You’re walking around stoned all day. The economic statistics fed to you by the government are concocted to induce euphoria. For one thing, inflation is grossly understated. Because of these artificially low reported inflation rates, the Federal Reserve can continue lowering interest rates without incurring the wrath of people worried about the dollar and excessive credit creation. The artificially low interest rates in turn lead to commodity speculation, one of the main reasons for global food shortages and rioting.
A good example of the government’s humbuggery comes from San Diego. From 2001 through 2005, San Diego experienced one of the nation’s biggest housing bubbles. Median home prices soared 77 percent, points out Kelly Cunningham, economist for the San Diego Institute for Policy Research. But the Bureau of Labor Statistics number for San Diego inflation was a mere 3.7 percent in 2003 and 2004 and 3.6 in 2005. “It’s a little bit suspect,” says Cunningham. San Diego’s consumer price index for last year was only 2.3 percent. “It seems almost ludicrous,” adds Cunningham.
Yes, it’s ludicrous. Ludicrously political. In 1983, the Bureau of Labor Statistics took housing prices out of the consumer price index. A rental equivalent, or what homeowners might get for renting their homes, replaced actual home prices. Voilà! Inflation as reported by the government went down. “Because low inflation encourages low interest rates, which in turn make it much easier to borrow money, the [Bureau of Labor Statistics’] decision no doubt encouraged, during the late 1980s, the large and often speculative expansion in private debt — much of which involved real estate, and some of which went spectacularly bad between 1989 and 1992 in the savings-and-loan, real estate, and junk-bond scandals,” writes Kevin Phillips in the May issue of Harper’s. Phillips’s new book, Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism, tells how one cause of irresponsible speculation and debt accumulation is dishonest government.
The phony statistics “create a false sense of economic achievement and rectitude, allowing us to maintain artificially low interest rates, massive government borrowing, and a dangerous reliance on mortgage and financial debt even as real economic growth has been slower than claimed,” Phillips writes. The misleadingly low inflation also permits the government to pay lower cost-of-living adjustments on Social Security, wages, and contracts.
Based on the official 2.3 percent inflation rate of last year, Cunningham is predicting 3 percent inflation for San Diego this year, “but I would think it would be higher,” he says. If inflation were calculated the way it was 30 years ago, “the rate would be almost double that,” he says. Phillips thinks the national inflation rate is actually 7 to 10 percent. Alan Gin of the University of San Diego thinks a decline in the rental equivalent will keep San Diego inflation from soaring this year, but he concedes that some economists say that as people lose their homes to foreclosure, the demand for rentals will go up, and so will the rental equivalent and local inflation rate.
The rental ploy is only one crooked arrow in the government’s quiver. Since the mid-1990s, there have been other ruses. One is called “product substitution.” If steak gets too expensive, the government says you will switch to hamburger. “When someone buys chicken instead of steak because meat has gone up in price, that’s evidence of inflation,” says Barry Ritholtz, a strategist for an institutional research firm who often writes about misleading government statistics. Through the product substitution hocus-pocus, costs that are rising most rapidly get a lower weighting in the inflation index. So inflation looks tame. Of course, the government doesn’t assume people will move up to steak from hamburger or chicken.
Then there is a dandy called the “hedonic adjustment.” Although buying a new car may take a higher percentage of your income each year, the government might assume the car’s price is going down because the car is improving in quality. Moreover, some economists say that the consumer price index gives inordinate weight to products that go down rapidly in price, such as electronic gear. Hedonics, which is very subjective, opens the door to all kinds of mischief. By and large, most products improve over time. “Hedonics is premised on a flawed assumption: that quality is static,” says Ritholtz. But some products and services don’t improve: for example, your milk used to be delivered, toys were once safe, and a man’s suit came with two pairs of trousers. There is no adjustment for decreasing quality.
And then there is the concept of “core” inflation: because their prices tend to be volatile, food and fuel are left out. The Federal Reserve watches core inflation more than it watches the standard consumer price index. Of course, the core is likely to be lower, particularly these days. If you don’t eat, heat your house, drive a car, or ride in airplanes, core inflation is for you.
So what can you expect this year? Inflation, even with the ruses. Commodity prices are zooming. One reason is that the Federal Reserve keeps lowering interest rates, claiming it has room to do so because reported inflation is moderate. So the dollar goes down and commodity prices go up. Another reason is that the U.S. government is making still another mistake: subsidizing ethanol. Farmers are shifting to corn production. That causes distortions. For example, Mexican farmers have been burning their blue agave, used to make tequila, so they can plant corn. You won’t have bargain tequila to toss down anymore. “The U.S. has been dealing with energy problems in the worst way, and it has been doing it since the first oil shock in 1973,” says Ross Starr, economist at the University of California, San Diego. “Subsidizing ethanol from corn is someplace between really dumb, dumb, bizarre, and protectionist. Agriculture in every country is screwed up.”
That goes without saying. There are food riots in poor countries. The massive shift of production to subsidized biofuels gets part of the blame, along with rising consumption in emerging nations, wheat crop failures, currency market volatility, and commodities speculation that is greatly based on artificially low interest rates.
Starr expects inflation this year, although he thinks it will drop in the subsequent year or two. James Hamilton of the University of California, San Diego, also expects inflation. “The ethanol program is one factor driving up food prices in the U.S. and the rest of the world, and low interest rates have encouraged commodities speculation,” says Hamilton. “There is a contribution of U.S. policy in these global problems — an unwise policy on our part. It doesn’t make sense to drive cars powered by corn, and it doesn’t make sense for the Federal Reserve to drive interest rates as low as possible as quickly as they have.” Excessively easy money and credit can boost inflation.
For one thing, lower interest rates make it less expensive for commodity speculators to hold larger inventories of oil and grain. For another, the rise in the price of oil — caused greatly by lower interest rates and a weak dollar — makes it more profitable for farmers to grow corn for ethanol. And that causes all kinds of shortages and market distortions.
Phillips says that the falsifying of the consumer price index evolved gradually under both Democrats and Republicans. One economist calls the phenomenon “Pollyanna Creep.” The phony numbers have “had a hand in the abetting of political dishonesty, reckless debt, and a casino-like financial sector,” says Phillips. Those are the woes that are burying us. And contributing to food riots abroad.