The inflation rates reported by governments are generally, at the very least, a little lower than they actually are. And the US government is not an exception. It makes the CPI (Consumer Price Index) artificially lower (by making changes in the methodology) and benefits from it in several ways (increasing its revenues while the voters don’t realize they are being lied to and losing their purchasing power).
How the Government Lies about Inflation
The official CPI in the US was 7.5 percent in January 2022 (to know more about this huge increase, click here). However, if measured by 1980s methodology (as is done by Shadow Government Statistics), the CPI was above 15 percent in January 2022. This huge difference can be explained by the several changes made in the methodology of calculating the CPI since the 1990’s:
Home Prices and Rents
Current CPI methodology does not actually include home prices. And about 1/4 of its calculation is represented by “owner’s equivalent rent”. This indicator is based on the following question that the Consumer Expenditure Survey asks of consumers who own their primary residence: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” So, it is just a guess. As of December 2021, house prices have increased by 20 percent YTD. Over the same period, rents have increased by 17 percent. ‘Owner’s equivalent rent’ increased by 3.5 percent. If we use the 20 percent increase of house prices instead of the 3.5 percent ‘owner’s equivalent rent’, the 6.8 percent CPI recorded in November 2021 would be 11 percent.
The annual increase in rents (July 2021) as in realtor.com was 25 percent. This figure is closer to a proper representation of the increase in rents, as the prices listed on realtor.com are the ones that people actually pay.
Chained CPI (Substitution)
Chained CPI is a measurement that accounts for changes in consumer preference and product substitutions due to changes in relative prices of goods made by consumers. This is the substitution effect: if the price of something goes up, consumers will naturally buy less of it and replace it with something else. For example: If the price of steak increases too much, consumers substitute it for chicken. So, the government argues that if consumers are not buying the most expensive things there is no reason for them to be included in the CPI, and therefore the cost of living didn’t go up. As Peter Schiff says, by this logic, if chicken becomes so expensive that people can’t afford it and start eating dog food, then just put dog food in the CPI instead of chicken and there will be no inflation.
Hedonics refers to a method of adjusting prices whenever the characteristics of the products included in the CPI change due to innovation or the introduction of completely new products. For example, if prices go up by 10 percent, but (according to the government) the product is 20 percent better than what the consumer used to buy, then the price didn’t go up by 10 percent, but rather went down by 10 percent because the consumer is taking 20 percent more (or the product is 20 percent better) and is only paying 10 percent more.
Peter Schiff argues that this reasoning makes no sense because, in many cases, just because a product is better it doesn’t necessarily mean that it delivers a better experience to the consumer (who pays for these improvements regardless of whether she/he uses them or not). Peter Schiff gave the example of electronics (like computers or laptops), which get better and better over the years, but not everyone uses all the improvements (like an SSD with more storage, but the user doesn’t even use 1/4 of this storage). Of course, one can argue that there are SSDs of 256GB, 512GB, 1TB, 2TB, etc., and the consumer can choose one that best suits her/his needs. However, there are several other factors to be considered when buying a computer or laptop, such as the CPU, GPU, RAM, etc. And it may be hard to find one that is exactly as the consumer would like, unless she/he buys the components separately and build her/his PC. Schiff also argues that when products improve and prices rise, it is not because they have gotten better, but because inflation pushes prices up. In an economy with no government interventions (inflation, taxes, public spending, and regulations) prices would tend to fall and, at the same time, the quality of products would increase, since there would be much more investment in productivity.
Furthermore, Schiff argues that, in many cases, the quality of products and services declines and there is no corresponding adjustment in the CPI. He mentions the example of airfares (which used to include the cost of luggage, meals, pillows, blankets, etc., and now must be paid separately). According to the government, the airfares are not rising much because they are not adjusted to the great degradation of the quality of the service. Schiff also mention examples of companies that, even keeping their prices unchanged, start to substitute more expensive and better materials for cheaper and inferior quality ones. This is an example of shrinkflation, when the price is unchanged, but the quantity or the quality of the product is lower.
Changes in the CPI Methodology (January 2022)
Since even with all these tricks the CPI is at 7 percent in December 2021, the Bureau of Labor Statistics (BLS) decided it was time to invent new tricks to further hide inflation. So, in January 2022, the BLS changed the weighting of the CPI components (mainly food, vehicles and shelter and energy)
Back in December 2021, “food” represented 13.99 percent of the CPI. In January, the BLS changed it to 13.37 percent. Since food prices are getting a lot higher, the BLS lowered the weighting of the food component so it does not impact the CPI to the same degree as it used to.
The weighting of “new vehicles” and “used cars and trucks” was 3.88 percent and 3.42 percent, respectively, in December 2021. In January 2022, it was 4.1 percent and 4.14 percent, respectively. Prices of new and used vehicles are skyrocketing due to chip shortages. But this shortage is expected to end. When this happens, prices of new and used vehicles shall go down. And, if these components have a higher weighting in the CPI, they will make it so that the final number is lower.
“Shelter” is the CPI component that possesses the higher weighting (32.95 percent as of January 2022). And it is broken down to “rent of primary residence” and “owner’s equivalent rent of residences” (which I already mentioned in this article). “Owner’s equivalent rent” represented 23.51 percent of the CPI in December 2021 and 24.25 percent in January 2022. “Owner’s Equivalent Rent” annual percentage change was at 3.8 percent in December 2021 and 4.08 percent in January 2022. This is much lower than the 10.1 percent increase in rents in December 2021 compared to December 2020, as in realtor.com. The BLS increased the weighting of “owner’s equivalent rent”, so that the CPI comes even lower than it would if they used rents that people are actually paying.
For more details, watch this video from George Gammon.
How the Government Benefits from an Artificially Lower Inflation Rate
Irwin Schiff, Peter Schiff’s father, used to say that expecting the government to give honest information about inflation is the same as expecting the mafia to give honest information about crime. Obviously, the mobsters have a vested interest in underestimating the crime numbers (since they are the ones who are committing them). If there aren’t a lot of crimes, you don’t need as much police officers (and the mafia doesn’t need to spend that much money bribing them).
The government has the same incentive to report an artificially lower inflation rate. Let’s look at some of the reasons:
Voters Don’t Like High Inflation
This is the most obvious reason. Governments say that inflation is good for consumers. However, anyone with a common sense quickly realizes that any rate of inflation is bad for consumers because their standard of living decreases (since they can’t buy the same amount of goods and services as before). So, voters don’t like inflation and tend to blame the incumbent (although, in many cases, not only the incumbent is to blame, but also those who were elected before). If the government cooks an artificially lower inflation rate, voters have one less reason to blame the incumbent.
Inflation Reveals the Cost of Government Programs
People love government programs (like the stimulus checks handed out to people during the pandemic). However, these programs would be much less popular if people knew their cost. Most government spending is not financed by taxes (which is most directly felt by voters), but rather by debt and/or inflation (increase of the money supply). And voters do not understand how they end up paying (they even pay more than they would if the programs were financed only by taxes, as indebtedness brings interest payments and inflation brings price increases).
Through inflation, the government hides the cost of its popular programs and gets more votes. Inflation is nothing more than a stealth tax.
With an Artificially Lower Inflation Rate, Real GDP Gets Artificially Higher
The GDP (Gross Domestic Product) statistic is often used by governments to say that their economic policies are being effective [note: a higher GDP does not necessarily mean an improvement of the economic activity; a better indicator would be “Gross Private Product” (GPP) or “Private Product Remaining” (PPR)]. Real GDP, which factors in the CPI, is higher if the CPI is rigged. So, the government can pretend the economy is growing.
Peter Schiff provided the example of the US social security, since its payments are indexed to inflation. Each year, payments are adjusted upwards based on the annual CPI. Since US social security (as well as the social security of most countries) is broke, the government has no money to make up for it and politicians have no incentive to cut social security payments or cut other expenses to make up for social security. Then, one way of reducing the social security payments is to make the CPI artificially lower so that the annual adjustments are lower.
More Revenue for the Government
Government revenues are higher due to an artificially lower CPI. Schiff argues that many taxes are indexed to the CPI. Therefore, people must pay more taxes due to a lower CPI, since tax brackets are not properly adjusted. To illustrate it, imagine that you make $1000 a month and pay a 15 percent income tax. Also, imagine that incomes up to $900 are tax exempt. If the CPI (not rigged) is 10 percent (meaning that, in real terms, you made $900), then you should be exempt. However, if the government uses a methodology that lowers the CPI and it was 5 percent, then your income in real terms (according to the government) is 950, and therefore you must continue to pay a 15 percent income tax.
The Government Pays Less Interest on Its Debt
With an artificially lower CPI, the government pays less interest on its debt. Governments often issue bonds of which the principal or the interest is indexed to the CPI. In the US, for example, there is the TIPS (Treasury Inflation-Protected Security), which is the debt security that pays the principal adjusted by the CPI. Since the CPI is designed to show a lower inflation rate, the adjustment to the principal turns out to be smaller (see more details on why TIPS is not a good hedge against inflation here).
The government also pays lower interest rates on bonds that are not indexed to the CPI. An artificially lower CPI makes investors believe that future price increases are going to be lower. Thus, the interest on bonds (including those of longer maturities) becomes lower.
Governments have several incentives to skew economic indicators in their favor. They are not entities that have to satisfactorily serve those who finance them. After all, taxpayers are forced to fund the government, whether they are satisfied with the service or not. The government doesn’t have incentives to be efficient, and voters are often dissatisfied and angry. To calm them down a bit, governments cook economic indicators with special spices.
THIS ARTICLE ORIGINALLY POSTED HERE.