Washington's Great "No Inflation" Hoax

Billionaire California bond manager Bill Gross calls it "a haute con job." Bloomberg News columnist John Wasik describes it as "a testament to the art of economic spin." More and more shoppers and consumer simply disbelieve it.

The subject of this scorn is the federal government's vaunted Consumer Price Index or CPI. Americans are now beginning to understand that this indicator has its own share of gimmicks not unlike a sub-prime mortgage or the six pages of fine print that accompanies your credit card agreement.

Some of these CPI ingredients -- product substitution weightings, "hedonics" (price reductions for added product quality or satisfaction), and use of owner's equivalent rent (instead of home ownership costs) -- have a comic aspect suitable to mockery by Bill Maher, Stephen Colbert or Jon Stewart. But in a larger sense, they're not remotely funny. That's because the federal minimalization and misrepresentation of inflation, pursued statistically over the last 25 years, has been the main buttress of Washington's over-favorable and self-serving portraiture of the U.S. economy.

Distortions aplenty have followed. Some of the most pernicious include the shortchanging of federal pension and Social Security obligations and cost of living increases, a parallel shortchanging of cost-of-living increases in wage contracts tied to the federal CPI, the suppression of equitable interest payments on bank accounts and certificates of deposit, and the camouflaging of weak U.S. economic growth through inadequate adjustments for inflation. The benefits to the executive branch in Washington jump out -- huge annual federal savings on Social Security and pension outlays, as well as on the amount of interest paid on the federal government's multi-trillion-dollar debt. Some $250 billion a year could be involved.

If many individuals are losers, many businesses and financial institutions have been winners. Minimal cost-of-living increases favor corporations, while low interest rates make money cheaper to the financial sector. In particular, the gargantuan $10 trillion increase in financial-sector debt since 1994 could become unmanageable if mounting inflation forced borrowing costs up to 8% or 9%. And it is axiomatic regarding equities that when rates rise in the bond market, that competition usually undercuts stock market values.

In short, there have been three big gainers from understatement of U.S. inflation: the federal government, wage-paying businesses and the institutions and markets of the swollen U.S. financial sector. But skeptics have a weighty counter: Okay, it's easy to understand how they all might profit from understating inflation. But if the understatement is patently false, how can they hope to get away with it?

In fact, the belief by many conservative U.S. economists that inflation is under control, despite global indications to the contrary (including soaring commodity and energy prices), has a major ideological component -- their fidelity to monetarist economic principles (that only money supply expansion can create inflation) and to the Efficient Markets Hypothesis (that markets process all available information, so that if inflation were serious, markets would have reacted already). As late as January, monetarists on the Federal Reserve Board, notably Chairman Ben Bernanke and colleague Frederic Mishkin, believed in the new-version CPI and argued that U.S. inflationary expectations were safely "anchored."

Financial economists and money managers generally agree. A late April survey of 120 U.S. institutional money managers by Barron's, the financial weekly, found that on average, they predicted a CPI inflation rate of 2.72% in December 2008 and just 2.79% in December 2009. Elsewhere in the world, central bankers and politicians are worrying about another wave of commodity inflation akin to that in the 1970s, but U.S. money managers take comfort in the Efficient Market Hypothesis and in the wisdom and sanctity of the CPI.

Critics, by contrast, smell a potential disaster. Oil is up over 80 percent in the last twelve months. The New York Times' consumer reporter, W.P. Dunleavy, wrote on May 3 that his own groceries now cost $587 a month, up from $400 a year earlier. That's a 40 percent increase. Reports in the financial press make frequent reference to foreign investors who distrust the U.S. dollar because they calculate true U.S. inflation at 6% to 9% including food and energy.

California economist John Williams, who runs an organization called Shadow Statistics, contends that if Washington still used the CPI measurements applied back in the 1970s, inflation would be in the 10 percent range. My own analysis, set out in much more detail in an article in the May issue of Harper's, comports with that of the cynical foreign investors.

Therein lies the danger. If the current inflation rate is really 6-9 percent instead of the 2-3 percent claimed by government and most U.S. money managers, then Washington's official estimates that the economy still grew at a rate of some 0.6 percent in the first quarter of 2008 become nonsense. Subtracting a 6-9 percent inflation rate from nominal GDP growth would identify an economy that was deteriorating and shrinking, not growing. Concerned foreign dollar-holders would become even more concerned.

In theory, a vigilant Congress might want to hold hearings, but in practice I suspect not. Democratic presidents (notably Bill Clinton) have been involved in the numbers game along with Republican administrations. Neither party has clean hands. Far more likely that any serious investigation will be mounted clandestinely by central banks or sovereign wealth funds in places like China, Singapore and Saudi Arabia as part of their ongoing study of just how much longer they can continue to support a deteriorating U.S. dollar. It is not a happy prospect.

Kevin Phillips's new book Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism was published by Viking in April. His article on untrustworthy government statistics ("Numbers Racket") appears in the May issue of Harper's.

Comments

[Camel54]

I am no economist and don't claim to understand half of what you people are talking about. What I do know very well is my own budget. When I have to make a shorter and shorter grocery list each month just to spend the same number of dollars on groceries, I know something is amiss. When I have to trade in my pickup and start driving a 2001 Corolla (which gets about 33 mpg btw) even though my income has not changed since I bought the truck, I know something is wrong. The fact that I had to switch to Wal*Mart to do my grocery shopping and still a $100 only fills the cart half full, I am as qualified as anyone to say this business about any growth in our economy is bullshit.

[FloaterBall]

Let me add to camel's observations. As a blue-collar construction guy, all kinds of government stats and indexes are mumbo jumbo to me. But I do know that fourteen years ago, when I first moved to Colorado to build houses, $5 was an extravagant amount to spend for lunch at Wendy's, the local chinese buffet, a supermarket deli or wherever we decided to take our break that day. Now I routinely spend 10 bucks for the same exact things. That would be, oh, I don't know, a 100% inflation rate in my world over fourteen years. That's right in Mr. Phillips' ballbark, 7.1% anually. And have my wages doubled in that time? Hell, no! In 1994 the price to hang a tract home door ranged around $12-$20, same as today. Those of us in the real world know the government's stats are, and have been, BS.

[LOL123]

Last paragraph...that or they abondon the dollar completely, not that far of a stretch. We are wayyyyy past a recession they just don't want to start a panic....

[michiganfan]

Excellent analysis. I couldn't agree more. I have been suspecting that our inflation numbers have been wrong for some time now. I have wondered how we can keep interest rates so ridiculously low, and not have inflation.

Another idea that has occurred to me is, how is the index incorporating inflation in targeted areas that are more heavily influenced by the cheap availability of financing?

- Housing and property prices (the first part of our economy to burst) have risen by an obscene amount since the late 80s. How are they incorporated?

- Automobile prices have also gone up by a large amount. How are they incorporated?

- The price of a college education is now astronomical. How is that incorporated?

- What about the prices of other durable goods that are typically purchased with debt financing? How are they incorporated?

We have been running expansionist policies in this country for a long time. Think of how much more debt exists in the economy now. There has been a huge increase in the money supply because of these policies and the increase in debt. That has to have had an effect on inflation.

[batbird]

Greenspan invented a new way to adjust inflation based on added value offsetting cost and price increases. Allowing a weighting for quality works great in the automotive market. If the auto manufacturer adds value, say a new stereo system that costs $1000, but they only increase the price of the car by $700 for this option, then this counts as a loss to the manufacturer and consequently creates a downward pull on inflation even though the price has risen.

The value figure can be adjusted to pretty much make it come out the way they want.

This was done to dampen sharp increases in inflation (CPI) and keep Social Security payments and salaries tied to COLA from rising behond what they considered appropiate. People should complain.

[therealredstateblues]

"Automobile prices have also gone up by a large amount. How are they incorporated"

I am often puzzled by this as well. US branded autos have more and more foreign content from cheap labor countries mexico and china, and labor has made some major concessions in pay and benefits.

There is also a glut of new and late model used cars on the market that arent moving

Where is the downward pressure on price? Where is the saving from cheaper materials and wage and benefit cuts?

none of this is being passed on to the consumer

[SCG]

Do you think Greenspan was over inflated too?

[TovSquirrel]

Welcome to the party!

Anyone who has shopped for groceries in the last twenty years KNOWS that the CPI is not based in reality.

If only the government will tell us where they shop to come up with these figures we'd all make out like bandits!

Stay the course! Vote Democratic­-Republica­n. Keep the corruption where it belongs--in government!

[Fremon]

I agree with some comments insinuating that the reason for lying about inflation numbers is to keep SS dollars, tied to some inflation index, down. Sorry that the Democrats have gone along with this charade. But, the reason is obvious as it is a brewing problem. That is (from the Democrat viewpoint) we are for SS but want to pay out the least possible dollars. The repo point of view. Let's get rid of SS and then the problem. Besides, their financial friends will make the money from a populace that thinks (usually younger folk) we know how best to handle our money. The sub prime mess shows the fallacy of this argument. Without a healthy SS benefits there will be lots of oldies under bridges.

[jrldev]

The last paragraph in Mr. Phillip's article is the most accurate observation about what is happening
(and why) in our country for the last 16 years.

[jumperpin]

Gov't economic stats are an out-of-control disease.

Negative job growth somehow translates to "decline" in unemployment. Hiking prices on medical, insurance, utilities and energy costs saves our GNP from "negative growth". Measurements of wealth polarization remain buried in DOL's official "Personal Income" scam.

The best measure of our economic well being may well be something like MEDIAN personal disposable income. For many citizens, such has even become a negative number. So don't hold your breath.

1.5 incomes no longer support the average household today...not withstanding the accumulated official lies that "we never had it so good".

[dodes]

I will not argue that the CPI is all messed up. The gist of the article is correct. However, the article contains a fair bit of misinformation.

Here are two pieces.

All, every last one, of the issues you mentioned are well-known at the Bureau of Labor Statistics, which is the agency that puts the CPI together. How do I know this? I am well-acquainted with many people who work on the CPI at the BLS. They all know these things, but they do not have the resources to fix it.

If Bernanke is a monetarist, then Bush is a Democrat. In fact, the term "monetarist" hasn't been used in a couple of decades by actual economists. Bernanke has done path-breaking research on how monetary policy affects the real economy, and he has focussed on channels that are ANYTHING but "monetarist." Much of his work has focussed on how problems in credit markets allow monetary policy to affect the economy. This idea is anything but monetarist. How on earth would I know something like this? I know the guy and have read all of his academic work.

Do your homework!

[Herrington]

I have no doubt that the BLS knows they are "burnishing" the numbers on CPI. Unemployment as well, but at least they still publish U6 which is much closer to what the public perception of unemployment is. U1, the official number, basically only counts people who are on Unemployment Insurance. When they drop off the end, they are no longer counted.

Both figures are cooked to show happier results. It is a political decision, put in place by Reagan when his tax break stimulus did not materialize. Clinton went along with it. It is a politicians dream.

The poor folks at the BLS are roped in by policy. They report what they are told to report, and their politically contrived numbers are essentially worthless and deceptive. If the true numbers had been reported over the years, there would have been a revolt by now. As it is, the drift in accuracy is gradual enough that most folks can't muster an argument that it is bogus. Phillips mentions Shadow Statistics, here's a link http://www.shadowstats.com/alternate_data.

[tjfxh]

Bernanke may theoretically be a monetarist but he is acting like a Keynesian for the asset class by providing stimulation to prevent asset deflation and rescue the financial sector from their improvident mistakes. This is pure socialism for the rich at taxpayer expense.

[drkazmd65]

Thank you for your post Mr. Phillips!

Those of us actually working, living, eating and commuting in this economy already knew that the "3% Inflation" statistics were complete hogwash.

With gasoline up consistently over $3.50/gallon, my personal heating bill up >25% from last year, and my grocery costs up from a fairly consistent ~$125 a week to over $175 a week in a year - that pretty much rubbed out my COLA and promotion raise this last year plus some I suspect.

It is good to know that some of the Real Conservatives are still out there - and that you all haven't drank the NeoCon / Corporatist Kool-ade.

[therealredstateblues]

Indeed.

Todays neo CONS bear no resemblence to the true conservative message. There are only shades of grey differences between neo cons and neolibs

There is a lot to like about the true conservative message - fiscal responsibility, minding our own business and avoidence of foreign entaglements, investing at home and strengthening US industry first, less govt intervention in private lives, strong defense at home, national sovereignity, fair and smart trade

Labor has a natural ally in true conservatism. Under Clinton the democratic party betrayed and sold out labor

[Erdgeist]

Such inflation makes retirement impossible. A hundred thousand dollars in 2008 money would have lost most of it value by 2018.

[jteschke]

This is significant. This guy has a proven track record of accurately describing these issues in recent decades.

[BenjitheWolfdog]

The government's CPI index seems to have been taken directly from Alice in Wonderland. I agree that it is rapidly losing credibility. Any one who buys groceries or gasoline knows it nonsense.

[ajax2]

Thank you Mr. Phillips. as a SS recipient I know I've been taken to the cleaners with these cooked inflation numbers. Why do you think AARP and economist like Krugman have been so silent to this theft of $250 billion yearly?

[asl3676]

Well then eliminate COLA increases from Social Security and adjust the inflation calculations
to the pre 1980 levels.
Phillips is, of course, absolutely correct. THE GOVERNMENT IS LYING...I'M SHOCKED....