Thursday, January 19, 2006

Manipulation of inflation figures

Primer on my investment outlook

Richard Karn's Emerging Trends Report: The Gold Treatment - Here is a sample on the CPI:

During the first Bush Administration, Michael Boskin and Alan Greenspan urged that changes be made to the CPI. The rationale was that if the rate of inflation could be lowered via adjustments to the measuring criteria, the government could save tremendous amounts of money from lowered salaries and entitlement payments to the likes of Social Security recipients, which ostensibly would go a long way toward bringing the budget deficit back in line. The idea of manipulating statistics in order to deprive the needy to give more to the profligate raised such a hue and cry that the idea failed to eventuate.

Unfortunately, during the Clinton Administration, the Bureau of Labor Statistics (BLS) took it upon itself to unilaterally make changes to the CPI that amounted to essentially the same thing Boskin and Greenspan proposed, this time in the guise of 'geometric weighting.' Rather than employing the traditional direct arithmetic weighting to a basket of goods, geometric weighting interfered with the reading by assigning a lower weighting to items that were increasing in price and a higher weighting to those dropping in price, thus skewing the figures toward a lower inflation rate. By itself, geometric weighting's "net effect (is) to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology."9

Compared to the original methodology of calculating the CPI, this single adjustment has translated into a 30% reduction in Social Security and other entitlements since its implementation, which means checks should be 43% higher than they are today.10 Geometric weighting was but the first of a number of adjustments that have been constructed intentionally to lower the official inflation rate and to further cut entitlement programs. The others, which include methods such as hedonics, seasonal adjustments, intervention analysis, and owner-equivalent rent, are far more difficult to quantify in terms of their exact effect on the CPI but certainly lower the inflation figures farther. And let's not forget: the methodology used in the so-called core reading, which is the headline number most people read, excludes entirely food and energy prices.

Intentionally lowering the inflation rate creates a ripple effect that puts an increasingly positive spin on a whole slew of other figures. Two headline data series significantly impacted by the CPI are the productivity numbers and the Gross Domestic Product (GDP) figures, both of which are regularly bandied about as clear indicators that all is well with the US economy. Because the GDP is adjusted for inflation, the lower the CPI figure, the higher the GDP figure. This has the effect of making the economy appear to be in much better shape than it really is and makes possible seemingly contradictory notions, such as the so-called "jobless recovery."

As of December 2005, factoring in geometric weighting wizardry alone places the real inflation rate over 7%, which means despite the Fed's rate increases we are still in a negative real interest rate environment. Critics of gold often point out that the relic earns no interest, which is true enough. However, consider this: in a negative real interest rate environment, dollars in interest-bearing accounts are not only actually losing money (dollars depreciating faster than offsetting interest income is accrued), but also the interest on those dollars is being taxed for the privilege of doing so. This helps explain gold's appreciation; the recent dramatic increase in gold prices clearly anticipates even higher inflation in 2006, further victimizing dollars in savings accounts, not gold.

My comments :- Well, many of us are shown 100 yr charts of the stock market and we see huge gains in stock prices. What if we have been conned for past few decades to believe that inflation is lower than it was ? Would this not mean that stock earnings have tracked CPI (which is logical) and, only increases in stock prices have come due to P/E multiples expanding..Think of that the next time someone tries ot make you invest for the long run


Anonymous Pravin Varma said...

One way to see if there is any actual increase of wealth via the stock markets is to see how gold -the only legit currency no hedonics can tamper with- fared during these 100 years.

Can one buy one unit of the DOW with the same number of oz of gold now,as compared to 1980, 1970.?

7:36 AM  
Blogger anmol said...

Well. Gold prices have been in a strange place the past 100 years. We moved from a gold-based system to a fiat currency and theres no telling how this would have affected the gold price..

2:10 PM  

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