That means the CPI has been less than the COLA. So far so good.

But what if inflation is higher? It’s unlikely that 1970s-style double-digit inflation could return. But even an increase in inflation to 4 percent a year, for example, could rapidly erode pension values.

The possibility is real because Janet Yellen, currently the vice chairwoman of the Federal Reserve Board, long has advocated more inflation. She is a prime candidate to replace outgoing Ben Bernanke as the Fed chairwoman.

“Progress on reducing unemployment should take center stage … even if maintaining that progress might result in inflation slightly and temporarily exceeding 2 percent,” Yellen told a meeting sponsored by the Society of American Business Writers and Editors, as reported by Reuters.

However, similar “temporary” inflation policies were pursued by the Fed in the 1970s, but then things got out of hand and inflation rose much higher than expected.

CalPERS pensions could be cut in half in just 11 years

CalPERS’ set COLA of 2 percent a year is 1 percentage point less than the 3 percent historical inflation rate. A 1 percent per year erosion of pension payments over 20 years is a 20 percent reduction in benefits.  On a compounded basis, the reduction in pension payments would be even greater.

A looming increase in money inflation from the “tapering” of “quantitative easing” by the U.S. Federal Reserve, even if Yellen does not become chairwoman, is likely to result in CalPERS pensions eroding.

If inflation jumps to a compounded 9 percent, a CalPERS pension could be cut in half in as little as 11 years, as shown in the table below.  At a 9 percent inflation rate, pension benefits would erode by 74 percent over 20 years.

Inflation Averaged 8.75 Percent from 1973 to 1982

Inflation has averaged only 1.46 percent since the Mortgage Meltdown and Bank Crisis of 2008.  But inflation averaged 8.75 percent per year from 1973 to 1982.  The crisis led to President Gerald Ford’s Whip Inflation Now campaign, where he passed out “WIN” buttons. But it didn’t work. Only the tight money policies of Federal Reserve Board Chairman Paul Volcker finally crushed inflation in the early 1980s.

That is, Volcker applied the opposite policy to what the Federal Reserve Board currently is using, and which could accelerate if Yellen becomes its chairwoman.

Inflation is a double-edge sword. Fiscal conservatives have historically opposed inflation as a policy because they see it as a hidden tax. But high inflation may be the only way to bring California’s public pension system into line with reality.

If that happens, even as pension payouts increase in monetary amounts, inflation stealthily would reduce the actual value of the dollars sent to the retirees’ bank accounts.

CalPERS’ retirees, as well as employees paying into the system, then would have to lobby the Legislature for increased payouts. But if inflation occurs, it also would be squeezing other state budget items.

By Wayne Lusvardi

In 15th century Italy, the Medici Bank issued two sets of currency: gold Florins for exclusive use by the wealthy and silver Piccioli only for use by the poor.  Since it was forbidden to break down Florins into smaller coins that might be used by the poor, bankers had to invent a purely fictional accounting currency so that wholesale prices could be calculated.  Thus, the Lira a Fiorino, Denari, and Soldi were invented even though no such coins actually existed.

Unlike medieval Italy, the state of California does not have its own currency, but uses the U.S. dollar for accounting.  But 21st century California government apparently hasn’t advanced very much over medieval accounting methods.  While the value of the dollar is still the same, the number of dollars in each government fund depends on which agency is reporting it.

A new report issued by the California Legislative Analyst’s Office, “Issues Concerning the Accounting of California’s Special Funds,” indicates that the state Controller’s Office, the Department of Finance, the Legislature, and the governor’s office all use substantially different numbers in reporting fund balances in the state budget.  What’s worse, up to now there has been little to no disclosure that these numbers are inconsistent.  So presumably even the numbers the impartial LAO uses are not consistent with the Finance Department or controller.

Absurd Fund Accounting

As the LAO report sums up the absurdity of the state’s account reporting policies, “The fund balance is not the cash balance of a fund.”

If you want the actual fund balance, you are going to have to calculate that yourself. You can do this by subtracting the total fund liabilities from the total fund assets.  Don’t expect your government to accountably report the true fund balance for you.

And if you want the actual fund balance for the state’s “Special Funds” rather than the “General Operating Fund,” that number is calculated differently by excluding assets and liabilities.  Huh?

By now the state’s accounting practices sound so twisted that I’ve probably completely lost you and you don’t want to read any further.  But read on.  It get’s even more interesting.

Incestuous Fund Swapping

Since 2010, state Senate Republicans have requested the nonpartisan LAO to properly account for all the shifting of funds that have taken place back and forth from the general to the special funds.  Apparently, what brought about the LAO report now was the purported exposure that the State Parks Department was “hiding” $54 million in its “off-road vehicle recreational fund” while 70 state parks were closed for lack of funding.

While it is difficult to track all the shifts between the General and Special Funds, here are some of the larger shifts:

* $3.6 billion in net redevelopment funds went from special sunds to the general fund when redevelopment was shut down ($5 billion minus $1.4 billion left for affordable housing);

* $5 billion went from the general to special funds for prison realignment;

* About $3.6 billion has been sucked out of politically earmarked special fund accounts and into the deficit-plagued feneral fund (this includes the infamous $54 million in “hidden” state park trust funds).

* $2.1 billion was transferred from the general fund account designated for K-12 schools and community colleges to other fund accounts in the general fund, presumably for welfare-to-work, Medi-Cal, and other programs.

“Who’s On First?” – Abbott and Costello

It’s hard to tell the balance in each California state fund without a photographic memory and a lie detector test.  The recent LAO report dodges the issue of tallying up what the true level of funding for the General Fund should be when fund shifts are included. The only way to make any sense of what has been going on is to consider the total of both funds together.

According to the State Department of Finance, over the past 5 years the general fund has decreased by $10.4 billion but the special fund has increased by $13.5 billion.  That would indicate an actual increase of about $3.1 billion in both funds when considered together.   The claim by Gov. Brown and the Legislature that the general fund is running a deficit washes out to an increase when both funds are considered.

The LAO report calls for legislation to correct these discrepancies.

Most Fund Transfers to Cover Health & Welfare Programs

Many of the fund transfers from special fund accounts into the state general fund have been for health and welfare programs. Department of Finance spokesman H.D. Palmer is quoted in the Sacramento Bee:

“We’ve taken SSI (Social Security Income-Disability) grants down to their lowest level since 1983, CalWORKSs is down to the lowest since 1987 and state support for higher education is down by 25 percent.” 

But a new Report of the State Budget Crisis Task Force chaired by former head of the U.S. Federal Reserve Paul Volcker and Richard Ravitch, both Democrats,, states that the reason California’s Medicare levels are so low is that they have been successful in rolling some state-funded health care programs into the federal Medicaid program (p. 18).  Another reason cited as to why California’s medical program funding levels appears proportionately low is that its total budget is so large.

Gov. Jerry Brown has called for an emergency session of the state legislature on health care in December 2012 or January 2013.

Brown and the Legislature accuse the former state parks director of “hiding” $54 million in “special funds.”  Meanwhile, California government is hypocritically playing a game of “hide and seek” with its shifting accounts and different fund balances used by each state department.