Is the CPI rigged?

[lifeisgood]

Anyone can see that the government has a huge incentive to understate the CPI. Even if they aren't blatantly rigging it, there seem to be a lot of methodological issues that experts can argue over, and one could reasonably assume that such debates would be resolved in favor of the lowest increases.

My question isn't just are they rigging it, but how would one invest if one suspected they were rigging it? Is there a "tradable" idea if the official CPI is lower than reality?

 

[ziggy29]

I wonder if they overweight technology and electronics, which tend to drop in price and increase in capacity and performance.

It feels to me, though, that the CPI is constructed for people who spend a third of their money on consumer electronics. I can't believe many other people have only felt 2.3% inflation in the last year or even close to that.

 

[Nords]

Anyone can see that the government has a huge incentive to understate the CPI. Even if they aren't blatantly rigging it, there seem to be a lot of methodological issues that experts can argue over, and one could reasonably assume that such debates would be resolved in favor of the lowest increases.

Like you, I believe that the govt tends to behave in its own best interests.

But in "The Wal-Mart Effect", the author points out that the BLS doesn't even include Wal-Mart's lower prices in their CPI calculation. Two economists, Hausman & Leibtag, showed that the BLS doesn't correct for Wal-Mart's lower prices when they add a Wal-Mart store to their database. They just throw out the old store's data and start over with the new Wal-Mart data. The price drop between the two stores is literally ignored because the cost difference is assumed to be a lower-quality shopping experience. It's not inflation, it's hedonics.

It's calculated that Wal-Mart is causing the CPI to be overstated by 15%. The BLS is well aware of Hausman & Leibtag but has not changed its methods because, as a CPI economist said, "The truth lies somewhere in between and we don't know how to assess where in between it should be. If it were easy to fix, we would have implemented it."

My question isn't just are they rigging it, but how would one invest if one suspected they were rigging it? Is there a "tradable" idea if the official CPI is lower than reality?

The only asset that reliably returns more than inflation is stocks...

 

[cute fuzzy bunny]

Well, the guys who produce the stat point out that is merely *an* interpretation of inflation, and that any individuals direct correlation to it is more coincidental than anything. Theres plenty of correspondence and reports available online around the discussions of the crafting and adjustment of the CPI. A whole lot of it is summarized by saying "This would be good, but we cant do it because it'd be unaffordable". Swell.

Investment wise, I dont think theres a way to play inaccuracies or tracking error to your advantage, other than fully understanding that CPI indexed products do not necessarily "protect" you from inflation, nor do they necessarily produce a so-called "real" rate of return. About the only way you could "play" this is on the spending side. Avoid buying or infrequently buy things that go up in price, and keep basket/vendor substituting yourself as long as humanly possible. Then inflation would have practically no effect on you. Buy a cheap house in a cheap neighborhood, ride a bike for transportation, heat with wood, eat primarily beans, rice and pasta bought in bulk.

While some retailers and some products create pricing opportunities, many of those retailers (like walmart) have special versions of products made for them that are inferior to the same goods sold at other stores. So you're getting what you pay for. David Faber did a piece for CNBC called "The age of walmart". You might find the video on the web somewhere, catch a rerun, or read a synopsis. Its basically in part about a small business that sells their product through walmart, and how their product quality, size, features and labor are continuously nibbled at over a period of a little over a year. They looked very triumphant at becoming a walmart supplier. By the end they looked beaten. A readily available alternative is this: The Man Who Said No to Wal-Mart

Basket substitutions and hedonic adjustments just lose me. That I'd start buying chicken instead of beef because beef was too expensive isnt a measure of inflation, its a measure of inflations effects. While tv's and cars and computers have "gotten better", the average joe 20 years ago didnt own a computer, cell phone, pda, ipod, and drove a mundane american car home to watch his 17" tv set. So while some products are cheaper per inch/hp/whatever, there are more of them you more or less "need" to own to be part of the regular population. The TV I've wanted to own for the last 15 years always costs a couple of grand, and the computer I've wanted to own for the last 10 has always cost around a thousand. The most recent iterations are most certainly better, but I still had to buy them and that transaction looks the same as the ones I made 15 years ago. There is no special place to annotate that I got a superior product for the money that I paid to maintain a standard of living against my peers.

So its not so much the quality or content of the measure as figuring out how much like you the measured "person" is, then deciding how much normalization you can stomach.

Just pay attention when folks like the Bobsey Twins come by and tell you that if you buy TIPS that you can eat your principal and interest for 40 years, die on schedule, and never worry about inflation or market volatility. Probably not so. But if you like rice, beans and splitting firewood...maybe it'd be a good deal for you.

 

[twaddle]

If this isn't a Frequently Asked Question, I don't know what is.

So, let's get this into the FAQ archive, eh?

Q: Is the CPI rigged?
A: Of course it is! It's a government conspiracy to take your attention away from UFOs. Notice how they're both three-letter acronyms! Just like JFK and the CIA!

Q: But that means TIPS are rigged too, right?
A: That's right, Binky. The government is trying to sell you a product that "protects" you from personal inflation. Ha! Boycott the government!

Q: Wait, if TIPS are rigged, why do nominal bonds have the same yield?
A: It's obvious, ain't it? All bonds are rigged! The government pays the Chinese to buy bonds in order to hide the CPI consipiracy!

Q: Uh, that doesn't sound right. If everybody knows the CPI is rigged, wouldn't the market bid accordingly and push yields up where they really should be?
A: Uh, no. The whole damn market is a consipiracy! Haven't you heard of the Plunge Protection Team?

Q: But wouldn't that mean stocks are rigged too?
A: What are you, some kind of commie? Stocks only go up. Nothing to do with the market, economy, or inflation. Just buy 'em!

 

[wcv56]

The american dream= to be able to have enough time between
work and sleep to sit around and complain about nothing is fair
and everything is a conspiracy . We have had some slow years
if you have not noticed obesity now days!

 

[haha]

The american dream= to be able to have enough time between
work and sleep to sit around and complain about nothing is fair
and everything is a conspiracy . We have had some slow years
if you have not noticed obesity now days!

I nominate this for winner of a new category: "Most cryptic post of the week".

Ha

 

[wcv56]

If inflation is measured on a weight scale must be everything is cheaper because we sure are consuming more of it.
Vehicles have gotten lighter but passengers heavier so
the need for more HP to use more fuel.
Inflation only effects the bottom 95% of population anyways,
who cares. ( that is if you are eating at wal-mart) hahaha

 

[brewer12345]

I nominate this for winner of a new category: "Most cryptic post of the week".

Ha

You mean you think it is more cryptic than his other posts?

 

[ladelfina]

(Fish and fresh vegetables cost more than hotdogs and french fries last I checked.)

I LOVE "cryptic posts"!!

CFB, good post! Even if the folks say "it's unaffordable" to study more accurately, I wonder 2 things: one is, wouldn't more "accurate" numbers still get skewed down through the pressures that've been noted elsewhere (so why bother).. and the second is, how can anyone really put an objective, shared figure on the value of many things?

We can agree a pound of beans or a steak has a consistent intrinsic value over time because (barring variances in quality, pesticides, hormones or lack thereof) they provide x amount of calories and nutrition. Other things that have had hedonic adjustments like cars or electronics.. well, I don't see how you can measure what they provide.

I know a car gets you from point a to point b but how do they come up with a value adjustment for the hedonic improvements?.. stuff I may not need or want like 8 cupholders or a trip computer or a graphic equalizer that are now std. equip.?? I may not want animated windows flying around on my computer screen, but they are built in to the new OSes (and hence hardware) prices we have to pay, unless we want to limit ourselves to Mac SE or TRS-80 land or just chuck the computer altogether.

We're kind of locked in to paying some higher prices to have these things, then to be told that the car or electronic item is actually cheaper than we thought? Insult to injury..?

I like yr. "back to basics" suggestion!

 

[donheff]

I like Twaddle's FAQ. If you think the government is effective enough to create and maintain a vast secret conspiracy to tweak the CPI in ways no one can ferret out, hide UFOs, or whatever why are you so doubtful that they could administer a single payer health insurance system?

 

[Michael]

Using pre 1980 methods, inflation would be calculated at approx 10%. Using pre early 90s methods, inflation would be calculated about 6%. Detroit was forced to lease cars instead of selling them because most people couldn't afford to buy them any longer, but the improvements have actually made them cheaper. Because of rising prices both parents now generally need to work to make ends meet, but improvements have made things cheaper in inflation adjusted terms than they used to be. I suspect that the average person defines inflation as rising prices, while economists use some other technical definition that the average person doesn't understand. At least I don't understand how things can be cheaper in inflation adjusted terms if they cost more than they used to. Maybe someone can explain it to me in simple layman's terms.

 

[wcv56]

Boskin committe says 1.1% low.
Is that clear enough, the U.S. is a vast area with many diversities
so I guess a average will have to do.

 

[FinanceDude]

I think the number if BS, and most likely has been for some time.

Reminds me of why my dad started buying the local power company stock in the 1960's......."because my bill went up every year, and I figured the dividend was kind of a rebate back".............

 

[ziggy29]

CPI-U Components - How Consumer Price Index (CPI) Component Weights Hide Inflation

 

[maddythebeagle]

I vote for another FAQ, also...although a point-counterpoint between cutthroat and CFB would be preferable....

 

[cute fuzzy bunny]

Theres no conspiracy theory, and except for some folks attempts to create flame bait, not much evidence of one.

The Boskin Commisions findings reduced the federal deficit by a trillion dollars and increased the "solvency" of social security substantially. Anyone out there naive enough to think there werent any political influences on that committee and its results?

Is the contemplation of simple politics and the process of doing business akin to believing in UFO's? Really?

 

[cute fuzzy bunny]

I vote for another FAQ, also...although a point-counterpoint between cutthroat and CFB would be preferable....

Honestly, i'm not interested in debating the fired ex moderator. He never really had anything valid or interesting to say about anything finance or investment related, IMO. If Quicken didnt have a calculator for it, he didnt have much to say.

I believe his argument was that since he felt his costs hadnt gone up much that based on that anecdotal evidence, everyones inflation rate was low and therefore the CPI was a perfectly applicable measure of inflation for everyone.

A point he elected to bring up whenever he was feeling particularly bored and in need of attention, and he was out of shrieky political comments.

 

[Michael]

On January 31, 1940 Ida May Fuller received the first Social Security check of $22.54 (a month). Using the CPI to adjust it to today's money, it would be $335.67 Most of the CPI adjust was for years before Boskin, yet who could live on that kind of money today?

 

[Robert the Red]

I think the number if BS, and most likely has been for some time.

If the CPI has been under-reported for many years, this means that average Americans were considerable richer in the past than they are now. For example, if inflation since 1967 (say) were reported as a factor of 7 (say), but were really a factor of 14 (say), then $1 of income in 1967 would only be matched by $14 of income now -- but in fact, incomes have about held even with the CPI, so that $1 of pay THEN is only $7 NOW -- meaning that (in this fictitous example) the average person is 50% poorer than 40 years ago.

Now, you can argue about whether or not we (collectively) are poorer than before, but numerically the case is clear: under-reporting of CPI means the past was richer than we think. Over a long time, the difference mounts a lot (compound interest).

 

[wcv56]

They must of had some wonderful value on those outhouses

 

[kcowan]

If the CPI has been under-reported for many years, this means that average Americans were considerable richer in the past than they are now. For example, if inflation since 1967 (say) were reported as a factor of 7 (say), but were really a factor of 14 (say), then $1 of income in 1967 would only be matched by $14 of income now -- but in fact, incomes have about held even with the CPI, so that $1 of pay THEN is only $7 NOW -- meaning that (in this fictitous example) the average person is 50% poorer than 40 years ago.

Now, you can argue about whether or not we (collectively) are poorer than before, but numerically the case is clear: under-reporting of CPI means the past was richer than we think. Over a long time, the difference mounts a lot (compound interest).

You are making a common mistake. In the past 50 years, we have had the benefit of increased earnings through productivity improvements. As an example, I made $8500/yr when I started with megacorp, and 25 years later, I made $192k/yr. But my dear departed Dad retired in 1970 and passed away in 2000. During that 30 years, his ability to live off his CPI-adjusted pension declined every year. And even though he had some savings to fall back on, he continuously reduced his living standard to maintain a buffer.

Fortunately his 1984 car (Toyota Tercel) and his 1974 TV (Sony Trinitron) survived to serve him his whole life. He shopped at The Salvation Army used clothing store. When he died, he had $185k in savings left plus a house and a cottage purchased in the early 40s.

Having witnessed the effects of CPI-adjusted living personally, I will not trust it.

(PS the Tercel was scrapped in 2001 but the TV is still working in my brother's house.)

 

[haha]

Honestly, i'm not interested in debating the fired ex moderator. He never really had anything valid or interesting to say about anything finance or investment related, IMO. If Quicken didnt have a calculator for it, he didnt have much to say.

I believe his argument was that since he felt his costs hadnt gone up much that based on that anecdotal evidence, everyones inflation rate was low and therefore the CPI was a perfectly applicable measure of inflation for everyone.

A point he elected to bring up whenever he was feeling particularly bored and in need of attention, and he was out of shrieky political comments.

Since he isn't here to defend himself, I would like to say that it seems to me that you have given a very one-sided viewpoint. You both had interesting things to say; as Maddy said, it was a good debate.

Ha

 

[ziggy29]

On January 31, 1940 Ida May Fuller received the first Social Security check of $22.54 (a month). Using the CPI to adjust it to today's money, it would be $335.67 Most of the CPI adjust was for years before Boskin, yet who could live on that kind of money today?

Social Security didn't provide the same level of benefits in 1940 as it does today. I believe back in the '60s and '70s they started promising a considerably higher level of benefits in response to Boomers entering the work force in droves, making SS much more able to provide larger payouts. (Of course, as those boomers retire, we're seeing what a mistake that may have been.)

During that period, benefits increased substantially faster than inflation. Plus, inflation calculations used to be much different than they are today in several ways. Many would argue that inflation numbers used to be more indicative of true cost of living increases than they are now.

 

[Michael]

Before the 60s and 70s, Congress made occasional adjustments for inflation/wages. In 1972, benefits were automatically indexed to inflation. The 4 Historical Misunderstandings About Social Security Since it took one wage earner to support a family in the past, and two now, it is very possible that they were richer in the past (money bought more than it does now).