How the Feds Hide Inflation

(Economist Barry Elias provided invaluable aid in researching this column)

If the same methodology that was used in 1980 to chronicle the double digit inflation of that era were in use today, we would have an inflation rate of ten percent right now, according to Shadow Government Statistics. We are entering a massive era of stagflation which recalls to us our writing in Catastrophe, published two years ago, that “inflation may well be the enduring legacy of the Obama presidency.”

How does the federal government understate the inflation rate? Let us count the ways:

1. It excludes food and fuel costs from its rate of “core inflation.” Each month, the Federal Reserve calms national inflation fears by pointing to the low rate of core inflation, currently at an annual pace of just 2.1%. It reaffirms that the economy is meeting the goal set for it by the Fed of keeping core inflation around or below two percent.

Claiming that food and fuel are too unstable to be included in the inflation rate, it excludes precisely those areas in which inflation is felt most deeply. In the past year, the cost of commodities from corn to soybeans has doubled and the price of gasoline at the pump is one third higher than it was one year ago. The average American household budget devotes one-third of its cash to food and energy costs. Leaving these elements out of the inflation rate has no justification.

2. It substitutes less expensive products when prices rise When prices go up, the economists who generate the Consumer Price Index substitute less a expensive alternative product for the one that has risen in price. For example, if the cost of steak goes up, the CPI does not reflect the increase, but simply replaces steak with hamburger in computing the price index.

3. It excludes “hedonistic” products as price rises The Fed adjusts for price rises by dumbing down the luxury elements of the products whose price it measures. It might, for example, measure the price of cars without air conditioning as a way of avoiding reporting the increase in the cost of automobiles. Even when the luxury features cannot easily be removed from the product, the CPI economists assume that they are.

4. In averaging the price of different commodities, it uses a geometric — not an arithmetic mean. Since the geometric mean, which compares the square roots of product prices, comes out lower, it understates the rate of inflation. See the table below comparing two products’ prices a year apart:

To the layman, an increase in total spending of 50 cents on a base of $2 would represent a 25% increase in price. But that uses the arithmetic mean.

The geometric mean compares the square root of (new price / original price) multiplied by the same for the other commodity. Using this method of calculation, the increase in price would only be 22.5%.

The CPI switched to geometric comparison in 1994. Neat huh?

But no matter how the federal economists bend and twist the data, most Americans realize that we are in for a massive bout of inflation.

And this inflation is dramatically different from the last hyper inflation of the late 70s and early 80s. That inflation was caused by too much money chasing too few products. To slow down the economy and tame price increases, the Fed raised interest rates. But this inflation has nothing to do with demand. Rather, it is caused by the upward push of costs like gasoline, taxes, food, health insurance, and, soon, interest rates. This cost-push increase in prices cannot be tamed by cooling off the economy, which is, in fact, so cool already that it is approaching zero growth.

Stagflation, which will get worse and worse, may be Obama’s real legacy to this country.



  • Reason_For_Life

    Morris is right but the calculations done by the government are skewed even worse than Morris' account.

    The main problem is that characters like Bernanke and "Turbo-Tax-Timmy" Geithner is that after studying macro economics for years they have completely lost all knowledge of micro economics. Forgotten entirely is the concept of "budget".

    Let's say that you have a monthly budget of $2000 and you pay $500 for food and $500 for energy. If the prices of food and energy jump up 20% that means that you are now paying $1200 instead of $1000.

    Since, unlike Helicopter Ben you can't print extra money you have to cut your expenses for non-essentials. That fact that you only have $800 instead of $1000 to buy "other things" means that there is downward pressure on the price of those "other things". Those prices may actually decline due to the drop in demand.

    If those "other things" are the ones used to calculate inflation then it may actually look like there is no inflation at all, or worse, that there is actually deflation.

    This was never a problem prior to the creation of the Federal Reserve Board and the slow abandonment of a gold standard. Americans were told repeatedly that the gold standard was too inflexible for a modern economy. See where all that Federal Reserve Board flexibility has led?

    Some things shouldn't be flexible. The money supply is one of them.

  • kafirman

    Reason_For_Life is correct when he says "Some things shouldn't be flexible." He is also correct when gives an implied endorsement of the gold standard.

    But Reason_For_Life's view of the gold standard is not the best.

    In Economics, the most important constant is the value of your currency. If the dollar fluctuates over time then risk is added to contracts that involve an exchange over time involving dollars. To keep your currency at a constant value, government should adjust the amount of dollars in circulation. (E.g., sell bonds to decrease the money supply, lower interest rates to increase the money supply.)

  • WilliamJamesWard

    If there was a surefire way to have a secure ecnonmy and financial supports
    that keep our money safe, it would have been here long ago. What we have
    is the old smoke and mirrors being used along with common deceit to mix
    master a belief in sound money management. The truth be known, the dollar
    has lost dependability as a standard of value, store of value and means of
    exchange. The value of our currency disappears but our needs remain the
    same, so just how far after we bury our self esteem is our actual demise.
    What in our estimation will sustain us after leftist ruin has done it's work?

  • J676521

    @ Kafirman Nice try. The fact is, money MUST have intrinsic value. The amount of currency circulating is more of a mind game than anything else. When money has value, it is valuable. When money has no value. it is worthless. Pretty simple, huh?

  • Wesley69

    To end the threat of super-charged, hyper-inflation requires a strengthening of the currency. One way to increase the dollar's value is to stop printing so much of it.

    The FED, with its Quantitative Easing 1 & 2, has been printing tons of currency. As the value of the dollar has gone down, it is easier to repay government debts with cheaper dollars, yet the price of everyday products like food, gasoline, commodities like gold and silver are going up. How can the damage be stopped and reverse.

    Quantitative Easing MUST stop, but will Bernanke do this and hurt Obama's chances of reelection?? Even if this artifical "prosperity" continues until November 2012, the economic consequences will be catastrophic.

  • Wesley69

    If the FED starts raising interest rates, the dollar's value should stablize, but loans would become difficult to acquire for businesses and indivividuals. Not only would this result in no growth, but it may send us into another recession, that may be more severe from the recent one.

    Another thing that may need to be done, particularly if the dollar has pretty much collapsed is to peg it to gold or silver. That would strengthen it, but it would result in a loss of value as it would take more dollars to be exchanged for an ounce of silver. Besides gold or silver, another world-wide currency may be accepted for payment of services and goods. Naturally, in the exchange of old dollars for the new currency, value would be lost.

    Another thing that MUST be done is the removal of many unnecessary and costly regulations on businesses. They, not the government, are the vehicle to get us moving again, something this administration fails to understand.

  • Wesley69

    The federal budget needs to be cut, with a eye toward reducing the national deficit. Unneeded programs and duplicating bureaucracies need to be abolished.
    Cuts in corporate and business taxes must be part of the part. ObamaCare needs to be repealed and replaced with a system similar to Representative Paul Ryan's. Social Security will need to be addressed, probably to start with a raise in the minimum age to slowly move it up to 70.

    Energy policies need to be on a FAST TRACK to achieve national energy independence from foreign sources using ALL of our resources. Taxes raised from these different sources can be used to fund Green Energy projects and Mass Transportation (USING FUTURISTIC TECHNOLOGIES) We need a space race in this area. Funding for an increased Space Program would be one of those expenditures that would seen significant increases.

    This stagflation will be worse than the 70's as we continue to pursue policies, that if not checked, will lead to the collapse of the dollar. What happens to all of us receiving a set salary or living on a fixed income. We will experience an extreme change in our standard of living. The problem is that the FED and the Obama Administration seem to be okay with this. That is why both need to go in 2012.

  • Belinda

    The plan is to turn this country into an islamic nation with every hope of helping destroy Israel. There is no way any one who is onboard with the plan will help the country recover then it would be a failed plan. I said three years ago to my family and others that they better get ready for what is to come.

  • Belinda

    Islam wants to conquer the whole world and those who want communism think they will get their way but they are what muslims call "useful idiots". I refused to sign a lease on a gas well to be drilled on some of our properties in New Mexico and told the owner of the company to invest in Israel because he would lose when the Obama administration nationalized the oil and gas industry here. Look at what is happening today. The Obama administration will not stop until they have all major industries under government control but when people set idly by and depend on the government, then it feeds the frenzy. Of course, they will keep handing out and creating situations in order to hand out until their goal is met. I know there is real need out there but the problem is we were supposed to be helping each other not relying on this government who has nothing good in store for any of us. To make things worse is the fact that they will soon start flooding this country with so-called refugees and the islamic population will be overwhelming. That is probably why they held that meeting a couple of fridays ago and only let aljazeer in to cover it. The only hope any of us have is in Hashem through Yahshua HaMashiach. Shalom

  • Patrick Henry

    The governments of the EU, Japan and America are insolvent, in an accounting sense of the word, but because central banks can create unlimited amounts of money and credit, this game can be played out until inflation and the markets force a currency crisis. There will be a tipping point, maybe a natural disaster, a popular revolt, a sovereign default or bankruptcy of a major firm that tips over the first domino. A new paradigm will replace the old one and the transition will be painful and violent in many nations.
    The New World Order, to borrow a loaded phrase, could take the form of a socialist global governance with predictable results. Or it could take the form of a decentralized, global free market with precious metals-backed currencies competing for a new standard that will force the mixed economies to reform or witness a massive capital flight and brain drain to seek better returns and freedom. I say this with confidence because you cannot fake reality – you cannot borrow and create fiat money forever. This too will pass…and when it does, it will take the talking heads by surprise, but not me.

  • jackzeller

    Buy a gun and ammunition. You'll need it, if for nothing else, to retain that rabbit you just shot for your next meal…


    Interesting article.

  • rottenrollin

    I think a divided nation will outdo stagflation as Obama’s “greatest” legacy.