Why You Can't Trust the Inflation Numbers

It is very refreshing to see this article come out of the Wall Street Journal.   It is well known by economists that the government has changed the way it calculates inflation over the years.  However very few people on "Main Street" are aware of this or even take the time to understand the implications.   Here is the bottom line... every government statistic should be viewed with skepticism.   No, this is not a conspiracy, just hard working people that are trying to do better but end up creating more problems.  Either that, or they are so deeply entrenched in the system (Mr. Bernanke) that they have no choice but to tow the company line.  Either way, the losers are the American people.

Why You Can't Trust the Inflation Numbers 

A surprising number of people on Wall Street will tell you not to worry too much about inflation. 

After all, they'll say, just look at the numbers. The inflation picture is incredibly benign. In the past 12 months the Consumer Price Index has risen just 1.5%—a remarkably low rate. And when you strip out volatile food and energy costs, they'll say, it's even lower—a meager 0.8%. 

It doesn't stop there. Many economists will point out that wages are also rising by less than 2% a year. With so many people still out of work, goes the line, labor costs are going to stay low for a long time too. So what's the worry? 

Clearly, a lot of investors agree. Inflation-protected government bonds, which people would buy to protect themselves if they were worried, have fallen in price in the past couple of months. Gold, another inflation hedge, is down. Ten-year Treasury bonds yield less—3.3%—than they did when President Eisenhower left office. 

It's crazy. There is plenty to worry about. As you battle to manage your family's finances, be aware that there are three reasons why inflation needs to be on your radar screen. 

First, the official inflation numbers should be taken with a fistful of salt. 

Over the past 30 years, the federal government has made a lot of changes to the way it calculates inflation. It's taken place under presidents of both parties. Each change in methodology has come with plausible-sounding justifications. But, as if by magic, each change has had the effect of flattering the numbers. Funny, that. 

There are a few reasons investors might be wary of the Treasury market, says Brett Arends. Yet investment strategist Richard Bernstein explains why he's bullish on the dollar. And, advisers can help clients take emotions out of their investment decisions. Dow Jones Wealth Adviser's Veronica Dagher reports. 

According to one rogue economist, John Williams at Shadow Government Statistics, if we still calculated inflation the way we did when Jimmy Carter was president, the official inflation figures would look about as bad as they did when ... Jimmy Carter was president. According to Mr. Williams's calculations, if we counted inflation under the old system the official rate wouldn't be 1.5%. It would be closer to 10%. 

Mr. Williams is just one voice. But it makes sense to treat the government numbers with skepticism. 

Under the official calculations, if steak prices boom, the government just assumes you buy cheaper hamburger instead. Presto—no inflation! 

Or consider the case of Apple computers. We all know Macs are expensive. And we know Apple doesn't discount. The cheapest Mac laptop today costs $999. A few years ago, it also cost $999. So the price is the same, right? 

Ha. Not according Uncle Sam. Using a piece of chicanery called "hedonics," Uncle Sam calls this a price cut. His reasoning? You're getting more for the money. Today's $999 Mac is lighter, fancier and faster than last year's $999 Mac. So the government calculates that the "real" price has actually fallen. 

How's that work in the real world? Try it. Go into your local Apple store and ask for 50% off thanks to hedonics. (If you do, please, please video the exchange and put in YouTube. We could all use a good laugh.) 

Instead, the government is worrying about deflation, partly because of all the "cheap" MacBooks out there. 

The second reason to treat the official inflation figures with some mistrust is that they look backward. They register what just happened, not what's about to happen next. 

OK, so the prices of many things haven't risen. Yet. But if the laws of economics mean anything, they will have to. Why? Because costs are rising. 

Economists need to stop focusing just on labor costs. The world has plenty of surplus labor. But look at raw materials. Around the world prices are skyrocketing, from copper to cocoa. The United Nations Food Price Index has just hit a new record high. Oil's back near $90 a barrel. Wheat prices have nearly doubled since last summer. 

Soaring food prices helped spark the revolution in Tunisia. According to Alex Bos, commodities analyst at Macquarie Securities in London, other governments—especially in North Africa—have responded with panic buying of foodstuffs. 

Algeria alone, he says, has bought about 1.5 million tons of wheat this month—maybe triple its usual amount. Saudi Arabia is rushing to build up grain supplies. Corn supplies are as tight as they were back in the inflationary 1970s. 

Sooner or later this is going to show up in your supermarket, or at the mall, in higher prices. 

Just ask McDonald's. Or paints and plastics giant DuPont. Or Kleenex and Huggies maker Kimberly-Clark. Or 3M. Or Coach. These companies, and many others, have warned in recent days that they're getting squeezed by rising costs. They'll either eat the costs, which will hit the stock, or pass them on. How is this not inflation? 

The third reason to be mistrustful of the inflation picture? Simple. Economics. 

We are flooding the world with extra dollars. The Fed simply invents as many as it likes. In the past couple of years, to try to keep the economy out of a tailspin, it has more than doubled the size of the so-called monetary base. 

A dollar bill has no intrinsic value. Dollars are only "worth" something because you can exchange them for a haircut, or a pair of shoes, or a book from Amazon.com. So if you drastically increase the number of dollars without a commensurate increase in the number of goods and services, each dollar must, by definition, be worth less. That's another way of describing inflation. 

So far, this inflation seems to have shown up in the unlikeliest of places. It's like Whac-A-Mole. The price of vintage wines has skyrocketed 57% in the past year, according to the Liv-ex Fine Wine 50 Index. Real estate prices across China are in a bubble. So long as the Chinese tie themselves to the U.S. dollar, they are importing our inflation. But, once again, one wonders how this can be called benign. 

Is inflation certain? I'm wary of any predictions. Casey Stengel once said, "Never make predictions, especially about the future." Mr. Stengel would have lasted three days as a Wall Street analyst. But he won five World Series in a row, and he knew a thing or two.
Maybe inflation really will stay tame. But I'm not counting on it. I'm not buying the conventional wisdom, and neither should you. 

Source: Wall Street Journal – Brett Arends