The government is manipulating the Consumer Price Index in an attempt to keep inflation low and save money, and that has major implications for retirees and some investors, several statisticians who analyze government data say.
They say that artificially low inflation measures rob millions of elderly and pensioners who rely on Social Security cost-of-living adjustments to maintain purchasing power.
Investors in inflation-linked bonds are also being shortchanged by a manipulated CPI, the critics say, and underreporting price rises also gives a misleading impression of real gross-domestic-product growth.
The CPI has been changed “very deliberately” over a number of years in order to lower inflation and hence cut payments to Social Security recipients, said economist John Williams, founder of American Business Analytics and Research LLC, who runs the website Shadow Government Statistics, which is devoted to scrutinizing government data.
Although the debate over CPI indexes isn't new, inflation data have gotten more attention lately as market observers debate whether the economy risks hyperinflation on the one hand, or deflation on the other.
From March through October, the most commonly used CPI index, known as the CPI-U, which tracks prices of all items purchased by urban consumers, has posted year-over-year declines.
The last time that the government reported falling prices was 1955, according to the Bureau of Labor Statistics, which produces the CPI.
Mr. Williams contends that the current whiff of deflation is phony. His alternative index, which uses discontinued BLS methodologies, shows a 5% to 7% annual inflation rate since March.
Robert Arnott, chairman of Research Affiliates LLC, argues that the BLS distorted the index in August and September when it used car prices that were net of the Cash for Clunkers program.
That program gave qualifying automobile buyers up to $4,500 in rebates, which the BLS calculated as a price drop.
“That's pure fraud” in the CPI, Mr. Arnott said
But factoring in discounts on cars is “the standard method for estimating the transaction price,” Ken Stewart, a BLS economist, wrote in an e-mail.
The BLS also dismisses the other criticisms, contending that while the CPI isn't perfect, the methodologies under fire are in fact widely accepted by the statistics profession and have helped improve the CPI indexes.
How the CPI is measured, of course, is a big deal.
Last month, the government announced that for the first time in more than three decades, Social Security recipients and others receiving benefits won't get a cost-of-living adjustment next year.
Mr. Williams figures that Social Security beneficiaries were actually due for about a 2% raise.
The CPI index used by Social Security fell 2.3% in the third quarter, primarily due to a fall in energy prices, Mr. Stewart said. When that happens, benefits don't go down, he said.
Last year, Social Security recipients got a 5.8% increase after gas and food prices jumped, Mr. Stewart said.
Investors in Treasury inflation-protected securities and other inflation-linked bonds also rely on accurate CPI figures to preserve purchasing power.
A lower CPI figure “definitely has an impact” on investors, said Brad Daniel, founder of Daniel Wealth Advisors, who has clients invested in some CPI-linked certificates of deposit.
Gaming the index?
The issues that have caused the most controversy relate to how the BLS adjusts for consumer substitution and quality adjustments and how it measures homeownership costs. The BLS addressed these issues in a report last year.
Critics fault the BLS' move in 1999 to adopt a formula that assumed consumers shift toward lower-priced goods with no loss in standard of living.
“Your quality of life is going down when you're forced to buy [only the stuff you can afford, so there's a natural downward bias built into [the CPI]” said Richard Benson, founder of the Specialty Finance Group LLC.
The bureau contends that the criticism over substitution is wrong because it tracks narrow categories of goods in which consumers can shift to relatively cheaper items that aren't necessarily less desirable.
Critics also fault quality adjustments the BLS makes in estimating prices, such as assuming that the cost of a new computer went down because it has better features.
The BLS contends that it would be impossible not to adjust for quality differences and that most of these adjustments affect apparel and housing prices, not electronic goods.
Finally, the bureau uses a rental-equivalent measure, rather than actual values, to estimate home prices. Critics say that this has lowered the rate of housing inflation during the real estate bubble.
The BLS contends that the measure estimates the amount of money people give up by using their home for shelter instead of renting it out.
Using home values is a flawed approach because money put in housing is largely an investment, the BLS says.
Stock up on gold
CPI critics worry that a manipulated index might miss the return of inflation.
“I bought gold at $350 [an ounce] and silver at $450,” Mr. Benson said. “I do think the Great Inflation is coming.”
Mr. Williams said gold and silver have held their value over many decades, but investors shouldn't look to make money with the metals.
Metals are “a store of value,” he said.
Mr. Arnott still likes TIPS as an investment, “with the caution that the government is playing games with CPI numbers,” he said.
In the meantime, more negative CPI numbers are coming, he said, which will surprise the markets. That would be the time to buy “inflation assets” such as commodities, Mr. Arnott said, to prepare for a “serious jolt” of inflation three to five years out.
Over the next two decades, he predicts, emerging-markets stocks and bonds will outperform.
“Get assets outside the dollar that are short-term and liquid,” Mr. Williams said.”Outside the U.S., real estate historically is a good hedge against inflation.”
E-mail Dan Jamieson at [email protected].
“I DO THINK the Great Inflation is coming.”
Richard Benson
Founder
Specialty Finance Group
