The View From 1776

Stealth Inflation

Does the federal government deliberately under-report inflation, as measured by the core CPI, the Fed’s favorite, in order to facilitate monetizing the federal debt?

This website is not in the business of giving investment advice and does not necessarily endorse the investment recommendations in Richard Lehmann’s column, appearing in Forbes Magazine dated April 25, 2011.

With respect to inflation, however, what Mr. Lehmann has to say is of considerable interest.


The Federal Reserve says that inflation is well under control, telling us not to believe our lying eyes, which show us prices heading skyward. This downplaying of the increase in the cost of living is necessary to justify keeping short-term interest rates artificially low at the cost of savers. Don’t forget that the CPI is used in all government indexed expenses like Social Security, government wages and inflation-indexed securities.

The CPI includes a wide variety of components, 42% of them housing-related. When you take out food and energy, the housing component becomes 51% of the core CPI total. Since housing has been in decline for years and appears to be caught in a funk, it will continue to offset cost increases in all other components to produce a lower CPI. This would be fair, except I doubt many people spend 51% of their income on housing.

Adding to the understatement of inflation are so-called hedonic adjustments made to reflect the higher quality and functionality of goods today. New York Fed President William Dudley invoked the hedonic adjustment last month, offering up Apple ( AAPL - news - people )‘s iPad 2 as an example. It costs the same as the original iPad, but it does more, he told a working-class crowd in Queens, N.Y. Someone’s retort: “I can’t eat an iPad!”

Manipulating the CPI is a game government plays to help solve its fiscal problems through increased inflation. It is a tax on wealth and can be imposed without public debate or a legislative vote. While inflation is beneficial to government in the short term, its long-term effects are always negative. Hence, it must be done in secret—call it stealthflation. What this means for fixed-income investors is that long-term interest rates are going higher, as they have since last August.