Inflation is tame, we are told, over and over. It is under control. And it has been since the advent of the easy money, low-interest-rate policy championed by Alan Greenspan and the Federal Reserve since 1995. In fact, they say, between 1995 and 2003 the Consumer Price Index (CPI) rose only about 1% per year.

As anyone who lives in the real world already suspects, this may not be the whole truth and nothing but the truth. As evidence, consider that the money supply grew by about 8% a year between 1995 and 2003, which means it roughly doubled. Yet the amount of goods and services in circulation increased by only 3% per year, thus implying a 5% inflation rate due to the flood of new money alone. You simply can't expand your money supply without a corresponding growth in goods and services, and expect prices not to go up. This is Economics 101. More money chasing fewer goods = inflation.

Inflation there was, of course. First in the stock market. Then in the real estate market. As well as in the cost of energy, insurance, health care, education, and many other areas the government conveniently omits when measuring the CPI. The so-called "core CPI" leaves out food, too. Thus, those who don't eat, drive, get sick, send their kids to college, or try to buy a home--made out just fine.

The rest of us got stiffed, just as we have been since 1913, when the Federal Reserve--a private banking consortium that is neither federal, nor possessed of any "reserves"--was created. Since the inception of the Fed, the U.S. dollar has lost 97% of its value... and it's only going to get worse from here.

The fact of the matter is that the Fed would be happy with the "modest" 5% inflation rate noted above, especially if it were spread uniformly across the economy. But even if that were the case, here's what would happen: In 10 years, you'd lose 40% of your buying power. By the end of your working life, say 45 years, the toll would be 90%. You'd be retiring on saved dollars that were worth 10 cents, and that's not counting taxes you paid. Good luck.

Now, the cost of some goods has gone down, sure enough. This has been largely due to outsourcing manufacturing (think China) and improvements in distribution efficiency (think Wal-Mart). But many of the "real" savings here are questionable, when you consider that a lot of the junk we're forced to accept has no durability. If you have to replace it twice as often, it isn't really cheaper.

There's more. In October, PIMCO's Bill Gross--widely considered the country's leading expert on the bond market--published an investment outlook called "Haute Con Job." In it, he savaged the Fed and the government for the way in which inflation is computed.

His article rattled the markets and generated a firestorm of protest from many defenders of the status quo, such as the Fed's William Poole and John Berry of, but the response from many others was, "It's about time."

All Gross pointed out was that, in order to make inflation look insignificant, the government massages the CPI (i.e., cooks the books) in a couple of self-serving ways. They're called hedonics and substitution.

Hedonics refers to adjusting prices to compensate for quality improvements, a practice which began with computers. For example, if you pay $1,000 for a computer this year that has twice the power of last year's $1,000 device then, according to the government, the price of computers has been cut in half. Such adjustment in computers alone resulted in a downward revision of the CPI of 20% between 1997 and 2003, according to Dr. David Evans of Citigold. Hedonics worked so well with computers that it is currently applied to a broad spectrum of durable goods, including DVDs, video cameras, refrigerators and, believe it or not, college textbooks.

With substitution the government assumes that a consumer will substitute a lower-cost item for a more expensive one. The price of a Cadillac gets out of reach, so you buy a Chevy instead. The cost of transportation has gone down and so, magically, has the CPI; never mind that both Cadillacs and Chevies cost more than they did a year ago.

We could joke about this kind of nonsense if its effects were not so severe. Holders of fixed income investments like bonds suffer, of course. But those who live on Social Security and private pensions that are indexed to the CPI really get creamed.

The truth about inflation will get out, especially as a growing senior citizen population begins to wise up to this political con job and exercises its electoral clout. In the meantime, our counsel is the same as always: If you have the means, be sure to diversify into precious metals which have historically provided a measure of protection against inflation.

(Of course, as you can see from the advertisement just below, Casey Research, LLC., publishers of WWNK also publishes
newsletters covering opportunities in precious metals shares and so we are admittedly biased. Even so, you can count on us to only recommend investments we are sincerely convinced will offer the opportunity for a 100% return or better in the coming 12 months.)

Posted 11-22-2004 12:38 AM by Doug Casey