numbers.gifI love my country. I don’t always trust my government. Take the CPI, the Consumer Price Index:

First, there is the current self-serving focus on the lower Core CPI, which excludes food and energy due to their “volatility.” Well, yes, food and energy do tend to jump around more, but around a more rapidly-rising median than the overall CPI, and I’ve yet to learn how to live without food or energy. Furthermore, I suspect that if for any great length of time the overall CPI were lower than the Core CPI, the government would start to tout the overall CPI as the true number to watch.

Second, for its housing component, the CPI uses the rental value of your home, which makes no sense, because two-thirds of Americans own their houses. But the upshot is that as a result the CPI does not reflect the tremendous upward rise in the price of houses of the last decade. The concept of “Owner Equivalent Rent” was a product of the Reagan era and provoked controversy at the time. The recent meteoric rise in housing costs was to a certain extent masked by unusually low interest rates and low down-payment and no down-payment financing. Now that those are disappearing, the true pain of the true price of housing will be difficult to conceal. The last couple of years of flat or declining real estate values have only take the edge off the price of housing. It could take as much as a decade of flat or declining housing prices to return the cost of housing to its traditional ratio in the consumer budget.

Three more ways in which CPI is subject to dubious and downward adjustments is product substitution, geometric weighting, and hedonic adjustment.

Product substitution: If a product gets too expensive (butter or steak), the CPI assumes we consume less of it and more of a cheaper substitute (margarine or hamburger).

Geometric weighting: Goods and services of which costs are rising the fastest get a lower weighting due to a presumed lower consumption. If the price of gas goes up rapidly, the CPI assumes we consume less so the impact of rising gas prices has less proportional impact on the CPI than it otherwise would.

Hedonic adjustment is the most bizarre of them all and, ironically, was a product of the Clinton Administration. If innovations in a product or service increase consumer satisfaction, even if the price does not fall, the CPI assumes an increase in VALUE and therefore a reduction in effective cost, thus a downward impact on the CPI. Even more fascinating is that it does not go both ways. For example, there has been no effective increase in the cost of airfares due to the increased hassles of security or delayed flights, or in the cost of commuting due to increased traffic jams.

This is done in plain sight. There is no conspiracy per se and it is made possible by the combination of the complexity of the process, the complacency of the public, and the dumbing-down of the press whose primary goal now seems to be to entertain rather than to inform.

The government’s most obvious motivation behind tweaking the numbers is to keep the voters fat, dumb, and happy and it seems to work remarkably well. A secondary motivation is to save money, both in terms of keeping down the cost of the government’s huge borrowing (rational markets price in an inflation factor in interest rates) and many government payments include a CPI adjustment. By one estimate, Social Security payments would be as much as 70% higher without the above adjustments.

So don’t believe everything they tell you, as there are always a lot of fuzzy numbers behind the headline numbers.

Source: While much of this information has been printed in various publications over the years, I am indebted to the May 2008 Harper’s magazine article “Numbers Racket,” by Kevin Phillips, for providing an excellent summary of the issue.