: Brian Barnier, FedDashboard.com

The first chart Barnier looks at is price and quantity of higher education, health care, and housing from 1959 to 2015. For all three sectors, higher consumption appears to yield higher prices, which is a classic view of what happens when a scarce product sees more demand.

“This is why the Federal Reserve is concerned when prices go down, because they fear this is going to happen backwards,” where prices fall in the wake of reduced consumption, said Barnier.

But he sees government policy as a factor at play, with regulation and subsidies pushing up prices.

Three other sectors exhibit different behavior, which Barnier attributes to increased technology, which is not as big of a factor in health care, education, or housing.

Source: Brian Barnier, FedDashboard.com
Source: Brian Barnier, FedDashboard.com

A chart of household appliances, telecom services, and furniture shows an initial rise in prices with increased quantities. But then prices remain flat as consumption rapidly expands.

The world changed in the mid-1990s,” Barnier said. “That upward-sloping curve that reflected scarcity traditionally, that scarcity is gone,” he said. “This is entirely different than the textbook view, mostly because those textbooks came from before 1990, but they're still around.”

Source: Brian Barnier, FedDashboard.com
Source: Brian Barnier, FedDashboard.com

A third graph further illustrates the effects of technology. Barnier charted photographic, information processing, and audio-visual equipment. Those three industries saw major technological innovations in the past 56 years. To do so, he had to triple the price range on the chart’s y-axis and double the quantity consumed in the x-axis.

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All three types of goods had downward-sloping curves, with rapidly falling prices even as consumption increased exponentially. But even the expanded axes were not enough to capture all the data.

“If you're really going to pick up information processing equipment, that [price] index is over 7,000, so the chart would have to be almost 40 times as high as what you're seeing with this,” he said.

However, it’s not technology that has lead to stable, if not rapidly falling, prices with increased consumption, according to Barnier.

“We see peace-building,” he said of supply. “We see intellectual and physical capacity building around the world. We see pacts for trade.

On the demand side, consumption is changing because of e-commerce and the rise of the sharing economy created by companies like Uber and AirBNB.

“All this is changing and contributing to the world changing in the mid-1990s,” said Barnier.

“Central banks … largely don't understand this,” he said. “They’re just focused on the vertical axis [price] and not thinking about the quantity.”

For investors, Barnier sees an important takeaway from the charts. Namely, investors should look for leaders in industries where prices are stable or falling, but consumption is rising. He singled out tech companies like Apple (AAPL), Netflix (NFLX), and Google (GOOG, GOOGL) as one such example but has a few surprising others.

Look at the furniture companies and look at the appliances, because it's not just the production cost,” he said. “It's the research-to-retail supply chain and everything in between that's holding those prices flat or decreasing over time. That's where you can find real value.

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