Poking holes in the inflation conspiracy theory

The academic research makes clear that the best hedge against unexpected inflation is Treasury Inflation Protection Securities (TIPS). Despite the evidence, many investors won’t invest in TIPS because they believe that the U.S. government is (or will) cheat by underreporting inflation. 

It’s the “fox in the hen house” argument -- the government determines the inflation adjustment that determines the total interest cost of the TIPS it issues. Thus, the theory goes, it has the incentive to cheat.

Among those warning investors is Peter Schiff, CEO and chief global strategist of Euro Pacific Capital. Schiff has persistently warned about expansionary monetary and fiscal policies producing hyperinflation. However, despite the concerns he warned against buying TIPS because, as he stated in a January 10, 2013 interview with CNBC, “The CPI [consumer price index] is a total fraud.” 

The conspiracy theory

There are a few problems with the conspiracy theory. 

First, intentionally understating inflation wouldn’t help the government because investors would quickly learn they're being cheated. Investors would begin to demand a higher rate on TIPS -- a premium to offset the cheating and the risk of even greater cheating. The result would be that they would then have higher costs for issuing TIPS, not lower.

Investors clearly aren't agreeing with the conspiracy theorists. If they were, we wouldn't have 10-year TIPS yielding less than 0.7 percent. And those 10-year TIPS are currently yielding about 2.1 percent less than the yield on nominal bonds. Thus, we see that investors not only don't buy into the conspiracy theory, they don’t agree with Schiff’s view that we’re going to see hyperinflation.  

The second problem is that the claim of fraud isn't supported by actual data. Fortunately, we now have data on prices being calculated independent of the government. The MIT Billion Prices Project is an academic initiative that uses prices collected from hundreds of online retailers around the world on a daily basis. It then uses the data to construct daily inflation indexes across countries and sectors, and it studies their ability to match official statistics. Thus, while it's not a perfect match for the consumer price index, which includes things such as services and rents that are generally not sold online, if inflation were much higher than reported, you’d expect to see a big divergence between the independent index and the CPI.  

The website shows the two sets of data for the period beginning July 2008. Thus, we now have five-and-a-half years of data. A quick look shows that the two data sets have been tracking very closely. As of November 2013, the total gap over the period isn’t much more than 1 percent, or about 0.2 percent a year. There doesn't seem to be evidence that the government is “cooking the books.”