Inflation Part 2: The Results of Underreporting Inflation

(2008-06-23) by David John Marotta

Officially, inflation today is about 4%. Unofficially, it is over 7%. Inflation at this rate causes serious harm to our nation’s economy and its citizens.

Since 1997 the Consumer Price Index (CPI) has manipulated the raw data and significantly underreported inflation. This tactic has saved the government hundreds of billions of dollars. Entitlement program recipients find their benefits reduced every year. And middle-class taxpayers are pushed automatically into ever-higher tax brackets.

Instituted by the Clinton administration and willingly continued by the Bush administration, this hidden tax burden transcends the political ideology of conservative and liberal. It threatens the idea of limited government.

As economist Milton Friedman said, “Inflation is the one form of taxation that can be imposed without legislation.” John Maynard Keynes agreed. He commented, “The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” And none other than Vladimir Lenin wrote, “The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.”

Lenin may have intended to grind just the upper class. But in America, everyone ends up as grist for the mill. Average Social Security recipients, that is, retirees, are crushed the most. Technological advances are factored out of Social Security cost-of-living adjustments. Seniors are left to live Amish lives in a digital age.

Productivity and technological advances should result in dollars that are capable of buying more each year. If inflation was being reported accurately, simply putting dollars in the bank would result in a 3% boost in purchasing power. These technological advances are the fruits of capitalism and innovation as businesses develop better products and services. Why should the government deny people the advantages of business innovation by deficit spending and increasing the money supply?

In fact, the CPI is deceptively labeled. The name takes something that government has done to confiscate capital wealth and blames it on businesses: rising consumer prices. But businesses aren’t at fault. If the CPI was accurately named, we would call it “Capital Piracy by Inflation.”

Instead of seeing their money grow in value, people with dollars in the bank experience the equivalent of an extra 3% tax on their savings. People on fixed incomes such as Social Security experience the equivalent of a 3% reduction in their benefit payments. Like any compounded taxation, the cumulative effect over the past decade has taken its toll. The lifestyle of millions of the elderly has suffered as a consequence.

Middle-class workers aren’t exempt either. The alternative minimum tax (AMT), established in 1970, is not even indexed to official inflation. So middle-class taxpayers are pushed higher and higher into a tax intended for the ultra rich. The AMT punishes taxpayers for having children or living in a state with high taxes. Thus being hit with the AMT turns many of the tried-and-true rules of thumb on taxes upside down. Ironically, many of the wealthiest taxpayers are now avoiding AMT penalties entirely. Those with large incomes pay enough tax to avoid the AMT while the middle class is penalized.

There’s another concern too. Underreported inflation also masks the current recession. Official first-quarter real gross domestic product (GDP) growth was 0.9%. Current reports suggest that annual economic growth for 2008 will be 2.4%. But if official inflation is at 4% and actual inflation is over 7%, then real economic growth is 3% less than reported. That means growth for 2008 isn’t 2.4% but rather -0.6%. If it feels like a recession, don’t let official government statistics fool you.

During inflationary periods, finding capital is challenging. No one wants to loan expensive dollars today only to be reimbursed with dollars that are worth less in the future. This situation also makes it difficult for companies to capitalize their businesses. Why risk valuable dollars today to create and expand production when inflation devalues the rewards significantly? So of course businesses are not investing. First-quarter fixed investments were down 7.8%.

We risk a business environment similar to the 1970s. Inflation then caused declining price-to-earnings ratios and hindered small business capitalization. Small businesses are responsible for the majority of GDP and job growth. Inflation slows the economy and increases unemployment. Drastic steps by the Reagan administration were necessary to deal with the stagflation of the 1970s and put the economy back on a secure footing. Our current malaise may require some equally bitter measures.

Historically, people worldwide counted on the U.S. dollar holding its value. We sometimes forget that a stable currency is not a given in every country. In the past, people outside the United States were willing to trade their goods and services for nothing more than our currency’s safe store of value. The result has been a trade deficit where our biggest export has been U.S. dollars. About 60% of all U.S. dollars today circulate outside the United States.

But global confidence in the dollar has been shaken recently. Now foreign markets are not committed to holding dollars. They would rather trade those dollars for some of our real goods and services. All those dollars coming home to roost may be good for our trade deficit. But it only exacerbates the problem of too many dollars in this country chasing too few goods and services.

When we have no reliable way to measure the purchasing power of the U.S. dollar, all statistics calculated in our currency become suspect. How can economists or accountants measure anything accurately when their ruler is made of rubber? And if statistics aren’t measurable, then business forecasting is impossible.

All of these are serious public policy concerns. But they don’t have to block your personal financial goals. Despite inflation rates that are higher than reported, you can still protect your investments from being ravaged. In the final part of this series, we will describe practical ways you can hedge against excessive and unreported inflation and secure and guard a comfortable retirement.

from http://www.emarotta.com/article.php?ID=289

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