It’s all about the numbers (damning piece on our economy)

[SnyderShrugged]

Click link for some excellent graphs that support his statements

Economist Walter ” John” Williams has been following economic reports for more than 25 years. He knows how they are calculated and has seen changes in the government’s methodology for calculating them over the years. Most of these changes were made for the express purpose of presenting a more posit i ve economic outlook, but Williams has maintained these economic reports with the original methodologies and presents them in his electronic newsletter “Shadow Government Statistics” and on his Web site Shadowstats.com. He even keeps up the broad M3 money supply figure, which the Fed stopped reporting in 2006.

He knows where inflation, unemployment and Gross Domestic Product (GDP) really are and what the government is trying hard not to report. It is not a pretty sight but it is something all traders should know. In our conversation, Williams talks about how those reports have been altered, the real shape of our economy and why he thinks we are headed into a hyper-inflationary depression.

Futures Magazine : When did you first notice that government reports were being altered?

John Williams : This is something that has evolved over the last couple of decades. I started out as a private economic consultant, which I still am, over 25 years ago. I found within the first year or so that some of my clients where having problems with the econometric models. They had modeled their sales based on what was in the [Gross National Product] report. I looked at the data and saw there was a problem in the series and found that there were some bad numbers based on the trade deficit reporting. I corrected the numbers for my clients and they found their models started to work better. I expanded my client base and found I had a number of clients who at one time worked for the government as economists and they would tell me some stories. Most of my clients had been business economists, people who had to make a forecast that people used to make money as opposed to reports put out to the public as pablum to make them feel better about buying stocks or bonds.

FM : What was your next step?

JW : I started an annual survey of business economists that I put out in the late 1980s for the National Association of Business Economists (NABE) and found that 70% of business economists thought there was a problem with the way the government reported its numbers. A goodly portion suspected political manipulation. What I found from talking to these people is that you would talk to the chief economist for a large retail company and he would tell me that the retail sales numbers were absolutely horrendous but he thought that the money supply numbers were pretty good. Next I would talk to an economist for a large money center bank and he would tell me that the retail sales numbers were pretty good but the money supply numbers were horrendous.

FM : What did you see?

JW : As the GNP and GDP numbers continued to evolve, I found that historical relationships were not working any more. A lot of it was due to methodological changes that were taking place to the GDP and there were other series, such as the Consumer Price Index (CPI), the payroll series, the unemployment series. The changes that were being made generally had the impact of building upside biases into economic data, showing stronger economic growth going forward and building downside biases into the employment. And what has happened over time is the government reporting has increasingly moved away from common experience. You talk to an average person anywhere in the country and find he or she generally does not believe the government’s inflation number or economic data. They know how they are doing, they know how much they’re spending and they know their businesses are up or down, you can’t fool them. The people who tend to believe in the number are in the financial markets, or at least they trade off of it. That may be the game to a certain extent, but if you look at the number, net of these various methodological changes that primarily were made to boost the economic reporting or depress the CPI, you would find the inflation rate today, instead of being 3.9% year-to-year as of April, would be 7.3% if you look at the methodologies as of 1990; 11.5% if you look at the methodologies as of 1980. The unemployment rate, the way it used to be measured, would be up around 13% and the GDP would show we are in a recession.

In the late 1980s The Kaiser Foundation surveyed the public to see what they thought unemployment was, what they thought inflation was and what they thought GDP was. The story was run by the Washington Post and said basically ‘look how stupid the American people are, they don’t have any sense of where the economy really is because they thought unemployment may be double the official rate and inflation was maybe double the official rate.’ My contention is that the American people were a lot closer to what was happening because they were reflecting what they would view from a common sense perspective.

FM : How is it being manipulated?

JW : There are two ways that it is manipulated; the first is the methodological shifts over time, the second is when a specific number is manipulated for political purpose s. Look at the CPI for example. In its most popular use following World War II, when it became a cost of living adjustment for auto union contracts, the concept was to use it as a measure of a fixed basket of goods. Say you have a loaf of bread, a gallon of milk and a steak. You price them out one year, you price them out the next year and figure the percent change and figure out how much your income had to increase to maintain a constant standard of living. The key concept is a constant standard of living. That was the basic underlying premise of the CPI. At the end of the 1980s, Alan Greenspan and Michael Boskin , who was head of the Council of Economic Indicators, started a campaign to convince people that it was being overstated. The argument was, if steak goes up, people are going to just buy more hamburger ; if they buy more hamburger their cost of living will be less. It was completely contrary to the concept of the CPI because it took it away from being a measure of a constant standard of living to being a measure of a declining standard of living, which has no practical purpose other than its express purpose to reduce cost of living adjustments in Social Security. It was a way for Congress to contain Social Security payments without doing the unthinkable and vote against it. The concept didn’t fly at that time, but when you got into the Clinton administration, the Bureau of Labor statistics introduced geometric weighting of the CPI for the purposes of mimicking a substitution-based CPI such as Greenspan and Boskin had been advocating. So with the geometric weighting, if something goes up in price it gets a lower rating and if something goes down in price, it gets a higher weighting so it has the effect of giving you lower inflation than you would have had otherwise. The net effect of this over time was effectively 3% and it is accumulative in its effect. If the changes had never been made, Social Security payments would be roughly double what they are today so the intended purpose worked.

FM : What about unemployment?

JW : During the Kennedy administration the concept of the discouraged worker was invented. A person knows whether he is unemployed; if he doesn’t have a job and he is willing to work he considers himself unemployed. The difference in the governments’ measure is you have to be actively seeking employment, which is legitimate in areas where there is a lot of economic activity and people have a prospect for seeking jobs. But in areas where there are no jobs to be had and people have given up looking for work they were classified as discouraged workers.

During the Clinton administration, discouraged workers were redefined. If you were a discouraged worker for more than one year, you were no longer a candidate in any category whatsoever. That had the effect of sharply changing the measure. That reduced the count from roughly 5 million to about 300,000. The unemployment rate, as most people count unemployment, is up around 13%.

FM : Explain the problems with the CPI .

JW : There are a number of problems involved in the CPI beyond the change in the basic concept. There is the area called quality adjustment or hedonic adjustments. There is some legitimate use for that, but again it is a matter of academia vs. common experience.

An automobile is mandated to have a catalytic converter and let’s say that adds $500 to the cost of every automobile. From the standpoint of the consumer, he has to buy an automobile and he doesn’t care if it has a catalytic converter or not, but his cost now is $500 higher. From the government standpoint, they say this was a quality improvement and as a result we are not going to include it in the CPI. A similar example with hedonics is text books for students. If a book goes up in price because it has color photographs in it, that increase is not counted in inflation. From the student’s point of view he is not worried about buying a book, with color photographs. He has his books that he has to buy for the semester and the cost of the book has gone up by such and such an amount.

FM : Do they adjust downward?

JW : In theory yes, in practice rarely. You are seeing increased obsolescence built into products that are not modeled. I fly a lot these days. Is the quality of airline flight today adjusted hedonically for what it was 20 years ago? I am a heavyset guy; I fly first class now because I can’t fit into a coach seat. Now I am having trouble sitting in a first class seat and I haven’t put on weight. The quality of the service has gone down, the quality of the food has gone down. First class today is about as comfortable as coach was 20 years ago, but that is not adjusted to the numbers. If you are going to use hedonics, at least be consiste nt.

In the early 1980s, the first big change they made was in the way they measured the cost of housing. It used to be that the cost of housing included some measure of the cost of buying a house. The government changed that. It has the effect most years of lowering inflation. The government will estimate what the individual owning a house would pay if he was renting the house from himself and then calculate how much he would increase his rent on himself each month and that is what goes into the CPI formula. Over time, if you were to look at the housing prices of the last several years, there is probably a significant understatement of what was reported back in 1980.

FM : What about GDP?

JW : The key element is inflation. The way the GDP is popularly reported is net of inflation. So if you use an artificially low inflation rate for deflating GDP, you will end up with an artificially high GDP rate net of inflation. A lot of that had to do with the problem of hedonics. They overdid it terribly with computers.

Much of the gimmicking used in the CPI that has to do with the geometric changes is also applicable to the GDP. Generally you get about a 3% overstatement of real growth.

FM : What about using the core number?

JW : Core is a meaningless number. The Fed likes to report, ‘hey inflation is under control, look at the core rate.’ That is absolute nonsense; it is a gimmick. Fed Chairman Bernanke knows that. There is no basis in reality for having a core measure; these guys should be ashamed of themselves. Arthur Burns developed this concept in the 1970s under Nixon. It has some validity and that is we are dealing with volatile commodities, oil and food, and you look at the month-to-month changes [and say] ‘we had a big spike in oil last month, let’s take it out and see what inflation looks like.’ Where it becomes invalid is once you get on an annual basis you are not looking at month-to-month distortions, that is actual inflation people are paying for energy and food. Inflation is a real problem and most people know it. Even Wall Street is beginning to sense that it is an issue. If you are buying a long-term bond against inflation you want it to cover your cost of living.

FM : Why is M3 money supply important?

JW : Broad money growth is a good indicator of inflation. Come August and September, we are going to see pressure from the rapid expansion of M3, which the Fed no longer tracks. Ostensibly the reason they stopped reporting it was one, it had no meaning; and two, it was too expensive. Both of those are nonsense. In terms of inflation, if you want the best measure of money supply you use the broadest measure. In term of the cost of putting it together, most of the numbers are still published by the Fed, it is M2 plus institutional money funds and few other measures still reported.

FM : What is M3 telling people that the Fed doesn’t want them to hear?

JW : It stopped doing it because it had a pretty good sense of what lay ahead and it didn’t want people to see what was happening with the broad measure. M2 is dow n around 6% but M3 is at 16.4% and that number was the last historic high seen in June 1971, two months before Nixon closed the gold window and two months before he imposed wage and price controls. That is a very scary inflationary number. Prior to this, you had no broad money growth in modern reporting. At least since World War II we haven’t seen this and the implications for inflation are dire.

FM : What effect has the subprime crisis had on the economy?

JW : I would contend that the Fed at this point is not concerned about inflation. It is not concerned about the economy. Its primary concern and its primary function is keeping the banking system solvent. They lose the banking system, the other stuff doesn’t matter. So they will do whatever they can to keep the banking system afloat. If Bernanke had not done what he did in terms of setting up these funding facilities, we would likely have seen a failure of the banking system similar to what was seen in the 1930s with the resulting collapse of the broad money supply and a deflationary Great Depression. That is what he wanted to prevent. He is still working on it, it is not solvent yet. They will create whatever amount of money they can to keep the system afloat. Now they have not been formally creating any new money yet. What they have been doing by setting up this Term Auction Facility (TAF) is lending good liquidity (Treasuries) and taking collateral of mortgaged backed securities regardless of the rating. You have a circumstance that the banks that are reliquefied are able to act more like a bank, which includes lending money, which in turn increases the money supply. They are not concerned about inflation or the GDP; they can address those problems once the system is sound or at least they think they can. The cost of what they are doing to save the system is inflation.

The Fed has a balance sheet and they hold roughly $800 billion in assets, which is the underlying collateral for the currency in circulation. That used to be largely Treasury securities; the dollar now is being backed by mortgaged backed securities.

FM : What is the benefit of your service to individual traders?

JW : It gives you a sense of where underlying reality is, and I would contend over time underlying reality will win out in the markets. We are in a deepening inflationary recession which is not going to get much better, in fact it is going to get much worse. So over the next couple of months, the data will tend to see downside surprises on the economic statistics and some upside surprises on the inflation numbers, alt hough they are going to be far short of reality. We put out a monthly newsletter and flash updates in between as the market dictates.

FM : But if the market reacts to the faulty numbers, won’t they still be more valid?

JW : The markets will trade off of the official numbers but what we have will sometimes give you a fair bet on whether the coming number will be above or below consensus expectations and that could conceivably give you an edge. You will see a lot of hype about the recession being over. If you need to make any bets on that, I would not make a bet on a reco vering economy. In terms of the GDP being in contraction, if you look at quarter-to-quarter growth in inflation, adjusted retail sales, industrial production, housing, new orders and employment, they are all contracting and the contractions are worse in the second quarter. You don’t see that outside of a recession. The GDP numbers in the first quarter, as far as I could tell, were an absolute rig job aimed at helping George Bush and Ben Bernanke. Bernanke wanted to pull back on the easing so he put out the story that the economy was getting better so we don’t have to cut as much. That is nonsense. Cutting rates is not going to help the economy nor is raising rates going to fight inflation. The inflation you are seeing is not being driven by economic demand. When you have inflation being driven by commodity prices, a weak dollar, a money supply spike because of a banking crisis, those are not factors that are going to be improved by short-term Fed policy. The GDP is the most heavily biased and most easily rigged number they have.

FM : Where is the economy is headed?

JW : I expect to see double-digit inflation, even as reported by the government, within the next 12 months. Down the road the prospects are extraordinarily bleak for a variety of reasons, generally due to the effective bankruptcy of the Federal government.

Back in the 1980s, the big 10 accounting firms decided to set up a system so that the Federal government would report its financial activity the same way as businesses, with accrual accounting. Starting in 2000, the Treasury, under law, started publishing these generally accepted accounting principles statements on the U.S. Government signed by the U.S. Treasury Secretary and audited by the government Accounting Office (GAO). If you put in the year-to-year change in unfunded liabilities for Social Security and Medicare, the average deficit over the last four years has been about $4 trillion. To put $4 trillion into perspective, if the government were to seize all personal income and corporate profits, there would still be a deficit.

That is frightening because it means it is beyond containment. People in Washington know this, the Fed knows this and David Walker, who recently resigned as head of the GAO started to talk about it. Politicians won’t address it because they don’t have a solution. The 10-year note, certainly a 30-year bond, will have problems within 10 years on whether or not they are going to be paid off or what they are going to be paid off in. There are obligations that the government has no way of covering. When governments are in that sort of a situation, rather than renege on debt, the common solution is to rev up the printing press and you end up with a hyper inflation so you get paid off in worthless dollars. I think that is where it is headed.

FM : Any way to avoid this?

JW : No. Well yes, slash Social Security and Medicare. Back in 2004 the Medicare system was overhauled and prescription drugs put in place. Washington set that up knowing that it was unfunded to the tune of $8 trillion. That is almost criminal.

None of the options are happy ones. Bernanke is faced with a devil’s choice. If we go into deflation, we will end up in a deflationary depression; if you go into inflation you are going into a hyper inflationary depression. The Fed has made the decision in concert with the administration that they don’t want to see the system collapse. They will fight the future inflation fight when they have to fight it, but they want to keep the system afloat.

[DarrellsMyHero28]

Hear that?

Its the sound of SHF and his graphs coming this way!

:laugh:

[SnyderShrugged]

personally, I have a huge problem with the government changing the way economic indicators are measured.

[JohnLockesGhost]

personally, I have a huge problem with the government changing the way economic indicators are measured.

I like the idea of Sir John Cowperthwaite (http://en.wikipedia.org/wiki/John_James_Cowperthwaite), architect of the post-World War II Hong Kong economic miracle, that just collecting economic statistics should be frowned upon as it only encourages economic interventionism.

[SnyderShrugged]

I like the idea of Sir John Cowperthwaite (http://en.wikipedia.org/wiki/John_James_Cowperthwaite), architect of the post-World War II Hong Kong economic miracle, that just collecting economic statistics should be frowned upon as it only encourages economic interventionism.

hmmm, interesting thought. The only worry I would have is if dangerous trends arent identified early enough, then there is no chance to prepare for an economic disaster.

that said, the current practice of collecting stats that only paint a rosy picture will accomplish the same dangerous surprise.

[SnyderShrugged]

I apologize, I was just notified that the URL is giving some folks fits in viewing what is already a very long post.

I'm not sure how to remedy it, but if anyone is interested in the link, I can PM it to you.

sorry for the hassel!

[Larry]

I apologize, I was just notified that the URL is giving some folks fits in viewing what is already a very long post.

I'm not sure how to remedy it, but if anyone is interested in the link, I can PM it to you.

sorry for the hassel!

Format for embedding a link (in UBB code) is: (URL=link)text(/URL)

(I've changed the square brackets to parenthesis, so that the board doesn't interpret it as UBB code.)

"link" is the URL of the page you're linking to.

"text" is whatever actually shows on the screen when somebody looks at the post.

(On the "go advanced" page, there's an item you can click that will format it for you. The first thing it asks for is the text to be displayed. That part is optional, but if you leave it out, what you get is a link where both the link and the displayed text are the URL.)

(The reason for the formatting problem is that words without spaces in them (like URLs) can't be "wrapped" to fit the screen. Therefore, they force the browser to make the enclosing frame wide enough to fit the long word on a single line. Since the frame is now bigger than the viewer's screen, he gets a scroll bar. Since the frame is now wide, all of the other paragraphs will fit the (wide) frame, which means for the viewer to read the paragraph, he has to scroll the window side-to-side for every line of the post.)

But if your link is

(URL=ReallyLongLink)text(/URL)

Then what the viewer sees is text (in blue or whatever color). And since "text" is really short, it doesn't matter how long the URL is, it won't force the frame to expand.

[techboy]

I don't buy it. I don't think this guy is trustworthy, and calling himself an "economist" is highly misleading given that he has a bachelor's in economics.

None of the legitimate economists and finance people I've read share his view, and I don't buy his "hyper-inflation" story for two reasons.

1) While I do not doubt that the federal government would, indeed, "cook the books" on inflation if they could, I don't think it's possible for them to do so. The "basket of goods" they use for determining prices, as well as the prices of each item, are a matter of public record. If this guy's right, he wouldn't be the only one saying so. People with actual credibility would be.

2)As of 7/03, the 10 year TIPS yield was 1.42. The 10 Year Treasury yield was 3.99.

The difference between the two is 2.57. That means that the Bond Markets expect inflation over the next ten years to be right around 2.5% (or a little less, actually, since there is an uncertainty risk premium built into the treasury yields), which is well in line with the government numbers, and there's no chance of conflict of interest like there is with the government, because private bond traders have no incentive to make the government look good, and every incentive not to (if they're wrong, they lose money).

Remember, not all aspects of the economy are inflationary. Certainly commodities are placing inflationary pressures on our economy in certain areas. The Fed's recent monetary policy could also be said to do so.

On the other hand, though, there are deflationary pressures in the market, too. Consider Is The Inflation Scare Over Yet?. An excerpt:

The recent downtrend line has been broken. Is the inflation scare over? That is hard to say. It's much easier to say is that it should be.

Destruction of credit via massive writedowns in banks and financials, accompanied by sharply rising unemployment rates, falling wages, and curtailment in credit lines everywhere is simply not an inflationary environment.

Of course, this all starts with a proper definition of inflation. In Austrian economic terms, inflation is an expansion of money and credit. Money is not expanding and neither is credit. There is an illusion that they are as discussed in Bank Credit Is Contracting.

We have reached Peak Credit, a once in a lifetime event.

Those focused on the CPI, M3, and other such measures are completely missing the boat. Yes, the CPI is understated (at least on the surface). However those using CPI data to short treasuries over the past few years have had their heads handed to them. OK there was a selloff from March to June, but seasonally this is an expected event. April and May are typically the worst months (tax season).

Unless I'm given some reason to think otherwise, I'm chalking this "economist" up as a nut on par with the 9/11 "truthers" and their graphs.

[techboy]

FM : What is the benefit of your service to individual traders?

JW : It gives you a sense of where underlying reality is, and I would contend over time underlying reality will win out in the markets. We are in a deepening inflationary recession which is not going to get much better, in fact it is going to get much worse. So over the next couple of months, the data will tend to see downside surprises on the economic statistics and some upside surprises on the inflation numbers, alt hough they are going to be far short of reality. We put out a monthly newsletter and flash updates in between as the market dictates.

And here's another reason I don't trust him. He's selling something.

[SnyderShrugged]

Techboy, what are your thoughts on his point about the changing the way key indicators are measured?

[techboy]

Techboy, what are your thoughts on his point about the changing the way key indicators are measured?

You talking about dropping the M3? That's a joke. The Fed isn't publishing it anymore, because it's too expensive, but they still publish the numbers used to calculate it, and anyone with the formula (which is in most Econ textbooks) can do so.

Here's one such calculation.

They're not hiding anything, because the information is all still out there, most of it from the Fed itself...

This guy is just stirring the flames of paranoia, trying to sell his newsletter.

I forgot to mention this before, but I also don't trust him because his website doesn't really cite any sources or show any methods. It just presents numbers to be accepted as gospel.

Garbage, I say.

[herb mul-key]

so....jsut a question....but what happens if we hit a new "depression"...what is the scenario around the country for the peoples...?

[PF Chang]

1) While I do not doubt that the federal government would, indeed, "cook the books" on inflation if they could, I don't think it's possible for them to do so. The "basket of goods" they use for determining prices, as well as the prices of each item, are a matter of public record. If this guy's right, he wouldn't be the only one saying so. People with actual credibility would be.

2)As of 7/03, the 10 year TIPS yield was 1.42. The 10 Year Treasury yield was 3.99.

The difference between the two is 2.57. That means that the Bond Markets expect inflation over the next ten years to be right around 2.5% (or a little less, actually, since there is an uncertainty risk premium built into the treasury yields), which is well in line with the government numbers, and there's no chance of conflict of interest like there is with the government, because private bond traders have no incentive to make the government look good, and every incentive not to (if they're wrong, they lose money).

Remember, not all aspects of the economy are inflationary. Certainly commodities are placing inflationary pressures on our economy in certain areas. The Fed's recent monetary policy could also be said to do so.

On the other hand, though, there are deflationary pressures in the market, too. Consider Is The Inflation Scare Over Yet?. An excerpt:

:laugh: I thought I was going insane when I read this post, as I could've sworn I had read it a few days ago. I had to search and find:

http://www.extremeskins.com/forums/showpost.php?p=5299555&postcount=14

to ensure my sanity.

[skinfan2k]

Hey guys, i have an option to invest in savings bonds at my work? Should i go ahead and start since im only 21?

[techboy]

:laugh: I thought I was going insane when I read this post, as I could've sworn I had read it a few days ago. I had to search and find:

http://www.extremeskins.com/forums/showpost.php?p=5299555&postcount=14

to ensure my sanity.

I did change a few words, but I see no need to reinvent the wheel.

Actually, if you search on the part with the TIPS-T-Bill spread, you'll find it 4 or 5 times, with new numbers each time.

Hey guys, i have an option to invest in savings bonds at my work? Should i go ahead and start since im only 21?

Saving early is infinitely preferable, and the earlier the better. More time to let compound interest work to your advantage.

As to what you should save in, that's a matter of your choices, your risk tolerance, and your goals.