M3 is the inconvenient truth that the Labor Department no longer reports. It is the fullest measure of the U.S. money supply… and it is going up three-four times faster than GDP itself.

Mr. Bernanke assures us inflation is under control. Excluding food and energy, he says, the cost of living isn’t going up too much.

We will get to that in a second. But in an effort to thwart our ever-declining purchasing power, thanks to the prodigal magic of fiat money, your editors here at the Penny Sleuth have tried to wean our nasty addiction to food and energy.

It’s harder than one may think.

So we’re a little concerned that monetary officials keep dismissing the “food and energy” effect.

We certainly understand their motivation.

Our friends at the Cleveland Fed just reported that energy prices have risen at an average annualized monthly rate of roughly 30% during the first four months of the year and soared nearly 90% in May.

To make matters worse, the World Food Program reports that purchasing costs have risen roughly 50% in the last five years. Corn prices alone have jumped 120% in the last six months…

But the Fed assures us there’s nothing to fear. The CPI excluding food and energy was up a modest 1.8% (annualized) in May, and the median CPI fell to 1%, its slowest monthly growth rate in over four years.

That’s reason to cheer, right?

We’re not so sure.

If the CPI (consumer price index) were measured by the same standards used in the 1970s, today’s inflation rate would soar well above the 2.69% stated rate.

How can this happen?

Well, for one, the Bureau of Labor Statistics (BLS) has significantly modified the way we calculate the number. Take a look at this one adjustment.

In 1983, the BLS dramatically changed the way we account for rising house prices, a figure that makes up 28.4% of the CPI. It no longer measures the actual price change of the tangible asset itself (in this case, the house). Instead, it measures rising house prices through a method called “owners’ equivalent rent.”

According to the BLS, “Rental equivalence measures the change in the implicit rent, which is the amount a homeowner would pay to rent, or would earn from renting, his or her home in a competitive market.”

Well, it doesn’t take a Ph.D. to notice that six years of extremely low interest rates have prompted most Americans to buy, instead of rent. Consequently, the demand for rentals has dropped significantly. So when demand for rental properties drops, so does the price a homeowner could earn from renting.

We believe this approach dramatically understates housing price inflation.

So when you exclude energy, food and housing, Mr. Bernanke may have a point: The cost of living isn’t going up too much.

But our cynicism toward American monetary policy over the past 100 years isn’t directed toward Mr. Bernanke himself. In fact, we commend his concerted effort to address inflation. We know Mr. Bernanke didn’t get us here.

The bankers and big government spenders before him brought us to this point. They’re the Keynesian disciples who sat back, spent and soaked up the champagne. Unfortunately for Big Ben, he’s stuck nursing the hangover.

Let’s be sure of one thing… Your editors believe all prosperity begins and ends with a sound money system. History has proven this fact time and time again.

American lawyer, lecturer and author Rene A. Wormser once wrote: “No government can operate with a monetary system consisting only of fiat money without sustaining gross economic turmoil and eventually facing a tragic day of reckoning. A fiat money system prompts legislative profligacy and inevitably produces inflation.”

He has a point. Deficit financing and government intervention have taken their toll. A 1940 dollar is worth only roughly 5 cents today.

Meanwhile, for the second consecutive month, China has been a net seller of U.S. securities. If this move proves to be more than a passing trend, this could put further pressure on the downward slide of the U.S. dollar.

China sold a net $6.6 billion of U.S. securities in May, following net sales of $5.8 billion in April. The last time China sold U.S. securities for two consecutive months was in January and February 2004.

This may have a lot to do with the major slide in the U.S. dollar in recent weeks.

Eventually, the consequence of eternal credit expansion will rear its ugly head. Maybe not today… maybe not tomorrow, but someday the gentle breeze of a butterfly’s wings will shake the thin-veiled foundations on which this fragile house of cards auspiciously rests.

The question is… Will you be the one left holding the mighty greenback?

Until next time,
Christopher Hancock
July 27, 2007

P.S.: I’ve been researching this very thing for years. Unfortunately, most people think that there’s nothing they can do to protect themselves, short of storing bricks of gold in their house. But I’ve found many other more sensible ways to protect you from this inevitable crash.

P.P.S.: My colleague and fellow Penny Sleuth editor Greg Guenthner has recently opened a new investment service he calls Bulletin Board Elite. This service covers some of the most lucrative companies in the world. In fact, all of his current picks are up right now.

Downfall of the Food and Energy Industries was originally featured in the Penny Sleuth.