Measuring inflation is a dauntingly complex task, as we saw in Part 2. But with Social Security benefits, pension payments, tax brackets, investment and insurance products, not to mention a host of labor and other contracts all linked to an "official" inflation rate, it is a measurement that impacts everyone's pocketbook. One can't help seeing a parallel with a similar statistical mystery--the Bowl Championship Series. Football fans in Idaho are well acquainted with that politically deceitful, statistically convoluted black box that can be counted on each year to send Boise State to the Little Sisters of the Poor Bowl while schools with proper pedigrees divide the financial spoils of the BCS. (See this video on What If Everything Worked Like the BCS--The Spelling Bee.)
We know the BCS is complicated. We know the BCS is crooked. We've almost learned to live with that. But, could it possibly be that measuring inflation is even more complicated than the BCS...and just as crooked?
"There are three kinds of lies: lies, damned lies, and statistics." - Mark Twain (attributed to Benjamin Disraeli)
Unless you are into anti-government conspiracy theories--after all this is Idaho, and we do love to hate the Feds--you may never have given much thought to the possibility that the official inflation numbers published by the Bureau of Labor Statistics (BLS) have been manipulated to your detriment. Over the last few decades the BLS has made important changes to how it calculates the CPI that significantly lower the reported inflation numbers. This is no secret, and the methodology and impact of these changes is well documented. There is considerable controversy, however, as to whether these changes were appropriate, or part of a complex plot to lower the official CPI estimates to order to minimize inflation's apparent impact. And, more importantly, minimize the on-going increases of government expenditures linked to the CPI.
First, a quick summary of the controversial changes in CPI measurement:
On one side of the inflation controversy are economists that contend that the CPI for years was systematically overstating price levels to the tune of 0.8% to 1.6% per year. These were the findings of the Boskin Commission, appointed by the Senate Finance Committee in 1995 to study the effectiveness of the CPI estimates, finally resulting in the late 90's changes mentioned above.
In the other camp are those that believe the pre-1982 methods of measuring inflation would give a truer picture of the debasing of the dollar and the impact of price changes on people's well-being. A well known, vocal proponent of this point of view is Walter J. "John" Williams and his work can be found on his Shadow Government Statistics website. Here is his 2006 take on the changes to CPI measurement:
The CPI was designed to help businesses, individuals and the government adjust their financial planning and considerations for the impact of inflation. The CPI worked reasonably well for those purposes into the early-1980s. In recent decades, however, the reporting system increasingly succumbed to pressures from miscreant politicians, who were and are intent upon stealing income from social security recipients, without ever taking the issue of reduced entitlement payments before the public or Congress for approval.
In particular, changes made in CPI methodology during the Clinton Administration understated inflation significantly, and, through a cumulative effect with earlier changes that began in the late-Carter and early Reagan Administrations have reduced current social security payments by roughly half from where they would have been otherwise. That means Social Security checks today would be about double had the various changes not been made. In like manner, anyone involved in commerce, who relies on receiving payments adjusted for the CPI, has been similarly damaged. On the other side, if you are making payments based on the CPI (i.e., the federal government), you are making out like a bandit.
According to Shadow Stats, the current annualized inflation rate, measured using older pre-1982 methodology is about 10.5%, compared to the official rate of a little over 2.9%--over 7% higher!
Ignoring the 1983 housing change, the cumulative impact of the other methodological changes is less dramatic, but still significantly large enough to be make a major dent in the COLA adjustments to your government check.
Are Williams and other critics right, and the federal government is manipulating statistics to hold the official inflation down? I'm not qualified to pass final judgment on the BLS statisics, but I have to say their methodology seems OK to me. For one thing, if the Shadow Stats' numbers were used and Social Security and government pensions were all about double today's level--does that even pass the smell test? It's not like wages and salaries have been rising at a screaming pace. Does it seem right that Social Security benefits and pensions should be rising at over 10% per year? I don't think so.
Just because inflation used to be calculated one way, doesn't mean that is the way it should be done in perpetuity. Just because cost-of-living increases were calculated in the 70's using the old way, doesn't mean it's a good idea for the new millennium. And, just because college football has always had a corrupt bowl system where elite colleges meet to crown a champion and divide the TV money, doesn't mean that is the way it always has to be.
Like the CPI, we should give economists a chance to redesign the college football post season and bring it into the 21st century. One thing for sure, it would certainly look different than the current BCS. Unfortunately for BSU, however, the championship will likely still require kicking a field goal.
In Part 1, the necessity of thinking clearly about inflation was stressed, along with planning for future inflation rates. (For more on this, also see this recent Morningstar article.) However, as it turns out, just figuring out what the current inflation rate is turns out to be much more complicated than most people realize.
Determining price levels and the rate of inflation is not as simple as measuring other things. For example, when you weigh yourself in the morning you just step on the scale and get a nice digital readout. There are, of course, some similarities between prices and our weight--a lot of short term ups and downs, but generally a small percentage movement up and to the right every year. But, think about it. If you are trying to measure price movements, the first question is the price of what? Each of us spends our money on so many different goods and services over the span of a year, and each of us spends our money different than the next guy. If gasoline goes up 5%, and bread goes down 5%, and milk stays even--what does that say about inflation? What if light beer goes down in price, but microbrews go up 5%? What if cable TV goes up so darn much you drop it altogether, saving $100/month?
In order to get a handle on price changes the U.S. Bureau of Labor Statistics goes to great effort to construct two major categories of price indexes. The first set, which we will ignore for the purposes of this discussion, are the Producer Price Indexes which measure price changes from the perspective of producers along various points of the supply chain. The second set of indexes is the Consumer Price Index, which measures changes from the perspective of the end-use consumer. This is the most familiar, and has the most impact on most of our everyday lives. A quick scan of this document from the BLS tells you the first thing you need to know about inflation--it is an incredibly complex measurement that must take an army of economists and statisticians to pull together.
But wait, that's not all. You may not have realized there isn't just one CPI number--that would be too simple. There are actually a number of Consumer Price Indexes calculated. These indexes are calculated regionally, then averaged for the country. Also, the indexes are published in both seasonally adjusted and unadjusted form. If you are making any decisions from this data, you want to be careful to understand what you are looking at. Below are the key indexes you likely will see quoted in different contexts.
A couple of key points about inflation should be obvious by now. First, it is impossible to get an exact read on what inflation really is. The BLS goes to great effort, and probably does a superb job, but like most statistics about the economy it is an elaborate estimate that takes on the cloak of accuracy. Second, no CPI is going to measure your exact experience with price increases. You experience somewhat different inflation than your next door neighbor (the one drinking light beer while you sip your microbrew), not to mention the retiree in Florida, the oil worker in North Dakota, or the single mother in New Jersey.
What may not be obvious from all of this is the government conspiracy that is currently gaming the inflation numbers. (Yes, this is playing to the local crowd, but the best way to get Idaho readers to continue to the next post is to mention a government conspiracy or complain about the BCS. You get both in Part 3.)
It may come as a shock to you, but apparently some financial advisors have made mistakes with their own money. Some will even admit to their financial blunders--to family, friends, colleagues, or even clients. However, a financial advisor with an inclination to own up to his errors in personal financial management should probably think twice before coming clean in a New York Times article. Just ask Carl Richards.
Carl Richards is a Certified Financial Planner and investment manager in Park City, Utah (formerly located in Las Vegas, Nevada). He has developed quite a following for his "personal finance on a napkin" sketches and his personal finance blog posts at New York Times. (I truly look forward to seeing the latest sketch each week. But, really...who has time to read financial planning blogs?)
Experience is a hard teacher because she gives the test first, the lesson afterwards. -- Vern Law*
Richards' story is similar to millions of Americans'. He bought too much house in Las Vegas during the boom years. They borrowed too much off the equity to fund his business start-up, and live a bit better than they could really afford. After considerable soul searching, they stopped paying on the underwater home they could no longer afford, and eventually arranged for a short sale. You can hear Carl tell his story on a recent NPR Planet Money podcast.
Judging by the reader comments on the original article, Richard's struck a raw nerve for many people. Many cannot understand how a financial planner could make such mistakes, and still be an advisor. For example:
That is just a sampling of the negative comments fit to print. To be sure, there were also a number of readers who expressed positive sentiments. Many readers simply took the opportunity to tell a bit of their story of how the real estate downturn had affected them. And, a surprising number of humble folks took the time to explain how they were much better managers of their finances, much too wise, and much too moral to get caught in such a reckless fiasco.
Financial professionals have been debating the wisdom of Richard's mea culpa. Some believe he has harmed the profession and undermined the credibility of financial planners with the public. (Frankly, is that even possible?) Others see it as a breath of fresh air, and the start of number of useful conversations of how we all do stupid things with money, and how to avoid repeating them. I'm in the latter camp. The whole controversy has reminded me of the many mistakes I have made over the years, and how they have shaped the advice I give today. Just a few examples:
"Experience is a brutal teacher, but you learn. My God, do you learn." - C.S. Lewis
It just could be that our ability to learn from our own mistakes, and the mistakes of others, is the best thing financial planners have going for them. I thank Carl for encouraging me to reflect upon my past experiences, and reminding me to not be so darn smug and self-righteous about the "right way" to handle personal finances. Hopefully, financial advice delivered with a little more humility and a lot more understanding will be more acceptable, and ultimately more effective at improving the lives of clients.
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*Yes, the Vern Law from Meridian, Idaho. The Cy Young Award winning pitcher with the Pittsburg Pirates is also credited with saying, "A winner never quits and a quitter never wins." Who knew? I thought Coach Manship at Ladera Vista Junior High made that up.
Next page: Disclosures