If you’re on Social Security and you’re looking forward to the biggest annual cost of living adjustment in decades, here’s the bad news.

The way the government calculates the ‘official’ inflation figures is probably going to cost you several hundred dollars. On average, about $340 per recipient.

That’s because the government reckons inflation is about two full percentage points lower than others might put it.

And the official inflation figure is what they use to calculate the annual COLAs.
“The first thing I’d emphasize is there is no attempt by BLS to “deliberately” undercount inflation,” an economist at the federal Bureau of Labor Statistics tells me. The issue, he says, comes down to “longstanding methodological procedures” for calculating inflation.

The problem?

The government thinks housing inflation is running at a mere 2.8% a year.
Meanwhile other estimates put it much higher. Actually, I don’t know anyone outside the Bureau of Labor Statistics who would look at the current nationwide housing mania and conclude housing costs were going up by 2.8% a year. I told a highly respected mainstream economist about the official 2.8% figure over the weekend and he burst out laughing.

The S&P/Case-Shiller national house price index is rising at 16% a year.

Realtor.com calculates that house price affordability has fallen 15% in a year, and says rents are rising around 8% annually. (Realtor.com shares a corporate parent, News Corp., with MarketWatch.)

It’s not quite so simple. The BLS points out, the CPI doesn’t measure house prices, per se, because we don’t buy a new house every year. It’s a cost of living index, not a cost of goods index.

And it tells me that even though rents for new leases may be rising quickly, that doesn’t mean average rents are rising at the same pace. That’s because most people aren’t moving.

There are, says the BLS, “new tenants with new rents,” “same tenants with new rents,” and “same tenants with same rents.” And the CPI figures are supposed to reflect changes in “average” rents across all three, not just new rents for new tenants, even if those are rising at 8% a year.

The problem is that even with this explanation, the figures rely on a lot of guessing. The main element of the house price index calculations rely on asking people what they think their house would rent for.

And housing is by far the biggest element of the inflation numbers. Fully one third of the official CPI calculations rely on these estimates for housing inflation.

So last week the government reported that overall inflation was running at 5.4%. But that relies on these modest housing estimates. If they’d used the 8% figure instead, the overall CPI would have come in a full 2 points higher.

On the average Social Security check, that would be worth about $340 a year.
If Social Security recipients feel hard done by, spare a thought for those who own so-called TIPS bonds, or Treasury inflation-protected securities. These are bonds issued by Uncle Sam where the annual interest is effectively adjusted to compensate you for inflation.

They used to be almost the perfect investment for retirees. But that was when they promised to pay inflation plus around 2% a year, which was in line with historic bond returns.

Today they promise to pay inflation minus one or 2 percentage points a year. You are guaranteed to lose purchasing power every year you hold them. And that would be the case even if the inflation adjustments really compensated you for rising prices.

If actual inflation is about 2 percentage points higher than the official figure, TIPS investors are losing even more each year than they had realized.

The term for this used to be a ‘certificates of confiscation.’ Now apparently it’s normal.

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