The US inflation rate rose by 0.6% in May — the highest monthly increase since last November.

The core inflation rate, however, which excludes volatile food and energy prices, only rose 0.2%, easing fears that rising commodity prices would feed into more widespread inflation

But can the government’s inflation data be trusted? John Brown in The Daily Reckoning doesn’t think so…

Perhaps, the greatest area of concern about statistical manipulation is the measurement of inflation, or Consumer Price Index (CPI). By manipulating this single statistic the government can miraculously transform rising prices into economic growth.

The Department of Labor has set so-called “core” inflation, excluding food and energy, at 2.2%. Even “headline” inflation, including food and energy, is published officially at only some 4%. The problem is that these figures bear very little relation to the reality of price increases experienced on Main Street, which some estimate to be in excess of 10%.

Statisticians assign different weights to the elements comprising the CPI that are often not reflective of the spending habits of ordinary citizens. For example, housing maintenance (including heating oil), a major expenditure, is given only a small part in the Index’s makeup. In addition, the re-pricing of items such as automobiles to allow for added “hedonistic” features such as enhanced “value for money” is wide open to varying judgments. How these statistical decisions are made is really anyone’s guess. But it is absurd to assume that the government’s overwhelming interest in reporting low inflation does not influence the final numbers.

The financial consequences for investors can be severe. For example, the Dow Jones Industrial Average Index, against which many investment returns are measured, closed at a nominal high of 14,093 on Oct. 12, 2007. The media reported it as a sign of good things to come. On May 23, 2008, the Dow closed at 12,480 – off a bit, but apparently not too bad. But if that day’s close is adjusted for the official CPI, then it’s not worth 12,480, but only 9,856 when compared with its previous market cycle high, of 11,723, in the year 2000.

Worse still, if adjusted for the more likely but still conservative inflation rate of 8%, the recent close of 12,480 becomes the equivalent of only 6,742 in the year 2000. What looks like a nominal gain of some 757 points or 6.4% is, in fact, a real loss of 4,981 points or some 42% over those eight years!