I’m going to go ahead and give you the long and short of this right up front: Whatever the true rate of inflation is, it’s not what the Consumer Price Index (CPI) indicates it is. And – as I’ll explain later in this article – it’s very unlikely that the CPI overstates inflation. There’s a much higher probability that the CPI numbers understate the actual rate of inflation.

Why am I talking about the CPI and inflation here? Well, there are three primary reasons:

1. The CPI is the main economic report that the US government uses to track inflation.
2. Gold has always been the ultimate hedge investment for protection from the loss of purchasing power that results from inflation.
3. We’re all about gold here. 😊

You put all that together and you get to number (4) - If the CPI is underestimating the rate of inflation – if the actual inflation rate is much higher – then there’s a considerably more urgent need to diversify one’s investment portfolio with a higher percentage of investments in gold and silver (i.e., REAL money).

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I think the Federal Reserve should start printing new US currency notes. Yeah, they should issue new $10, $20, $50, and $100 Federal Reserve Notes in the blue, red, green, and gold colors of Monopoly money. That would be a sort of “truth in advertising” measure that would give people a more honest picture of what the US dollar is really worth these days.

The U.S. Bureau of Labor Statistics (BLS) publishes the CPI report, the federal government’s primary inflation tracking tool, monthly. The numbers released often have a significant impact on the financial markets, especially if there’s a major divergence between the projected CPI numbers and what the numbers actually turn out to be. In addition, the Federal Reserve makes interest rate and other policy decisions based largely on the inflation rate as indicated by the CPI. That’s a very important little factoid – because if the CPI numbers aren’t an accurate indication of the rate of inflation, then the Fed could be adjusting interest rates, or making other policy moves, based on a false picture of the state of the US economy.

How the CPI is Calculated

So, how is the CPI calculated? – Well, nobody outside of the BLS exactly knows, because the BLS is not about transparency when it comes to the CPI. Rather, it intentionally keeps the exact methodology of its calculation of the index secret. That alone should ring some alarm bells for you. Why doesn’t the BLS want us to know how the Consumer Price Index is calculated? Can you think of any good reason for the BLS adopting that stance? On the other hand, it doesn’t take a rocket scientist to figure out a nefarious reason for the government wanting to keep its inflation calculation methods secret from the public.

In addition to its exact formula being hidden from the public, the methodology for calculating the CPI has changed substantially over the years, and can even change significantly from one monthly CPI report to the next. The BLS might change the calculation formula, the items used in the calculation, or the percentage weight given to an item included in the index.

Originally, the index was calculated by comparing the total cost of a predetermined “basket” of goods and services from one price period to the next. Thus, the CPI was essentially a cost of goods index (COGI). However, over time the calculation of the CPI has evolved so as to make it more a cost-of-living index (COLI). Therefore, rather than directly comparing the changing prices of goods and services – (so it’s already diverging from being an accurate indicator of inflation, of how much and how fast prices are rising) – the CPI now more precisely aims to reflect changes in the overall cost of maintaining a specified standard of living.

The changed calculation methodology now takes more into account changes that have occurred in the quality of goods and how substitutions may affect the cost of living. Substitutions, in this context, refer to changes in purchasing habits that consumers make in response to increasing or decreasing prices. For example, if milk becomes extraordinarily expensive, then consumers might shift to substituting powdered milk instead of buying regular milk. The CPI is a “weighted” index, and changes in the quality of goods and substitution changes can result in changes to the relative weighting given to various goods and services that make up the CPI’s “basket”. It’s been observed that the typical, overall result of such changes tends to produce a misleading, relatively lower CPI number.

In accounting for changes in the “quality” of goods, the number crunchers at the BLS came up with an obscure concept that they call “hedonic adjustment”. Using this hedonic adjustment lowers the prices of goods that are used in calculating the CPI figures, supposedly to offset the goods being of higher quality. Well, one of the obvious problems with this adjustment procedure is that it’s blatantly arbitrary and subjective, and can, therefore, easily distort the numbers and the final index figure. Also, while the BLS is a big fan of lowering price figures to offset alleged quality improvements, it rarely, if ever, assigns any higher prices to goods when the quality is lowered (for example, when a clothing company, in order to reduce production costs, starts using a lighter weight/thickness of cloth).

The many economic analysts who are harsh critics of the CPI believe that the underlying shift from a COGI to a COLI is part of an intentional manipulation of the numbers that is designed to enable the government to report an inflation rate that is significantly lower than the real rate of inflation. Whether that’s true or not, it’s obvious that it would be easy enough for the BLS to manipulate the CPI numbers if it wished to do so, given the facts that:

1. The exact formula used for calculating the index is not transparent
2. Key factors used in the CPI calculation, such as “hedonic adjustments” for quality changes, are extremely subjective – the BLS can make subjective judgment calls that can significantly alter what the final CPI number turns out to be

Other potential problems with the CPI calculation include things such as the fact that the sampling methodology that the BLS uses – especially with smaller geographic regions and certain categories of goods – can be subject to data input errors.

The CPI is a Lagging Indicator of the State of the Economy

Even economists who don’t subscribe to the “intentional government misrepresentation” theory still criticize the CPI for other reasons – such as for being a badly lagging indicator. That is, they believe that whatever the CPI figure being released this month is doesn’t accurately reflect the current rate of inflation. Rather, it’s more indicative of what the rate of inflation was at some point in the past. – How far in the past? Well, it might well be the distant past. The BLS has been shown to be extremely slow about adding new products into its basket of “representative” goods purchased by consumers. Here are just a few glaring examples of just how far behind the times, in terms of keeping up with what goods and services people are buying, the BLS can be:

• Window air conditioners quickly became popular in the early 1950s – but they didn’t make into the BLS’s basket of goods for calculating the CPI until more than 10 years later - 1964.
• Video recorders and personal computers hit the US market in the late 1970s, and quickly became popular items with consumers. But neither item showed up in the CPI basket of goods until almost 1990.
• There were more than 35 million cellular phone users in the US by the mid-1990s. When did the BLS finally get around to including cell phone service in its basket of CPI goods and services? – Not till around the turn of the century.

By being slow to include new consumer goods, the CPI conveniently misses the substantially higher prices that items such as consumer electronics typically command when they’re first introduced. For example, I can remember when the first big-screen TVs sold, on average, for about $3,000 to $5,000.

Additionally, the whole process of calculating the CPI is more subjective than it should be. As already noted, the BLS can play fast and loose with the numbers simply by making slight adjustments to either what goods and services are included in its basket to survey, or by adjusting the relative weight given to the various items in the basket. For instance, if rent prices suddenly spiked substantially higher, the BLS could lower the impact of that on the CPI calculation by lowering its estimation of the percentage of total household expenditures that rent accounts for from 30% to 25%.

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How Badly Does the CPI Understate the Rate of Inflation?

Let’s look at the price increase for just one item – one staple good that most everyone purchases regularly: a gallon of milk. Let’s see if that can provide us with some indication of the disparity between the CPI’s reported rate of inflation and the actual rate of inflation. The average price of a gallon of milk in the US in 2020 was $3.19. In 2022, the average price had increased to $4.22. That’s roughly a 33% price increase in just two years. I’m pretty sure that belies any ridiculous idea of the annual inflation rate being as low as 2-3%. It, in fact, indicates an annual inflation rate, at least for milk, that’s even substantially higher than 10%!

Maybe milk is an outlier, right? Maybe price increases on other goods aren’t nearly so high – heck, maybe they’re even going down. Okay, let’s try average price of a gallon of gas:

2020 - $1.87
2022 - $5.05

Well, it has since dropped back down to $3.75 in 2024, buuuuut, I’m pretty sure that a 4-year price increase from $1.87 to $3.75 (yes, that’s right at DOUBLE the 2020 average price) is still indicative of a much higher inflation rate than what our dear friends at the BLS are telling us about inflation.

Want another indication of how inaccurate, and understated, the CPI may be as a measure of inflation? Well, there’s the fact that there’s a notable disparity between the price figures that are reported by the BLS and the price figures that another government agency – the US Department of Agriculture (USDA) – reports. For example, the BLS indicates that meat prices have gone up by approximately 20% over the past four years. But the USDA says that beef prices increased by 26% over that same time period. Oops! At least one of those numbers must be wrong.

The CPI Versus the Core CPI

And here’s another problem with the CPI. The BLS actually puts out two CPI numbers in its monthly report. The first is the regular CPI. The second is what’s referred to as the “Core CPI” number. Now, doesn’t the phrase “CORE CPI” (emphasis mine) sound like it’s more official? – like, “This is the core stuff, the essential stuff that really matters”.

Well, here’s the difference between the two figures: The “Core CPI” excludes the costs of…wait for it…food and energy. Say WHAT?! Food and energy?? Don’t food and energy costs, what you spend on groceries and gas – along with housing costs – account for the bulk of monthly expenses that most people have?

The BLS states that excluding food and energy costs when measuring inflation is more accurate because of the fact that food and energy prices are more “volatile” than the prices of other basic goods and services. Well, they may, indeed, be more volatile than some other prices – but that doesn’t in any way change the fact that they represent major expenses that everyone has to pay every month. Therefore, I see no reasonable reason to exclude them from calculating the rate of inflation.

Why Would They Lie about the CPI?

I see “Happy Harvey” (also known as “Blissfully Ignorant Harvey”) in the back of the room there, wondering, “But, gee, why would the government lie to us about the rate of inflation?” I know, I know – it’s hard to believe that Big Brother – who loves us so much – would ever tell us falsehoods (gasp!) about the rate of inflation – would try to convince us to not believe our lying eyes when we see the $3.40 price tag on the frozen dinner that we clearly remember being only $1.75 just a couple of years ago.

Gosh, why would they do that?

Well, the answer is very simple really. The government has a very, VERY strong vested interest in those inflation numbers being as low as possible. Many major government expenditures, such as Social Security payments, are calculated – and increased year by year – based on the CPI numbers. Obviously, the lower the CPI figures, the less money that the federal government has to pay out to Social Security recipients. And, in fact, it’s a very common complaint from senior citizens that the cost-of-living adjustment that they get each year from Social Security falls well short of actually matching up with their increased costs of living.

And, of course, there are political reasons to keep those CPI readings as low as possible, too. Let’s not forget that the BLS is an agency of the federal government and under the purview of whoever the current occupant of the White House is. And if that current occupant plans to run for re-election, well, they certainly don’t want to see a lot of high CPI numbers in the months leading up to election day. Congress, too, likely doesn’t want the citizenry to be getting all hot and bothered about a rapidly rising cost of living – so it’s also in their best interest if that citizenry can be sold the idea that inflation is “under control”.

It's possible that however accurate or inaccurate the CPI data is now, it could be more prone to being inaccurate, or more inaccurate, in the future, due to things such as increasing government debt levels and other excesses. Savers, investors, and lower income earners could suffer as sound financial planning becomes more difficult. After all, it’s difficult to make smart financial planning decisions if the data being used to make such decisions isn’t sound.

The CPI and the Federal Reserve – Consequences of Bad CPI Figures

Bad CPI numbers can have bad consequences for the economy.

As has been very evident over the course of the past year, the Federal Reserve relies heavily on the CPI reports in determining their interest rate policies. The financial markets of late, hopeful of seeing rate cuts in the back half of the year, have been holding their breath with each monthly CPI report, hoping for blessedly low numbers that can, hopefully, fool the Fed into thinking that inflation is no problem at all, so it can go ahead and cut those interest rates and boost the economy. Cutting or raising interest rates, monetary easing or tightening, stimulus or austerity programs – they’re all based on the “official” rate of inflation, as indicated by the CPI. A clear example of this is the Fed’s recent move to stop interest rate hikes – which was primarily based on the CPI’s indication of inflation being back down around 3%.

But what if those CPI numbers aren’t accurate? – Then the Federal Reserve could easily be misled into making wrong-footed fiscal and monetary policy moves. For example, mistakenly thinking that it has tamed the inflation tiger, the Fed might cut rates at a time when, in fact, the real rate of inflation is much higher than the CPI numbers would lead us to believe. That could have the effect of sparking hyperinflation and making the economy, ultimately, more vulnerable to recession.

The federal government is also guided, at least in part, by the CPI figures when it considers setting tax rates and other federal monetary policies. Again, if the numbers aren’t an accurate representation of economic reality, then economic policy measures that are based on the CPI numbers are more likely to have negative, rather than positive, results.

The CPI is a Government Lie – Conclusion

As I said at the beginning of this article, the one thing we can know for sure is that whatever the true inflation numbers are, they aren’t a match with whatever numbers the BLS puts out in its monthly CPI reports. Now, I’m not saying that BLS is intentionally manufacturing false numbers. However, I think I’ve adequately shown in this article that – 

• The BLS could manipulate the CPI figures if it wanted to
• Even absent any intentional deception, even if the BLS is as honest as the day is long, the methodology of the CPI calculation, including significant subjective elements, leaves the index vulnerable to inaccuracies

Pretty much anyone who’s paying even mild attention knows that, while the CPI may be saying that the annual inflation is only about 2-3%, we’re all paying considerably more than 2% higher prices for things than we were a year ago. It’s like, “Hey, if you actually believe that inflation is at only 2-3%, well, I’ve got a beautiful bridge in Brooklyn that I’d be willing to sell you at a bargain basement price.”

You want some idea of the real rate of inflation? – Then look at the price of gold over the past 20 years. Gold has done an overall very good job of tracking the loss of purchasing power in the US dollar that results from inflation. As the US dollar’s purchasing power has taken a nose dive, gold has caught a moon rocket. In fact, precious metals market experts have tried to make the point that the rising per ounce price of gold isn’t a reflection of gold having actually increased in intrinsic value, so much as it’s, rather, a reflection of the ever-eroding purchasing power of the US dollar.

Those “Monopoly money” Federal Reserve notes are losing value seemingly by the day – or probably at least with the release of each monthly CPI report. In sharp contrast, the price of gold is more than 10 times higher than it was around the turn of the century. (Kind of hard to remember those days back when gold was only around $250 an ounce.) If nothing else, the CPI clearly indicates that inflation is an ongoing problem for investors. The one investment asset that has consistently proven to provide solid protection from the ravages of inflation is gold. Inflation can keep going higher and higher…fortunately for investors, so can the price of gold.

• J.B. Maverick

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Sources:

https://www.forbes.com/sites/perianneboring/2014/02/03/if-you-want-to-know-the-real-rate-of-inflation-dont-bother-with-the-cpi/

https://www.investopedia.com/ask/answers/012915/what-are-some-limitations-consumer-price-index-cpi.asp

https://www.gisreportsonline.com/r/cpi-inflation/

https://www.forbes.com/sites/georgecalhoun/2022/02/25/problems-with-the-inflation-figures--the-cpi-has-a-kink-in-it/

https://courses.lumenlearning.com/wm-macroeconomics/chapter/examining-the-consumer-price-index/

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