Many years ago I was involved in starting a business in Russia. This was just weeks after the collapse of communism and I was meeting with a Russian accountant who would be charged with the duty of keeping the company’s books. One of his first comments to me was: “What do you want the numbers to show?”

I asked what he meant and he explained that he could adjust or skew the numbers anyway I chose to reflect a profit or loss or to hide income or expenses. I was taken aback and explained that I wanted the numbers to reflect an accurate picture of the financial position of the company. He eventually agreed that he could do that, but his demeanor indicated that he felt I was quite naive.

I had a flashback to that incident this week when the U.S. Bureau of Labor Statistics released the latest inflation numbers. According to those numbers, on a seasonally adjusted basis (I’m not sure what than means), consumer prices rose just 0.2% in April. This reportedly included a 1.6% decline in petroleum based energy and a 0.9% rise in the food index.

I find this somewhat ludicrous because I go to the grocery store and to the gas station on a regular basis. I pay bills for electricity and for natural gas. In fact, the combination of energy and food costs is the second only to my mortgage as a percentage of my household income. And over the past several months, my perception is that costs for food and energy have increased dramatically. Certainly I have not seen the effect of any decrease in petroleum based energy costs.

It is difficult for ordinary consumers to dispute the government’s numbers on prices because most of us do not maintain an index of specific items that we update on a regular basis. So we are forced to merely roll our eyes and snicker when the government informs us that inflation remains in the low single digits and really poses no threat to the economy.

By the way, if you want to amuse yourself by trying to figure out how the government tracks inflation, here is a link to the official web site: http://www.bls.gov/home.htm

As I indicated last week, there are a number of ways the government can benefit by manipulating actual inflation and inflation numbers. For example, Social Security and other programs have built-in cost of living increases that are tied to inflation numbers. Keeping these numbers as low as possible avoids cost increases for programs that are struggling to remain solvent.

On the other hand, when inflation is high, consumers are motivated to spend rather than to save. It does not take them long to learn that as the buying power of their currency decreases, it is to their advantage to purchase desired items as soon as possible to avoid price increases. Consumer spending is the primary engine for the U.S. economy so this buying pattern helps keep the economy churning.

At some point inflation might increase to a level where its existence can no longer be denied or explained away. That isn’t necessarily a worst-case scenario for the government either. For example, many economists and analysts are concerned about the high amount of government debt and financial obligations.

To put this in perspective, let’s imagine that you as an individual are in a similar situation. You have debts that exceed your available financial resources. One option is that you can declare bankruptcy and avoid fulfilling your obligations. Naturally you would prefer to avoid that option. What if you had a printer in your home that printed perfect U.S. currency and there were no penalty if you used it? You could wipe out all of your financial obligations in a very short time.

Guess what? The government has those printing presses and they can run them day and night if needed. In a short time the government can print enough money to pay off all of the U.S. debt. You might think that the government would never do such a thing because it would devalue the U.S. dollar and destabilize the world economy. In reality, it has been done many times by many countries, including superpower Russia in the early 1990s.

The U.S. dollar has already been seriously devalued in the past few years. That is not totally bad. A devalued dollar means that U.S. products become much more attractive in foreign markets. At a low enough level, manufacturing would shift back to the United States and the trade deficit would become a trade surplus. U.S. automakers would love it if all the people in the world who want them could suddenly afford U.S. cars.

I am not implying that allowing runaway inflation is something our government is planning or prepared to do. I just want you to understand that it would not be the first time such a thing has happened and it would not necessarily result in a total collapse of the world’s economic system. It would certainly be uncomfortable, but it could also provide quick solutions to some sticky problems.

For now, Wall Street recognizes that the government is playing games with inflation numbers. Until that situation is resolved, it will be difficult for the stock markets to resume a long-term upward trend.
F.S.

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