By Ron Robins

This editorial is part of a series Mr. Robins* is writing on the ethics, and sometimes extraordinary biases he believes he has found behind the design and presentation of many government statistics. His view is that investors need to know much more about what is in these statistics in order to optimize their returns. His research reveals many surprises. For additional articles in this series, see Editorials.

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Media relentlessly publish the latest government statistics, and markets react to them, sometimes violently. Often your paycheque, government support payments and investment income are significantly influenced by them. But are they valid?

Some astute economists and statisticians conclude there is obfuscation of these statistics, and subsequent misrepresentation of them in the media – who usually have neither the time nor expertise to examine them. Take the US ‘consumer price index′ or CPI. These authoritative observers note that the current US CPI incorporates numerous and continuous changes in components and weightings of components within the index, rendering it a mostly theoretical exercise based on highly questionable hypotheses.

According to John Williams (a private New Jersey consulting economist who has specialized in government statistics for several decades), the “Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that.” (The old system, Mr. Williams says, existed prior to the Clinton Administration.)

On his website at http://www.shadowstats.com/cgi-bin/sgs/article/id=343, Mr. Williams states that, “Inflation, as reported by the [US] Consumer Price Index (CPI) is understated by roughly 2.7% per year… due to recent redefinitions of the series as well as to flawed methodologies, particularly adjustments to price measures for quality changes.”

Mr. Williams discusses how the government statisticians include a concept called ‘hedonics′ to adjust values in the index. He states, “Hedonics adjusts the prices of goods for the increased pleasure the consumer derives from them. That new washing machine you bought did not cost you 20% more than it would have cost you last year, because you got an offsetting 20% increase in the pleasure you derive from pushing its new electronic control buttons instead of turning that old noisy dial, according to the BLS [US Bureau of Labor Statistics].”

Williams continues, “When gasoline rises 10 cents per gallon because of a federally mandated gasoline additive, the increased gasoline cost does not contribute to inflation. Instead, the 10 cents is eliminated from the CPI because of the offsetting hedonic thrills the consumer gets from breathing cleaner air. The same principle applies to federally mandated safety features in automobiles. I have not attempted to quantify the effects of questionable quality adjustments to the CPI, but they are substantial.”

The way US housing costs are included is another oddity, keeping that component — at 32% of the CPI — low. Despite two-thirds of the US population living in their own homes, the statisticians use theorized ‘imputed′ home rents as the basis for the housing statistic! Of course rents have been virtually stagnant for years — even going down in many cities due to overbuilding — while home purchase prices, insurance and local taxes, etc., have been going through the roof!

For those Americans dependent on CPI adjustments to their welfare, social security or other government payments, they have had their payments massively depressed. Williams says that US government welfare and social security payments are now 70% lower than what they would have been had the old 1970s style CPI been used with its fixed basket of goods.

Another astute statistician, Jim Willie, elaborates further on this point. In Domino Distortions from Inflation, an article on his website at http://www.goldenjackass.com/jwarticles.html, he comments, “In my view, the [US] CPI has become little more than a measure intended to exploit the trend of falling imported finished product prices, in order to keep cost of living raises down in US Government pensions of various types…The CPI is kept low by ignoring numerous rising prices, such as property taxes, town usage fees (water, sewer, sanitation), professional services (doctor, dental, lawyer), home services (carpentry, plumbing, electrical, roofing), college tuition, restaurant meals, sports club fees, and more.”

The US CPI affects not only Americans, but consumers and investors everywhere. US domestic and global interest rates, bond yields, and returns from many other investments — all are significantly influenced by it.

It is worth remembering that the BLS is headed by a political appointee, who just may have certain biases towards statistical methodologies that most please the government — as well as to what gets out to the media.

Reviewing the December 2007 charts on Mr. Williams′ website, we can easily see the startling differences in outcomes with the varying CPI methodologies used over the past thirty years. Using the CPI methodology as it was in 1980 shows inflation today rising +12% year-over-year; employing the CPI methodology as of 1990 shows inflation higher now by +7.5%. However, today’s BLS press release has their CPI-U (urban dwellers) gaining just +4.3% over the past year!

I believe the current US government reported CPI is constructed to play down inflation. This helps to keep interest rates artificially low, as well as to lessen social security and other related government payouts that are indexed to the CPI. Frankly, it is unfair, misleading, and simply unethical.

* Ron Robins, MBA, is founder, Investing for the Soul, (http://investingforthesoul.com/), Huntsville, Canada. He advocates, writes and teaches on the subject of ethical investing. This is his first article in an editorial series on Unethical Statistics. They concern the ethics surrounding the construction and portrayal of US government statistics. The articles are posted on his website and in other publications. To contact him, e-mail to Ron Robins or call 705-635-3034.

Updated and revised, December 14, 2007

© Ron Robins, 2006-2007