Most Americans have been led to believe that the Consumer Price Index (CPI) actually measures, from one year to the next, the "cost of maintaining a constant standard of living" as the prices for goods we purchase increase. Indeed, we are foolish enough to believe that the index is an accurate measure of the price increases for the same basket of goods we buy every year. If this were actually true, the index would show an honest increase of 3% - 4% in price, there would be no productivity miracle, interest rates would be much higher, and bond and stock prices would be lower. Of course, with an election approaching, our elected officials don't want the CPI to be an honest measure of the cost of maintaining the same standard of living or quality of life. They want a politically convenient index, cleverly devised to hardly ever rise at all! What you should find unsettling and fraudulent are the ways that the CPI is manipulated to ensure there is no inflation, regardless of how high the prices rise for things we must buy to live. Manipulating the CPI - specifically because the benefits to the retired on Social Security, Medicare and Medicaid are tied to it - and making people believe that inflation is low, will keep the "fraud" of monetary inflation alive. The government simply can't afford to keep the promises it has made, and it needs to use this clever accounting fraud. If productivity is really so high, why isn't government policy pushing through a 10% flat increase in Social Security benefits so that the retired can get their share of the productivity miracle? (Maybe the real miracle is robbing them without them noticing!) By changing the definition of "what inflation is", our government won't have to pay nearly as much to retirees as they were anticipating. The implications of defining inflation away are vast, and the magnitude of the fraud is extraordinary! The primary sources of manipulation are: 1) Making sure the wrong items are in the index; 2) Taking "hedonics" to ridiculous extremes; 3) Getting consumers to do more of the work and receive less services; and, 4) Changing to a Chain Weighted Index. First, it is not a coincidence that the CPI assumes that everyone in the country rents their home. (Rents have been declining over the last year in some major cities, such as San Francisco -6%; Denver -4.3%; and, Atlanta -4.5%). Making sure that the CPI does not pick up the real cost of housing is critical because the very reason that rents are soft is that with easy mortgage credit available, former renters are leaving the rental market and buying houses instead, which has pushed up housing prices. Over the last four years, housing prices have risen 45%, so how could the index possibly be kept so low if housing prices were actually part of the "cost of living"? The drop in rents is very material since the cost of housing is a full 30% of the CPI. Unfortunately, for those 80 plus million Americans with incomes tied to the CPI, 69% of households own their home. So, over two-thirds of Americans are forced to use a Consumer Price Index that has absolutely no relevance to them! To say the cost of living is going down for homeowners is just ridiculous! If the CPI was honestly set to measure the costs associated with owning a home for those 69% (vs. renting), the index would be rising over 3% a year! Those 80 plus million Americans who are short-changed include recipients of Social Security, Medicare, welfare and food stamps, as well as retired military and many private pensions. To take a closer look, my wife and I prepared a monthly "nut" spreadsheet on our own personal expenses. We own our home and car outright (so we don't have a mortgage or car payment), but we still have all the usual expenses, including: Insurance for Health Care, Automobile and property; electricity; DSL connection; telephone; property taxes; monthly maintenance; etc. Before we have even purchased a gallon of gas, a piece of clothing, or a single grocery item, our annual nut amounts to over $25,000 and it is rising around 8 to 10 percent a year. We recommend you do the same and then compare your "housing cost" to the CPI. You'll notice that you probably do not live in the world the government describes! Second, the CPI is managed down by arbitrary decisions made by bureaucrats on the "quality improvements" in goods and services, pleasantly referred to as "hedonics". When you buy a computer that has "more storage" or purchase a new car made with more plastic rather than steel, the bureaucrats at the Bureau of Labor Statistics, Bureau of Economic Advisors and the Federal Reserve, get all excited because productivity and deflation can be "defined into existence" the same way that the Federal Reserve can "print new money out of thin air". While there are some benefits from quality improvements in the cost of goods and services, the extent of the "arbitrary hedonic adjustments" are breathtaking and, alone, are adding 1% to 1.5% of real Gross Domestic Product (GDP) growth by "magically lowering inflation" by the same amount. All you need to do is look at the actual number of dollars spent on "technology equipment" in the GDP. Dollar spending hardly changes, but "real spending" is rocketing up. Take a look at the price deflator for tech equipment, falling from 90% to 60% over the past few years, to realize how arbitrary these hedonic adjustments are and how devoid the adjustments are of any common sense. Looking forward, the good news is all the attention being paid to the rising cost of health care, but these costs may prove to be "embarrassing" in an election year. So much so, that the CPI is in the midst of a major "make-over" to include all those tremendous "hedonic improvements" in health care that granny is getting from her HMO. The government staticitans have entered the world of science fiction: "Please beam me up Scottie". Third, every time we pull into a gas station in the rain and have to swipe a credit card and pump our own gas, we remember the old days when a gas station attendant actually provided service, checked the oil, and cleaned the windshield free of charge! In my own business, travel reservations are made over the internet which is convenient but time consuming when researching flights. For other services, just try and get through to technical support (which is generally a fee-based service) or speak to a customer service rep; the whole day could be spent on hold waiting to speak to someone in Bangladore or Calcutta. Everywhere we look, the consumer is now providing a portion of the labor in order to receive normal services. Yes, this holds measured prices down but the downside is the loss of the purchaser's valuable time. The government masters of the CPI who welcome "hedonics" turn a "blind eye" to this significant cost phenomenon. Moreover, we spend an additional 30 minutes a day cleaning ìspam off of our computers. Not one minute of this lost time shows up as a cost and drain in productivity. Remember, "Only the good stuff counts." Do you honestly think the time you spend delayed in traffic, on a train, or on an airplane, would be calculated in the CPI? What about the extra hour we get to spend at the security gate at the airport? What does that do for your "productivity"? Isn't that a real material cost? Fourth, in order to guard against anyone actually seeing inflation, the Bureau of Labor Statistics, at the Federal Reserve's urging, wants to use an "Expenditure/Chain-Weighted Index." This price weighting idea works something like this: If you consume a very small amount of something and its price goes up a lot, it will affect the CPI very little because it has a very small "Weight in the Index". This, of course, is correct. What the Federal Reserve and the Bureau of Labor Statistics want to do next is insidious and should be criminal fraud - the Fed wants the Bureau of Labor Statistics to change the weights as the prices change. This is the way the Index will be constructed: As the cost of some items goes up and you can no longer afford to buy them, you are then forced to use that item less and find a less expensive alternative. Then, the weight of that expensive item goes down, but the weight of the less expensive item goes up, resulting in prices that have hardly changed at all! (George Orwell would simply love this!) Indeed, think about Granny in the kitchen: She used to buy steak and croissants but the price got so high that she now has to eat spam and dough balls fried in lard. Since she doesn't buy steak anymore and now eats spam and uses lard (items she never used to buy) her cost of living has gone down! (Grannyís weight for steak is now zero.) Obviously, Granny's standard of living went down when the price of steak went up. What matters in today's world is not Granny's standard of living, but her cost of living! Granny's costs need to be kept down and the way to do that is to keep her CPI down! If Granny receives $400 a month to live on, it is truly convenient to make sure her "cost of living" stays the same even if surviving on $400 a month means she freezes in the dark, cancels cable, and eats what her dog eats. Yet, she should feel good because the CPI tells her that costs haven"t gone up. The real miracle in America isn"t the productivity miracle; it"s the never rising Consumer Price Index. The Federal Reserve wants to run an easy money policy and keep interest rates down; the Treasury wants to short-change social security recipients and buyers of TIPS and I-Bonds. Fudging the CPI is the way to go; however, this strategy is intellectually dishonest, morally fraudulent and will remain quite effective until Americans start looking at their actual cost of living, or discover one day that what's good for Rover is good for them. - Richard Benson is president of Specialty Finance Group, LLC , offering diversified investment banking services. Copyright David W. Tice & Associates LLC 2003 http://www.prudentbear.com/archive_comm_article.asp?content_idx=31899