Money Matters: A misleading inflation rate: Consumer Price Index

By William Dostman III

The Daily Record Newswire

The U.S. government provides a number of different inflation measures, but one of the more publicized ones is the Consumer Price Index, less food and energy. Also known as the core CPI, this index measures the price changes for a basket of consumer goods excluding the more volatile prices of food and energy.

Headline CPI includes all items in the index such as groceries, utilities, gasoline, vehicles, shelter and medical care, among others, and does not adjust for seasonality or food and energy. While the headline number includes more items, the core number has typically been regarded as a more valuable gauge of inflation because it removes the short-term price volatility of food and energy. However, when a short-term price increase in food and energy turns into a long-term trend, the core CPI number can become misleading.

The price inflation of food and energy has outpaced the other categories recently, as the Fed has maintained its loose monetary policy. Though the Fed points to these as transitory costs and discredits the value of the headline figure, the U.S. consumer is certainly noticing the price increases at the grocery store and gas station.

By focusing on the core number, the government is able to point to low inflation as it continues to pump liquidity into the system in an attempt to jump-start our economy. This loose monetary policy will catch up with us though, as the U.S. dollar has weakened and will likely remain weak for an extended period of time.

In the long run, this policy will essentially result in a tax on the lower and middle class. By ignoring the headline inflation figures, our weakened dollar will give rise to an increased cost of imported goods for our consumers and thus a lower standard of living.

While a weakened dollar will hurt our consumers, it can be beneficial to many large corporations. Businesses that generate a significant percentage of their revenues from overseas will experience an increase in earnings as their foreign sales are converted back into weakened U.S. dollars.

This monetary policy is being used not only to invigorate the U.S. economy but also to crawl out from a portion of the massive debt hanging over the country. The U.S. government is essentially inflating its way out of debt. In a sense, this can be considered a default on our debt, as we are not living up to our initial obligations. However, since we have the ability to control our currency, our "default" will not look nearly as bad as a traditional principal default.

Real figures, when referencing economics, are the initial figures adjusted for inflation. The U.S. will be able to default on its obligations by lowering the real value of their payments. Whether it is lower real Social Security payments or negative real yields on U.S. Treasuries, our government is managing to reduce its obligations without actually making payments.

For investors, the next question is: How do I manage my money given these circumstances? While everyone's situation is different and should be discussed with a qualified advisor, these inflationary trends tend to be positive for domestic equities, international equities and commodities. Conversely, cash and fixed income products tend to produce unsatisfactory returns in this type of negative real rate environment.


William Dostman III is senior domestic equity manager for Karpus Investment Management. He can be reached at (585) 586-4680.

Published: Thu, Apr 28, 2011