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The CPI and Inflation Hedges

Chris Farrell Jul 7, 2008

Question: I’m interested in I-bonds and TIPS, but I don’t trust our government to honestly calculate our rate of inflation (much as it uses a measure of unemployment that is highly unrealistic—if we used the French measure, our rate would look like France’s). Are there any First World nations whose equivalents of the CPI are more to be trusted?

But maybe inflation-protected instruments only come into their own when the inflation rate is so high that missing a few percentage points won’t matter too much, compared with having no hedge at all.

A similarly paranoid question: Why should I trust the government’s promise not to tax Roth IRA or 401(k) earnings when they’re cashed in? We’ve allowed tremendous mismanagement of our spending, taxation, and the national credibility that backs our currency, and I think the bill is already coming due. In twenty or thirty years, Roth-backed wealth may be too tempting a target for Congress to ignore. If it were an instrument popular among the rich, I’d think it safer, but by necessity they don’t use Roth accounts that much. Michael. Boston, MA

Answer: By definition, the Consumer Price index (CPI) falls short at measuring changes in the overall price level. It only reflects price changes of a representative basket of goods. There are a some assumptions about housing that are quirky at best, and prices are difficult to measure in certain parts of the economy, like medical services. Our personal inflation rate and the CPI can diverge significantly.

In Bad Money, a new book by political analyst and author Kevin Phillips, he traces the current “global crisis of American capitalism” to the politics of peak oil, the rise of financial mercantilism, the triumph of market fundamentalism, and even the spread of religious conservatism. He devotes a lot of space arguing inflation is higher than we know and that the government has deliberately changed the CPI calculation in ways that keep the figure artificially low. It’s basically bunk. Put it this way: Investors from the around the world have their capital at risk, and if the CPI we manipulated in such a way, the markets would see through the ploy and drive up interest rates. The message of the market seems to be that over time the CPI offers a reasonable measure for gauging inflation pressures and rates.

Treasury Inflation-Indexed securities and I-bonds are both good hedges against inflation ravaging the value of your fixed income portfolio. Both are good insurance policies against a depreciating dollar.

As for your second question, the safest forecast in politics and economics is that Congress and the White House will tinker with the tax code. Both John McCain and Barack Obama are proposing major tax initiatives.

That said, there is so much money tied up in both Roth-IRAs, 401(k)s, 403(b)s and the like that Washington will tread carefully-very carefully. My guess is if there are any major rule change involved retirement savings and taxes that it will be on the liberalizing side of the fiscal equation. Society is aging, after all.

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