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Is The Government Lying To Us About Inflation? Yes!

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.”

Finally, a quick note: I am doing a webinar on Tuesday for Mauldin Circle members. The current state of the equity markets brings back memories of 2007. As the market continues to reach new highs, stock selection on both the long and short sides requires considerable expertise. That is why I decided that now is a good time to introduce you to one of the leading long-and-short investment managers, Jacob Gottlieb, CIO of Visium Asset Management. During our conversation on Tuesday, March 26 at 12:00 p.m. EDT (9:00 a.m. PDT), we will find out what’s on Jacob’s mind – his investment themes and where’s he seeing equity opportunities on both the long and short sides.

 If you are not aware of Visium, they are a premier long/short multi-strategy manager with over $3.7 billion in assets. It’s a firm I have been watching for some time. Bloomberg cited Visium as one of “The 100 Top Performing Large Hedge Funds.” Take a look at this recent write-up on Visium: “The Quiet Ambition of Jacob Gottlieb.”

 You will need to register for this exclusive webinar through The Mauldin Circle. If you are a Mauldin Circle member and a qualified purchaser or an investment advisor, a webinar invitation has been sent directly to you by email. A replay will also be available to qualified registrants. If you are unable to listen in to the live discussion, be sure to register so you can receive the replay information. If you are not a member of The Mauldin Circle and are a qualified purchaser, please join today. Upon qualification by my partners at Altegris, you will receive an email invitation . I apologize for limiting this discussion to qualified purchasers and investment advisors, but we must follow the rules and regulations. I look forward to having you at this exclusive Mauldin Circle event. (In this regard, I am president and a registered representative of Millenium Wave Securities, LLC, member FINRA.)

Have a great week. I know mine will be eventful – daughter Amanda is due to give birth to granddaughter Addison on Monday!

Your thinking about the world Addison will discover analyst,

John Mauldin, Editor
Outside the Box

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Is The Government Lying To Us About Inflation? Yes!

By Gary D. Halbert
March 19, 2013

Consumer Price Index Jumped in February

On Friday, the Labor Department reported that the Consumer Price Index (CPI) jumped an unexpected 0.7% in February. This was above pre-report estimates and was the highest monthly reading since 2009. We should be very concerned, right? Let’s take a closer look.

Upon further examination, we find that if we subtract food and energy from the CPI, the cost index rose only 0.2% last month. It turns out that most of the big increase in the CPI last month was due to the sharp rise in gasoline prices. The experts tell us that due to the volatile nature of oil and gasoline prices, we shouldn’t include energy in the CPI. Ditto for food prices which can also be quite volatile.

I have always argued to the contrary, that food and energy prices do indeed need to be considered in the CPI. Think pocketbook: if gas prices rise $1.00 per gallon, and you have to fill up once a week, and it takes 20 gallons to fill up your car, then you have $20 less to spend on something else that week, or $80 less per month. Not good for the economy.

Some others disagree with me, arguing that you spend the same amount each month, and that if you spend more on gas, then you spend less on other things, but the overall economy gets the same amount of money from you one way or the other. Both points are valid.

But if you are trying to measure the true inflation rate, I maintain that food and energy should be included. Apparently the government agrees with me since they continue to report the headline Index including food and energy, and secondarily report what the Index was without food and energy.

The real question is whether or not the Consumer Price Index is really indicative of the actual inflation rate. I will argue that it is not a very good indicator with, or without, food and energy. At the very least, the CPI is controversial.

Why the CPI is So Controversial

The Consumer Price Index (CPI) is produced by the US Department of Labor’s Bureau of Labor Statistics (BLS). It is the most widely watched and used measure of the US inflation rate. For years, there has been controversy about whether the CPI overstates or understates inflation, how it is measured and whether it is an appropriate proxy for inflation.

Originally, the CPI was determined by comparing price changes in a fixed basket of goods and services. Determined as such, the CPI was a cost of goods index (COGI). Over time, however, the US Congress embraced the view that the CPI should reflect changes in the cost to maintain a constant standard of living. Consequently, the CPI has been moving toward a cost of living index (COLI).

Over the years, the methodology used to calculate the CPI has also undergone numerous revisions. According to the BLS, the changes removed “biases” that caused the CPI to overstate the inflation rate. The new methodology takes into account changes in the quality of goods and “substitution.” Substitution is the change in purchases by consumers in response to price changes, and this alters the relative weighting of the goods in the basket. The overall result tends to be a lower CPI.

Critics view the methodological changes and the switch from a COGI to a COLI focus as a purposeful manipulation that allows the government to report a lower CPI. Most critics prefer that the CPI be calculated using the original methodology based on a basket of goods with fixed quantities and qualities. Doing so can result in a significantly higher inflation reading.

On Friday, the BLS reported that the CPI rose only 2.0% over the last 12 months. Economists using different methodologies (including the original methodologies) estimate that the real US inflation rate over that same period was anywhere between 5% and 8%. That’s a huge difference!

If Inflation is 2%, Why Are Prices Up So Much?

I read a good article last week from TIME Business & Money columnist Michael Sivy. He pointed out that his printer ran out of ink recently, and he was “shocked” to find that the same printer cartridge had gone up in price by 25% in less than a year.

While the government’s CPI has averaged only 2% since the end of the Great Recession in early 2009, many basic commodities have soared since then. Gold was $930 an ounce when the recession ended, and today it’s just over $1,600. That’s an increase of 70% in four years, or an annualized rate of over 14%.

Of course, that’s just one commodity. How about a broader measure? The Reuters CRB Commodity Index, which tracks the prices of energy, coffee, cocoa, copper, cotton, etc. is up 38% over four years, or 8.6% at a compound annual rate.

The price of gasoline has gone up from $2.60 a gallon when the recession ended to around $3.70 today nationally. That’s a 41% increase in four years, or an annualized rate of 9%. Taxes have gone up almost as much. Federal, state and local income taxes have risen 35% over four years, an annualized rate of 7.8%.

Then there’s the so-called “Big Mac Index” that was popularized by The Economist some years ago. McDonald’s hamburgers are available in many countries and their prices reflect the cost of food, fuel and basic labor. The price of a Big Mac, therefore, can be yet another indicator of inflation in a particular country. Since the recession ended, the cost of a Big Mac in the US has risen from an average of $3.57 to $4.37, or 5.2% a year.

As the main grocery shopper (and cook) in our family, I am reminded several times a week how food prices continue to go higher. Take a look at this chart from the St Louis Fed.

And while we’re on the subject of food, have you noticed how many manufacturers reduce the size of the containers and/or packages so as to reduce the enclosed amount – but still charge the same price as before? I know I’m not the only one!

Severe Drought Led to Higher Food Prices

Forecasters lay much of the blame for higher food prices on the drought that swept through much of the US last year, and is continuing this year. Last year’s severe weather put nearly 80% of the continental United States in drought conditions – the worst in 50 years. Particularly hard hit areas include the Midwest states of Illinois, Iowa, Minnesota, Nebraska, Kansas, as well as Oklahoma, Texas, Arkansas and many parts of Colorado and California.

The drought damaged key crops like corn, wheat and soybeans while driving up commodity prices and forcing farmers to scramble to find feed for livestock. Farmers and ranchers have had to cut back on the number of livestock and poultry in order to limit their own costs, which created a shortage of beef, chicken and pork.

Although conditions have improved in some areas, roughly 61% of the country still suffers from drought, which is remains at its worst levels in more than a decade, according to the US Drought Monitor.

On a personal note, we are fortunate to live on beautiful Lake Travis, just outside Austin. Lake Travis is a Corps of Engineers man-made lake, and it supplies water for hundreds of thousands of area residents and countless businesses in Central Texas. As such, the lake level varies significantly, depending on the amount of rainfall we receive each year.

The drought in Central Texas is in its third year. Lake Travis, which is 65 miles long and over 200 feet deep in places, is now only 40% full (or 60% empty). As the water level falls, we have to push our dock out further and further to keep it in the water. A trip down to the dock is over 125 steps (one way)!

So How Is the CPI at Only 2%? It’s Not.

As we’ve seen above, the prices of many things that consumers buy on a regular basis have risen much faster than the CPI. So how can the CPI be at only 2%? And how could it have averaged just 2% since the end of the Great Recession four years ago?

Some argue that it’s because wages are down, and with the economy so weak, workers can’t demand higher pay to make up for their increased cost of living. Indeed, that’s one of the factors causing the decline in real after-tax household income.

Real median annual household income in January of this year was $51,584 – or 92.7% of the level in January 2000. Incomes inched up early in 2012 but have been treading water since May, according to the Household Income Index. While household income ticked up slightly in the past year, it remains well below the $54,008 level seen at the start of the recovery roughly four years ago.

These are all factors influencing the economic recovery (or lack thereof) and thus the inflation rate. But they don’t explain why the headline Consumer Price Index has hovered around 2% for the last four years, or why other inflation measurements are in the 5%-8% range. How can this be?

Quite simply because it’s a government report that’s been frequently manipulated over the last 35 years. Whether by design (my bet) or coincidence, these revisions have served to reduce the official inflation rate.

Also, keep in mind that our government has a record $16.7 trillion in debt it is paying interest on. If interest rates rise, it costs Uncle Sam more money. If inflation rises, interest rates follow. Obviously, the government has incentives to manipulate the official inflation rate lower than it really is.

The bottom line is that there is no absolute and objective gauge of inflation. Any particular measure is simply one way of making the calculation, based on a host of assumptions. We do know with certainty that a number of the costs that American households face are going up considerably faster than the CPI.

Finally, the fact that real world inflation is higher than the CPI poses challenges for investors. Investors should calculate their total required return net of the effect of inflation. As the inflation rate increases, higher returns must be earned in order to obtain a desired real rate of return.

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.

Obama’s Olive Branch – “Chained CPI”?

Before we leave the subject of CPI, I think it’s important to discuss something going on right now in the budget negotiations in Washington. Over the shrill opposition of liberal Democrats, Obama has verbally offered to change the way cost of living increases are calculated for Social Security and other entitlements. Instead of the CPI now used, he said he might consider using something called the “chained CPI.”

In a nutshell, chained CPI is a measure of inflation that seeks to account for substitution by consumers when prices rise. While the current CPI measure uses substitution to a small extent, chained 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 end result is that chained CPI is generally lower than the current CPI used for measuring inflation. As I noted above, the

CPI for the past 12 months was measured at 2.0%. The chained CPI for the same period was 1.8%.

If we switch to chained CPI for entitlement cost of living increases, which remains to be seen, it would mean that benefits would rise at a slower rate. Alan Greenspan recommended moving to chained CPI for Social Security back in his day at the Fed, but it went nowhere.

Liberal Democrats oppose the switch to chained CPI and demagogue it as a “war on seniors,” while Republicans feel it’s a way to save Social Security as we know it. Democrats prefer eliminating the cap on salary subject to Social Security taxation (read: increase taxes) to using chained CPI, which they view as a cut in benefits. It seems that only in a politician’s mind can a slower rate of increasing benefits be called a “cut.”

It’s still too early to tell how the current chained CPI debate will play out. This is one of those issues that hits both old and young. If chained CPI is used, then entitlement benefit increases will be lower. If it is not, then future Social Security taxes may well have to be higher. Either way, somebody’s got to pay, and it might end up being a little from both.

Hoping you stay ahead of inflation,

Gary D. Halbert

Discuss This


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Paul Steinmetz

March 25, 2013, 7:20 a.m.

Every couple of months Doug Short has a chart that shows how CPI and CPI based on Shadowstats would look side by side. He has updated it because of this article. Take a look on how he sees the stats. I for one have spoken to him on occasions about this exact subject and he stands by his analysis. It’s a good read. http://advisorperspectives.com/dshort/


March 24, 2013, 2:51 p.m.

Mr. Halbert please make up your mind.  If the actual inflation rate is already in excess of official rates used for SS COLA, and the CPI used for social security is adjusted down, it feels like a “cut” in benefits to me.  I guess you ran into conflicting “messages” that don’t meet your political needs.


March 23, 2013, 7:50 p.m.

If steak gets too expensive, we’ll buy hamburger, and when hamburger gets too expensive we’ll switch to chicken.  Then when gets too expensive, we’ll start trapping squirrels in the front and back yard, and if squirrels get too rare, we’ll trap rats and mice.  Eventually we’ll be reduced to eating soup stocked with sticks, tree bark and fescue.  Meanwhile back in Washington DC, the Democrat geniuses in Congress will still be eating steak and voting themselves, their staffs, and bureaucrat buddies raises.

Scott Wolfel

March 23, 2013, 4:22 p.m.


As always an excellent piece, although I thought it was a little anecdotal (as opposed to offering a statistically rigorous alternative measure) and didn’t emphasize the most important point that, if inflation is significantly higher, “real” GDP is significantly lower and at 5%-8% has been negative for a long time. If “official” inflation has been running at ~2% and “official” real GDP growth has been ~2%, under alternative measures the economy has been “growing” (um shrinking) -1% to -4% a year. Plugging in Shadow Stats or other data, we haven’t had “growth for decades.

On a separate note, you HAVE TO - YOU MUST - check out this EXCELLENT and SHOCKING story on the explosion of the disability insurance program ($260 billion a year and counting, 14 million people and counting)l. As a teaser, the most shocking statistic was that while we’ve created 150,000 jobs a month since the recession, 250,000 a month have applied for disability.

While it’s a good read, also listen to the “This American Life” story (“Trends with Benefits”), because it’s more shocking and evocative to hear. Segments (ie: 1 in 4 people in Hale County, Alabama. on disability and the Dr. who gets them there, the “disability industrial complex” and legal system that gets people benefits in a non-adversarial hearing, States paying consultants to move people off of welfare roles and unto Federal disability and children going on disability, and often staying, in order to supplement their family’s income) are very disturbing illustrations of another broken government program and the law of untended consequences on steroids.

While you’ve covered the story before at a high level, this piece takes a detailed look under the hood of a broken government system. I’ve been religiously reading your newsletters for well over a decade, and invariably they are one of the best things I read, and have never felt compelled to recommend something. (I regularly read the best Hedge Fund letters and macro research, including many of your friends,) . While I’m not sure you can reprint from NPR (you can link to it), this is a story that needs to be heard by your 1 million closest friends. http://apps.npr.org/unfit-for-work/




March 23, 2013, 3:26 p.m.

Good article highlighting the inherent difficulty of measuring cost inflation. I have the benefit of having a dear aunt, Ph.D economist, who sat on the board composing CPI many years ago. For many years CPI did overstate, as (e.g.) it failed to account for increases in quality. So the absolute rise in cost of tires raised CPI (e.g.), while the lower cost per mile (i.e. normalized cost) was ignored. I understand that is one of the “biases” that has been “‘corrected”.

I have also noticed the increase in food prices and numerous decreases in package size. However, I note that a Toyota Sienna costs less than 10 years ago. And of course virtually all sectors of information technology now cost less for greater capability [my Dell laptop 2-1/2 years ago cost 50% more than today]. And let’s not forget that mortgage rates are about 50% of where they were for many years. So inflation really is a function of each individual’s buying patterns.

Proposed fixes to CPI and/or Social Security will similarly affect people differently depending upon buying patterns and stage of life. Whatever the changes, they will make some folks less happy than others.

Craig Honey

March 23, 2013, 11:58 a.m.

Isn’t the weakness of this thesis that, if the government is so Machiavellian, why wouldn’t they inflate CPI rather than depress it?  This higher headline rate would push up both prices and wage demands thus inflating government revenues through sales and income taxes by stealth - a far more sure revenue increase than trying to push tax increases through Congress.  With average maturity of US treasuries over 10 years, the interest payments are locked in for some time - so marking the value of bonds in portfolios gets whacked when rates rise but a lot of those are on the Fed’s balance sheet and are not there for investment purposes (albeit China and Japan won’t be happy).  Further benefit will be to improve the asset/liability math on DB pension plans and a weaker dollar would make exports more competitive.  Seems to me there are many reasons to “inflate” inflation.
If the numbers are so easy to manipulate, then Japan should be able to move out of their deflationary spiral pretty easily with a few tweaks on their data inputs.

Nick Jacobs

March 23, 2013, 2:46 a.m.

The notion of using “chained CPI” is simply a scam, which the 1% would like to perpetrate on retired people. As Jim Beeton points out, if the cost-of-living adjustments to Social Security are so small that seniors have to eat dog food and buy clothes from the Goodwill instead of eating beef and buying new clothes, their standard of living has been reduced.
Using “chained CPI” to adjust Social Security really would be a reduction in real benefits. This is not a matter of politics, it’s fact.

The whole point of measuring inflation is to distinguish between real price increases and nominal price increases.
“It seems that only in a politician’s mind can a slower rate of increasing benefits be called a “cut.”” NO, John, if the slower rate of increase is less than the rate of inflation, then it really is a cut. You know that. Gary Halbert knows that. So whom is Halbert trying to kid?

Just to be clear, I don’t agree with everything in Jim Beetem’s contribution. Of course the government lies to us, all the time. This is not a Republican/Democrat thing, both parties do it when in power. Think Iraq.

John Voeller

March 22, 2013, 10:29 p.m.

It is good to see this kind of discussion but it would be good to take it from the specific to the general.  For example, all food products are identified under the UPC barcode system which correlates to SKU numbers used by each individual purveyor. For the past five decades, I have done a simple calculation in my head of the cost per lb of everything from candy to cars to anything that had a significant human-directed process in its creation, i.e. almost all retail goods. What was fascinating was how completely different things so often came near each other in price in a given era which one might lay to the common element of human handling, transport and sales costs being very similar in all types of goods.It was easy using this test to watch prices climb on a unit weight basis as the package sizes, ingredient mixes and other changes were made with their associated advertising fluff designed to divert attention from the reality. In the last three years, I have watched portions change downward in packages the same or larger than before. I have watched ingredient mixes change with some being more comical than I could imagine. The Hershey Air Bar with the air bubbles in them which is a great excuse for less chocolate at the same price with the promise it tastes better.Inflation becomes invisible when you track by SKU instead of pound but I can guarantee any housewife will tell you these same things as she laughs at the idea we now have low inflation. This coupled with the nutrient removal from foods to gain the much greater profits from those nutrients becoming nutriceuticals which the remaining food is processed forconventional consumption is a another form of inflation in food. SImply put, if you antificpated 1-2 billion new food clients moving from a simple asian diet to a more western consumption and you knew that same population was not going to provide any substantial portion of that new diet, where and how would you be ready for this new market opportunity.


March 22, 2013, 7:07 p.m.

Why not account by price increases due to reduction of net weight sold to the public. Inflation as measured by officials is misleading. I suspect real inflation is well above official statistics, and has been for quite a while.