Irrespective of Government Reporting Games

Global financial markets recently had seen significant hyperventilation by Federal Reserve policy makers as to U.S. inflation having to rise to a certain target-rate level, before the Fed could reverse its post-2008 banking-panic Quantitative Easing (QE) programs. predicament.

Recently, though, the Fed increased its hype and minimally began to reverse its QE actions, despite headline CPI consumer price inflation never having risen to its designated “recovery” level.  At work here are at least two open, central-bank deceptions, with meaningful implications for the handling of one’s personal assets and investments.  



First, as previously discussed (see Summer 2016 Executive Global), the various QE programs were designed first to save national banking systems – at any cost – with only secondary or tertiary consideration given to boosting actual domestic economic activity and inflation.

Second, thanks to U.S.-led policy changes beginning in the 1980s, which meaningfully redefined and understated headline inflation against common experience, the Fed never had to worry about being forced into an earlier-than-desired reversal of its QE programs.  

The balance of this discussion focuses on the deleterious impact of understated official inflation on the investing public, versus the purchasing-power protection offered to investors by holdings of physical gold against the wealth-robbing ravages of actual inflation. 



Formal headline understatement of “common-experience inflation” since 1980 has led to serious issues with individuals and the investing public failing to maintain a constant standard of living with their finances.  In an environment currently accepting formally-understated inflation numbers, annual income-adjustment and investment-return targets will fall shy of adequate levels, if targeted against a too-low headline inflation rate.  Irrespective of the understated published headline inflation rates, investors still can protect the purchasing power of their assets, when invested over the long term in physical gold.  

Unlike most asset classes, gold prices have tended to move the with common inflation experience, not with the deliberately understated inflation series. The difference is significant, currently ranging up to seven percentage points per year in annual consumer inflation – depending on the measure – against the gimmicked headline inflation detail.  



Anecdotal evidence and occasional surveys have indicated the public believes inflation runs well above official reporting. The growing difference in perception and underlying reality versus the gimmicked headlines has reflected the government’s minimising changes to the CPI definition and calculation. The public broadly still has not become aware of or understood these changes.

Before the days of then-Federal Reserve Chairman Alan Greenspan and the Boskin Commission of 1996 recommending debilitating alterations to the U.S. government’s measurement of headline consumer inflation, common-experience inflation measured the cost of maintaining a constant standard of living. Previously, from back into the 1700s into the 1980s, headline inflation had been measured not only as the cost of maintaining a constant standard of living, but also included full inflation measurement for out-of-pocket expenditures.  


Without great public fanfare, the Bureau of Labor Statistics (BLS) began redefining its headline inflation measures in the 1980s, using “hedonic quality adjustments” with the effect usually of reducing previously estimated inflation.  Directly noticeable and measurable (quality changes, such as a reduced-size candy bar, packaged in the same box as before) always have been adjusted for by the BLS. In the case of the smaller candy bar – perceived lower quality – inflation was increased proportionately to the relative decline in the product size. Such was a legitimate price adjustment.

Hedonic adjustments of the 1980s (usually positive, meaning lower inflation) were computer generated estimates of quality changes that reflected impossible-to-quantify technology shifts. Though perhaps of some use in economic theory, they were not meaningful from the standpoint of measuring actual out-of-pocket consumer costs.  

For example, several years ago, a new computer purchased for $1,000, replacing one purchased ten years before also for $1,000 (to perform the same basis tasks as before), purportedly only cost $50 out-of-pocket, per the hedonically-adjusted CPI of the day. That was a full 95% rate of deflation, which the consumer certainly did not actually recognise or experience. If the product were that radically changed, without other versions available, it should have been introduced as a new product in the CPI calculations, with a new price base, as had been the prior practice.  



The push to reduce official inflation reporting further, by shifting in principle from a fixed-weight CPI, to substitution-based CPI came in the mid-1990s. Previously, again, literally for centuries, consumer inflation had been measured against maintaining a constant standard of living. In simplistic terms, the CPI would measure the price of a fixed basket of goods in one year, say a pound of steak, a loaf of bread and a gallon of gas, and then measure that same basket the next year. Whatever the cost change, year-to-year, that was the inflation rate that had to be overcome by income growth or by investment return.

Alan Greenspan pushed the concept, then, that the CPI overstated inflation and that how changing or “correcting” the CPI calculations would help to reduce the federal deficit. He noted, “The [CPI] index is based on a fixed market basket of goods and services. But, for example, if the price on an item like steak gets too expensive, consumers may switch to hamburger.”1   So much for the concept of maintaining a constant standard of living.

Both sides of the aisle in Congress and the financial media touted the benefits of a “more-accurate” CPI, one that would allow the substitution of goods and services. The plan was to reduce cost of living adjustments for government payments to Social Security recipients, etc., and few in the public paid any attention.  

The inflation redefinitions acted as a covert general tax on the public, cutting government outlays (budget costs) based on artificially-low headline inflation increases, with the side benefit for the government of artificially boosting inflation-adjusted headline economic growth. Nonetheless, despite the loss to consumer purchasing power, gold-price movements still have fully offset the costs of rising inflation, as it used to be measured.


Other than gold and precious metals such as silver, various asset classes traditionally act as hedges against inflation, including for example some collectables, rugs, jewellery and fine art, as well as real estate and equities. Fine jewellery and rugs tends to hold their value against inflation, as do rare coins and stamps, but determining value in stressed circumstances can be somewhat more subjective than that for commodity-based bullion or bullion coins.   

Although not broadly quantified in indices that allow easy historical comparison, real estate, by its nature, generally is good inflation hedge. In difficult times, relative to physical gold, it can suffer liquidity issues and generally lacks portability if one should be looking to move around.  

Equities, by their nature, at least should stay even with underlying inflation. In difficult times, they are portable, but also can face short-term liquidity issues. Since January 2000, up to the writing of this article in late-October 2017, despite the U.S. stock markets broadly being at or near historic highs, the total return on the widely followed S&P 500 index, with all dividends being reinvested, had more than covered headline inflation. In the same period, however, it remained meaningfully shy of the corresponding increase in the spot price of physical gold.

As to bonds, rising inflation in normal economic times usually results in market interest rates or yields rising in tandem on those instruments, with the related prices and values of those instruments dropping versus the higher yields. The longer the term to maturity, the more severe the price decline.

Consider U.S. Treasury bills, notes and bonds, traditionally the safest of the debt instruments. With headline annual September 2017 U.S. CPI inflation at 2.23%, a 90-day Treasury bill currently yielding 1.09%, offers a negative real return, net of inflation of 1.14% (-1.14%).  One has to go out on the yield curve to a seven-year note to find a yield that tops headline inflation. The thirty-year bond currently offers a real yield of just 0.73%.

The Treasury also offers inflation-adjusted securities, based on the headline inflation rate, but these securities are priced off the officially gimmicked, understated inflation rates. As defined, these securities never can come close to offsetting the real costs associated with the much higher, commonly experienced pace of consumer price inflation.

Gold prices have tracked common-experience inflation over time, irrespective of the government’s reporting games aimed at masking actual inflation. Physical gold is portable and liquid, and it provides a long-term hedge for preserving the actual purchasing power of one’s wealth and assets.   EG 

 1 Hershey, Robert D., Jr., “Panel Sees a Corrected Price Index as Deficit-Cutter,” New York Times, September 15, 1995.