They're lying to you about inflation

$120 a barrel oil.  $4.00 gas.  Rising food prices.  Yet only 3% inflation?  Job losses for several months in a row.  Yet the economy is still expanding?  Doesn't make sense?  You're not alone.

It's clear that as a result of the way the government now calculates inflation, its reporting vastly underestimates the true rate of inflation.  That, in turn, increases the rate of growth, and reduces cost of living adjustments the government has to make to social security recipients.  That, in turn, reduces the budget deficit.  In addition, wall street and the business press likes the incorred calculation of real inflation because that makes stocks more attractive to investors, and permits people like Larry Kudlow to crow about how great the U.S. economy is.

Fortunately, an astute observer like Kevin Phillips is on the case.

The subject of this scorn is the federal government's vaunted Consumer Price Index or CPI. Americans are now beginning to understand that this indicator has its own share of gimmicks not unlike a sub-prime mortgage or the six pages of fine print that accompanies your credit card agreement.

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Some of these CPI ingredients -- product substitution weightings, "hedonics" (price reductions for added product quality or satisfaction), and use of owner's equivalent rent (instead of home ownership costs) -- have a comic aspect suitable to mockery by Bill Maher, Stephen Colbert or Jon Stewart. But in a larger sense, they're not remotely funny. That's because the federal minimalization and misrepresentation of inflation, pursued statistically over the last 25 years, has been the main buttress of Washington's over-favorable and self-serving portraiture of the U.S. economy.

Distortions aplenty have followed. Some of the most pernicious include the shortchanging of federal pension and Social Security obligations and cost of living increases, a parallel shortchanging of cost-of-living increases in wage contracts tied to the federal CPI, the suppression of equitable interest payments on bank accounts and certificates of deposit, and the camouflaging of weak U.S. economic growth through inadequate adjustments for inflation. The benefits to the executive branch in Washington jump out -- huge annual federal savings on Social Security and pension outlays, as well as on the amount of interest paid on the federal government's multi-trillion-dollar debt. Some $250 billion a year could be involved.

If many individuals are losers, many businesses and financial institutions have been winners. Minimal cost-of-living increases favor corporations, while low interest rates make money cheaper to the financial sector. In particular, the gargantuan $10 trillion increase in financial-sector debt since 1994 could become unmanageable if mounting inflation forced borrowing costs up to 8% or 9%. And it is axiomatic regarding equities that when rates rise in the bond market, that competition usually undercuts stock market values.

In short, there have been three big gainers from understatement of U.S. inflation: the federal government, wage-paying businesses and the institutions and markets of the swollen U.S. financial sector. But skeptics have a weighty counter: Okay, it's easy to understand how they all might profit from understating inflation. But if the understatement is patently false, how can they hope to get away with it?

. . . .

Oil is up over 80 percent in the last twelve months. The New York Times' consumer reporter, W.P. Dunleavy, wrote on May 3 that his own groceries now cost $587 a month, up from $400 a year earlier. That's a 40 percent increase. Reports in the financial press make frequent reference to foreign investors who distrust the U.S. dollar because they calculate true U.S. inflation at 6% to 9% including food and energy.

California economist John Williams, who runs an organization called Shadow Statistics, contends that if Washington still used the CPI measurements applied back in the 1970s, inflation would be in the 10 percent range . . . .

Therein lies the danger. If the current inflation rate is really 6-9 percent instead of the 2-3 percent claimed by government and most U.S. money managers, then Washington's official estimates that the economy still grew at a rate of some 0.6 percent in the first quarter of 2008 become nonsense. Subtracting a 6-9 percent inflation rate from nominal GDP growth would identify an economy that was deteriorating and shrinking, not growing. Concerned foreign dollar-holders would become even more concerned.