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Inflation: The Big Lie
by David Stanowski
26 July 2007

One of the things that you repeatedly learn, when trying to analyze the markets, and the economy, is that you MUST have accurate units of measurement, or the task becomes even more difficult and complex! This has never been more true, than over the past 30 years, as inflation has introduced more and more distortion into the picture!

Inflation occurs when money is created, out of thin air, without something of real value (e.g. gold) backing it. When money is created, in this way, the value of each unit of that money becomes worth less than it was. When each unit of money is worth less, it takes more of it to buy things, which results in a period of generally rising prices. Money can be created by printing paper money, minting coins, and by extending credit to borrowers.

By itself, rising prices, of specific items or services, do not prove the existence of inflation, because prices also rise due to increasing demand and/or decreasing supply.

In the modern financial system, money is created every day, so inflation is ALWAYS increasing, unless it is offset by losses in the financial system. The most widely used measure of inflation is the government-created Consumer Price Index (CPI). Like nearly all government-created economic indicators, the CPI is largely fictional! It was never devised to provide an accurate measurement of inflation. On the contrary, the government manipulates their indicators to make the economy appear to be doing much better than it really is. Distorting the CPI also allows the government to under pay entitlements, like Social Security, whose cost-of-living increases are based on this index.

Studying the formulation for the CPI, reveals a variety of insidious ways that are used to greatly understate inflation. Every administration since WWII has manipulated these economic indicators to their advantage, but the CPI was modified so drastically, by the Clinton administration, that some financial analysts now compute the Pre-Clinton CPI and Post-Clinton CPI. This, and other changes to the government's economic indicators, allowed the Clinton administration to grossly overstate the performance of the economy, during those years!

Unfortunately, after the government releases its data, most reporters merely repeat it without any investigation as to its accuracy. After that, most people working in the financial industries add their positive spin, to this dubious data, and you get a pretty uniform chorus of voices telling you that things are much better than you perceive them to be! The only dissenting comments come from those who want to use economic problems to damage their political opponents, and a few independent financial analysts, looking for the truth.
CPI Pre-Clinton versus Post-Clinton

Since the Post-Clinton CPI is still the "official CPI", this allows the Bush administration to claim that inflation, during the last four or five years, has generally been running at the "very moderate pace" of 1.5 to 3.0%, even as the Pre-Clinton CPI shows that inflation has been at least twice that high!! Of course, even the Pre-Clinton CPI understates the true level of inflation. This is why most people instinctively feel that they are paying far more than an additional 1.5 to 3.0%, for things, than they did last year. THEY ARE!

Fortunately, there are a handful of independent analysts who are doing a much more accurate job, than the government, of estimating the true rate of inflation. Shadow Government Statistics has a good tutorial on the deception in government statistics, and you can see by this graph that their calulations show that the current inflation rate is actually over 10%!!

CPI SGS versus Post-Clinton
Note how much these series diverge since the changes in the CPI by the Clinton administration in the 1990's.

One of the government's economic indicators that has always been considered more accurate than many others is M3; the broadest measure of money supply. By watching the growth of M3, we could get a sense of how much the government was understating the rate of inflation in the CPI.


The green line represents M3 in dollars, and the blue line is the year-over-year rate of change of M3.

The rate of growth of M3 collapsed from 1982 to 1993, which created the George H.W. Bush recession, and cost him reelection. When the FED wanted to halt this slide, they hit the accelerator, and pumped up M3 to an annual growth rate of 13%. This helped to fuel the stock market mania of the late 1990's. As it was topping in 2000, the FED hit the brakes, and the stock market bubble collapsed into 2002. Fearing a complete financial meltdown, the FED started expanding M3 again, which fueled the real estate bubble of 2002-2005, and the current leg up in the stock market.

In early 2006, fearing a negative reaction by the financial markets, when M3 growth reached disturbing levels again, the Bush Administration simply stopped publishing this statistic!!

Once again, independent financial analysts have been gathering the data used construct M3, and have rebuilt it to maintain the history of this indicator. This has allowed us to continue to plot M3, even after the government stopped reporting it. From their work 
(in the graph above), we can see that, after reporting stopped on this indicator, M3 growth has climbed from the 6% range to 14%! This means that the purchasing power of the dollar has been collapsing during this period!

Now, all of these charts and graphs may seem pretty theoretical, and academic until you boil them down into the essence of what they mean to you in your day-to-day life. If you are living in a time when inflation is increasing at a rate of 10% per year, and you got a 2% raise, last year; you just lost 8% of your purchasing power, over the last 12 months! That means that in order to stay even, you need to cut your spending by 8%!

In a world where everyone knew that inflation was actually running at a 10% annual rate, and they had the self-discipline to restrain their spending by the amount that they lost in purchasing power (8% in this example); such restraint would help contain inflationary pressures. But, we don't live in that world! In our world, the government tells us that the economy is booming, and the Dow Jones just hit a new high; so times are good. We are also a people who do not want to accept any reduction in our standard of living/consuming. 
Therefore, we don't cut our spending.

When faced with the plague of inflation, we spend all that we earn, then we spend our savings (which are now gone), then we borrow as much as we can, and finally we speculate in the markets, with our borrowed money! We change our behavior in these ways in an effort to maintain and, even increase our standard of living. Of course, all of this borrowing just helps to increase inflation.

Savings Rate

Consumer Debt

The only thing that has kept this house of cards from collapsing is the miracle of increased productivity from technology. The advances we have made in technology have actually reduced the prices of many manufactured goods, even in these inflationary times. Notice, in the graph below, how televisions, which are almost purely a product of free market forces, have dropped in price by 75% (in relative terms, from 1978 to 2004), while the two markets that have the most government regulation and interference; medical care and college fees, have risen 400% and 700% respectively!!

If the government doesn't get you by inflating away the value of your money, they kill you with higher costs through regulation!

CPI 1978 to 2004

When you put all these pieces together to determine how the economy is really doing, as measured by the Gross Domestic Product, this is what you see:


Notice how the high growth era of the 1980's declined (along with M3 growth) into a negative GDP, by 1991. From there, the "boom" of the 1990's produced historically mediocre official growth rates of 2-4%, while the real GDP figures, from SGS (which remove inflation), reveal that the "Best Economy Ever", during the 1990's, was creeping along at a real growth rate of about 1%! 

After the plunge, from the stock market top in 2000, real GDP bottomed at -3% in 2001, and has only poked above 0% for one quarter since then! In short, the real GDP clearly demonstrates that the economy was mediocre in the 1990's, and it has gotten worse since then! Since 2000, real GDP growth has been NEGATIVE except for one quarter, which means that the economy has been surviving on credit, and the inflation it creates! Hopefully, this article demonstates that it is not wise to automatically believe what you hear about the economy, in the mainstream media, without checking with trusted independent sources!

Unfortunately, future erosion in the purchasing power of the dollar is virtually guaranteed! When the Federal Reserve Bank was created, in 1913, it took control of the currency, and the role of the central bank. Its charter was to end banking panics, stock market crashes, and maintain the value of the dollar.

Since then, there have been some bank failures, and we've had major bear markets in stocks in 1929, 1973, and 2000. However, the FED's true malfeasance has been in engineering the loss of 95% of the purchasing power of the dollar! This was not done by mistake, but by political design, for reasons that are too numerous to detail in this short article.

Put simply, it now takes $105,000 to buy what $5,000 buy would in 1913. That's serious inflation!   

This chart shows the 95% decline in the value of the dollar, from 1913 to 2006, as measured using the government's official CPI, which always understates the actual amount of inflation.

For more information on the U.S. Economy:


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