We liked this article, as it is a good opportunity for everyone to stop, reflect and check how one’s investments are faring compared to inflation – whether it is the “official” one or not… – and whether one’s investment strategy is satisfactory or not.By John Mauldin – March 22, 2013
In today’s Outside the Box, Gary D. Halbert (my old and very dear friend and former business partner of many years) reminds us about a few significant facts concerning the Consumer Price Index (CPI) that mainstream economists and the media tend to ignore. The central question is whether the CPI is really indicative of the actual inflation rate. Not likely, says Gary, since the US Bureau of Labor Statistics (BLS), which compiles the CPI, has engaged in methodological shenanigans over the past couple decades (as has been well documented by John Williams of ShadowStats, among others). The upshot of all their monkeying with the numbers is that the official rate of inflation may be two to four times lower than the actual rate (which is rather convenient if you’re a government bureaucrat trying to hold down interest costs and Social Security payments).
These changes are hotly debated in academic circles. There are many economists who agree with the changes and can show with their models that inflation is low. That is the currently accepted wisdom, or what passes for it. The problem is that inflation only shows up, as one person put it, in the things we actually buy. If your main costs are food, energy, education, and healthcare (ring any bells?), then inflation is a great deal higher than 2%. Other items are actually falling in price. It comes down to the mix of items in the calculations and whether you buy into the concepts of substitution (if beef gets too expensive we buy hamburger rather than steak) and “hedonics,” which says that prices of products drop over time as quality and manufacturing efficiency improve, so the calculation of inflation should take this into account.
Which means you can have official inflation at a low level (or even falling for certain items), while the amount you actually spend out of your very real pocket is rising! And thus the debate.
Having refreshed us on the basic techniques of CPI massage, Gary turns to food and energy, which the BLS includes in “headline CPI” but omits from “core CPI.” He points out that while headline CPI jumped an unexpected 0.7% in February, core CPI rose only 0.2%. That is, food and energy price increases accounted for more than 70% of the rise. “Not good for the economy,” he notes.
And of course, this is all bad news for unwary investors, since
Those who believe that inflation is only 2%, when it may be 5-8%, may be making investment decisions that are almost guaranteed to erode the purchasing power of their money over time. This is especially true with low-yielding investments such as CDs, Treasuries, etc.
Gary wraps up by taking a look at “chained CPI,” which he explains as follows:
[C]hained CPI assumes that when prices rise, consumers will resort to entirely different products, rather than just seeking a cheaper brand. For example, if beef prices rise, chained CPI would assume that consumers might opt for chicken to save money.
The chained CPI debate is raging as we speak: I got an email from the AARP this morning, urging me to tell my Senators to say no to chained CPI being used to calculate Social Security cost-of-living adjustments (COLA) – sounds like they may vote today (Friday) on a bill to do just that. But as Gary points out, we either calculate benefits using chained CPI – which, yes, is tough on those living on a fixed income – or we eliminate the cap on salary subject to Social Security taxation (that is, we raise taxes). As Gary says, “Either way, somebody’s got to pay, and it might end up being a little [of] both.”