WHAT IF, MR. BERNANKE?

What if Fed chairman Ben Bernanke and the other Fed board members actually believe that the Consumer Price Index means the same thing as it did in the 1970s?

The Bureau of Labor Statistics (an agency of the Labor Dept.) calculates the CPI, not the Federal Reserve. If the Fed Governors are unaware of the changes since then in how it is calculated, it would explain why they aren't in a panic over the current real consumer inflation rate.  It would explain why they really seem to be certain that we are not in a recession. 

It would also mean that unless they wake up from their time warp, the dollar and our economy are truly doomed.

The CPI in the mid 1970s was still calculated as it had always been: add up the prices of a "typical" consumer's market basket, and divide that figure by the price of the same basket of products in the starting year, multiply by 100, and you have the CPI.

But lots of changes have been made since then. A few years ago the Wall Street Journal did an exposé of "quality adjustments," whereby the prices of products are reduced for CPI calculations if their quality increases. 

The article showed how arbitrary and capricious these adjustments are.  For example, if a $1,000 computer now runs at 3 GHz compared to a $1,000 1.5 GHz machine sold in the base year, the price of this year's machine might be adjusted to $500.  Yet unless you are doing video editing or rendering, you won't be able to do twice as much work in a day, and you will still be $1,000 out of pocket.

Another example:  all those government mandated auto safety and emission controls are considered "quality improvements," even if few customers would be willing to pay what they cost if the government allowed them a choice.

Let's take a specific case. 

Ever wonder why diesel fuel costs more than regular gas now, when it used to be cheaper?  It's because Congress mandated that all diesel fuel now must be "low-sulfur," requiring refineries to install extremely expensive de-sulfurization equipment – or stop making diesel, which many refineries did.

So there's less diesel being refined, and it's more expensive to produce, thus it now costs much more.  Yet the BLS calls all this a "quality adjustment" and diesel fuel inflation magically disappears from the CPI.  And wait, there's more!

Diesel engines operate at higher pressures than gasoline engines.  Organic sulfur compounds are quite effective extreme pressure lubricants.  Without them, you have to add expensive additives to every tankful or else critical engine parts like the injection pump wear out and have to be replaced much earlier than normal.

Every trucker knows that diesel fuel, new diesel engines and diesel engine parts, plus maintenance are far more costly because of these government regulations, but "quality adjustments" allows the CPI to pretend they aren't.

"Substitutability" is another great CPI fudge factor.  If sirloin becomes more expensive, customers can substitute chuck steak, and if that becomes more expensive, they can substitute hamburger, and if that becomes more expensive, they can substitute chicken, and…

Then there is the "core CPI" fraud, as it doesn't include the more rapidly increasing food and energy prices.  Delete these and you somehow get a more valid measure of inflation.  Perhaps the Fed board members don't shop for their own groceries and gasoline.

GDP is said to have risen at a 1% annual rate in the first quarter of 2008.  GDP, as stated, is corrected for inflation.  But what if the CPI has been adjusted down even 3% below its true figure?  If so, we have been in an inflationary recession for quite some time.

How much has the CPI definition changed since the 1970s?  Actually, the current CPI is calculated to be about 3½% less than the pre-Clinton figures and roughly 7% less than by using the methods of the pre-Carter days .

A very useful website to consult for accurate, non-government-fudged data is shadowstats.  Take a look at their chart (scroll to second from bottom) which tracks, from 1980 to May 2008, the government's CPI compared to a CPI using 1980 methodology.

Or check out their stats showing that the real US deficit as calculated by generally accepted accounting principles for 2006 was $4.6 trillion, rather than the government-claimed deficit of $248 billion.

Then go to the BLS website and look at the PPI – the Producer Price Index – for a real eye-opener.  The PPI can't be manipulated like the CPI.  OFHC Copper, for example, is what it is – you can't substitute aluminum because it's cheaper.  To the best I know, the PPI stats remain valid – and they are truly alarming.  Especially when you realize the numbers aren't for one year, but for one month (May 2008).

Although Bernanke is a Keynesian, he is not a complete moron.  If he believes that the BLS's CPI figures mean the same thing that they did during the Nixon/Ford/earlyCarter years, it is easy to understand his lack of concern about inflation.  And if that is really the case, he needs an ear-splitting wake-up call.

TTP'er "Skye"is an MIT-educated scientist and entrepreneur who has been studying economics for forty years.