[OPE-L] Shadow Statistics

From: glevy@PRATT.EDU
Date: Sun Apr 23 2006 - 09:31:39 EDT

Guest Commentary, by Chris Meyer

Shadow Statistics
April 20, 2006

Christopher Mayer is editor of the Fleet Street
Letter. This essay was originally published by the
Daily Reckoning.

"Listen," I interrupted, "what nationality are you?"

"I'm English," she replied. "That is, I was born in
Poland, but my father is Irish."

"That makes you English?"

"Yes," she said...

                    - Henry Miller, Tropic of Cancer

Ben Bernanke, Fed chairman, recently delivered an
upbeat view of the U.S. economy. It was cheerful,
optimistic...and delusional.

The official government statistics hide many warts on
the face of the U.S economy. Like makeup dabbed on an
aging film star, they are an attempt to cover the
wrinkles and present a veneer of youth. To most
people, this is no revelation. Like plastic surgery
and tummy tucks, it is what stars do to keep up

However, few know the extent of the deceit. What if
you learned that inflation were closer to 7% than to
the official 3%? What if unemployment were closer to
12%, rather than the official 5%? What if the economy
were actually contracting, as opposed to growing?

What follows is a partial peek at the economy - sans
makeup. And, more importantly, what it means for you
and your hard-earned dough.

It was the genius of writer George Orwell that he
chose to build his dystopia on the foundations of
language and information - how it is used to deceive,
manipulate and control. His chilling novel 1984 stands
out precisely because it is only a distortion of
things that are happening now and that have always
happened. Orwell's dystopia is a mirror in a funhouse,
as you see enough of your own world in this disturbing

Thankfully, there are still some people doing the
important work of getting at the truth behind the
official statistics - piercing the veil of Newspeak,
sweeping away the cobwebs of sham. John Williams is an
economist dedicated to doing just that. His Shadow
Government Statistics reveals the extensive rot under
the floorboards of the U.S. economy.

Let's take the official inflation rate, tracked using
the consumer price index, or CPI. The idea behind the
CPI is to have a fixed basket of goods and track how
the prices of these things change from year to year.
It only gained prominence after World War II, as a way
to adjust autoworkers' labor contracts, a practice
that soon spread.

Over time, its importance grew and more people looked
to it as a gauge of general price inflation - and,
hence, to get a feel for the health of the economy.

The thing is, the way the CPI is calculated changed
dramatically over the years. Politicians have figured
out that these statistics are useful in winning
elections. Ergo, nearly every administration has
altered the calculation. And always, the changes made
the CPI lower. Every effort to change the CPI, by
design, aims to make the economy look "better" than it
looked before the changes.

The accumulation of these changes creates a huge
difference over time. It's like making a series of
small changes to a ship's course in the midst of a
long voyage. Soon, you wind up way off course, miles
and miles from where you think you are. The chart
below on William's Web page shows the extent of the
difference, which is just massive. The rate of
inflation using only the pre-Clinton era CPI is closer
to 7%!

The "Experimental C-CPI-U" is another innovation,
introduced by the Bush administration to lower the CPI
yet again, once again to paint a kinder portrait of
the old hag known as the U.S. economy.

But it's about more than just making the economy look
better. For example, since increases in Social
Security payments link to the CPI, a lower CPI also
saves the government money. According to Williams, if
you used the CPI when Jimmy Carter was president,
you'd get Social Security checks 70% higher than
today's levels. Yes, 70% higher.

The government also duped all those people who thought
it was such a great idea to buy TIPS (Treasury
inflation-protected securities). Changes in the CPI
determine the interest paid on these bonds. The higher
the CPI, the more interest paid to bondholders. Some
people loved the idea, figuring here was a bond that
would keep pace with inflation. Given the government
manipulates the CPI, you can be sure the interest rate
paid will not keep pace with inflation - nor has it

The manipulation of the CPI explains the great
disconnect between what the man in the street feels
when he pays his bills and what the confident,
well-dressed Fed chiefs and politicians try to tell
him. The cost of living is rising a lot more than they
want you to believe. At a 7% annual rate of inflation,
the cost of living would double in about 10 years.
Looked at differently, the purchasing power of your
dollar will fall in half.

What about unemployment? The government, since the
time of the Kennedy administration, has been changing
the definition of "unemployed." Again, many small
changes over time lead to dramatic end results.
According to Williams, if you back out the changes,
you get an unemployment number closer to 12%!

Let's look at the federal deficit - basically, the
amount of money the government is losing every year.
The official deficit for 2005 was $319 billion.
However, this excludes unfunded Social Security and
Medicare obligations. Throw them into the mix and
calculate the deficit the way a business does in its
financial statements - and you get an annual deficit
around $3.5 trillion.

That's more than 10 times the so-called "official"
deficit. By Williams' calculations, you could raise
the tax rate to 100% - dump everyone's salaries into
the U.S. Treasury - and still have a deficit.

Years of such deficits have created a mountain of
obligations for the U.S. government. As Williams says,
"The fiscal 2005 statement shows that total federal
obligations at the end of September were $51 trillion;
over four times the level of GDP." These debts are
unsustainable. The bills must go unpaid. If the U.S.
government were a private corporation, its bankruptcy
would be beyond dispute.

This is why Social Security and Medicare are not going
to exist in the not-too-distant future. As Williams
says, "There is no way the government can pay the
Social Security or Medicare it has committed to."

Williams believes GDP is contracting now. The
government reported only a 1.1% increase in the fourth
quarter. Even in an election year, and despite the
government's best efforts to paint a pretty face, all
it could muster was a measly 1.1%. More likely, the
economy actually contracted 2% in the fourth quarter.
This means we are in a recession NOW.

This is not conspiracy-theory stuff. As Williams
points out, it's all disclosed in the footnotes in the
government's reports. All he is doing is backing out
many of the changes to more realistically compare
these numbers with the numbers of the past.

The great H.L. Mencken, a scathing attack dog of
idiocy in all its forms, wrote about "damning
politicians up hill and down dale for many years as
rogues and vagabonds, frauds and scoundrels." We need
more Menckens. In the meantime, we'll have to make do
with Williams and his cogent analysis of government

Oddly enough, these insights do not change our
approach here in the pages of Capital & Crisis. In
fact, Williams' work reinforces several things we've
already covered in past letters. To wit:

Yields on real estate investment trusts (REITs) and
utilities - to say nothing about the bond market -
appear even more pathetic against an inflation rate of
7%. The yield for risks taken is simply not adequate.
If the slumbering bond market awoke to the reality of
a 7% inflation rate, there would be a sell-off the
likes of which this country has never seen. Interest
rates would bolt upward like a frightened cat.

And the U.S. dollar is a doomed currency over the long
haul. Bernanke, the self-professed student of the
Great Depression, accepts the mainstream view that the
Fed's great mistake then was not to flood the system
with dollars. He won't make that "mistake" again.
Expect the printing presses to run day and night at
full capacity when the trouble starts.

Trying to pin down the economy in precise numbers is
futile anyway. It's too big, too complex. All macro
statistics are severely flawed. This is why I seldom
write about them. Investing using macro statistics is
like trying to find the nearest post office with a
globe. They are so vague as to be useless.

The basic idea I want to leave you with is this: The
economy is far weaker than generally portrayed. Most
investors ignore the rat's nest of risks and invest
indiscriminately in stocks - without proper due
diligence. As investors, we need to stick to our
fundamentals more carefully than ever.

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