Kevin Phillips, author of Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism, has expertly detailed the history of false economic achievement in a recent Harper’s Magazine article. The culmination of 40+ years of gradual but consistent distortion of economic statistics have come home to roost and explain much of our current morass. Inflation statistics help determine interest rates, cost-of-living increases for wages and Social Security benefits as well as interest payments on the national debt. Inflation statistics also affect the planning, spending, saving and investing habits of every American. And lastly, decades of understated inflation means that GDP growth has been overstated.
It is Phillips contention that the under-measurement of inflation has put the country at great risk. To acknowledge the reality would send interest rates sharply higher. This would directly affect the continued viability of the massive build-up of debt, both public and private, that has fueled the economy over the last two decades. In addition, if the true state of inflation were acknowledged, the government would face huge increases in pension, retirement benefits and borrowing costs, overwhelming an already debt-burdened federal budget. Ultimately of course, the market will acknowledge the truth about inflation and interest rates will climb anyway. If government statistics remain distorted, institutional trust and credibility will be just two more victims of inflation.
No Discouraged Workers in Camelot
The long campaign of statistical massage began in the Kennedy Administration. Seeking a way to lower the high jobless statistics and make things look a little more like Camelot, the Administration pushed through a change that jobless Americans who had stopped looking for work were to be labeled “discouraged workers.” They were then left off the unemployment statistics. The workers were still unemployed, but no longer counted as such. Problem solved.
Johnson’s “Unified Budget” Ploy
President Lyndon Johnson, a clever political dealmaker, came up with the concept for the “unified budget” for the 1969 fiscal year as he was about to finish his final year in office. The proposal unified Social Security with the rest of the federal budget. This clever maneuver allowed the hefty Social Security surpluses to be spent to cover the growing deficits in the federal budget. Here was another short term solution with longer term consequences. We are now coming to the end of the Social Security surplus years, and four decades of surpluses have been spent. The “lock box” is now stuffed with paper IOU’s and little else.
Rotten to the “Core”
Not to be outdone by prior administrations, President Nixon requested that Fed Chairman Arthur Burns develop the concept of “core inflation” statistics. Headline inflation was rising in the early 1970’s and Nixon wanted a method to make the inflation number more politically palatable. Core inflation would be used to exclude those “volatile” categories such as food and energy.
This all sounds like déjà vu all over again. In his article, Phillips quotes economic commentator Barry Ritholtz as labeling core inflation “inflation ex-inflation.” That is the general idea, as politicians sought creative ways to bolster their administrations and fool the American people. President Nixon soon discovered the folly in that general concept.
BLS Adds to the BS Under Reagan
The Reagan administration added a critical element to the inflation manipulation game when they “convinced” the Bureau of Labor Statistics (BLS) in 1983 that housing inflation was overstating the CPI. The BLS came up with the concept of “owners equivalent rent” which estimated what a homeowner might get for renting his or her house. As home prices spiraled upward in the late 1980’s and mid 2000’s, the CPI omitted rampant housing inflation. Phillips points out that low inflation rates makes it easier to borrow money, and an artificially low CPI encouraged the speculative expansion in private debt starting in the late 1980’s.
Distortion Heats up in the 1990’s
Following Reagan, President George H.W. Bush had his turn at the plate. In 1990, Bush’s chairman of the Council of Economic Advisors, Michael Boskin, proposed a series of changes to economic statistics to reduce the measured rate of inflation. Under a smokescreen of making the methodology relevant to the “new economy,” the critics clearly saw this as a ploy to reduce rapidly growing government outlays.
Clinton Follows Up
The changes proposed by the Boskin Commission were not implemented until 1996 under President Clinton and with the support of Fed Chairman Alan Greenspan. The inflation statistics were now subject to the oft-discussed concepts of “product substitution,” “hedonic adjustments” and “geometric weighting” which have greatly contributed to the current underestimating of inflation.
The End of M3
The second President Bush kicked the ball along a little further by introducing an “experimental” CPI calculation in 2002, which shaved 0.3% off the official CPI. And in 2006, the Bush Administration stopped publishing M3 statistics, which would effectively highlight both rising money supply growth and rising inflation concerns. The laughable excuse from the Federal Reserve for deleting M3 was the expense of compiling the information. For an organization that prints money, the cost wouldn’t even amount to a rounding error.
Retirees have been Shortchanged
Economic statistician John Williams of Shadowstats.com tracks the pre-Clinton era CPI on his website, and is frequently quoted regarding inflation statistics. “If you were to peel back changes that were made in the CPI going back to the Carter years, you’d see that the CPI would now be 3.5% to 4% higher,” said Williams. Phillips notes that because of lost CPI increases Social Security checks would be 70% higher than they are currently. This would certainly have made a difference for many seniors relying on Social Security who have seen devastating declines in their lifestyles during the past two decades.
Moral Compass Out of Whack
“Americans misunderstood the nature of capitalism itself. It is not an ‘economic system’ that makes people automatically richer. It is a moral system… a system that rewards virtue and punishes error. You don’t get richer because of Free Enterprise. Indeed, as the economic history of the last quarter-century shows, you can get poorer. The market system merely provides the setting in which you get what you deserve. You could get rich- if you were to do the right thing: work hard, save your money, innovate, take chances, forgo consumption. But do the wrong thing… and you will pay for it.”
“When you spend more than you can afford, you get poorer. That’s the rule. So it should come as no surprise that Americans are getting poorer…though they are just beginning to realize it.” Bill Bonner
When the system is distorted however, the moral compass can be out of whack. Bad decisions can be rewarded and good decisions can be punished, at least for awhile. That’s what a system rife with manipulated statistics, untested financial instruments and easy credit will do. People will lose wealth and not even realize it until the music stops and reality is restored. Unfortunately, economic reality will be an unwelcome surprise to millions who have only known the debt-based economy of the last twenty years.
Walking in Quicksand
Kevin Phillips is an historian with an understanding that times change but human nature remains the same.
“Transparency is the hallmark of democracy,” said Phillips. “But we now find ourselves with economic statistics every bit as opaque, and as vulnerable to double-dealing, as a sub-prime CDO.”
“Were mainstream interest rates to jump into the 7 to 9 percent range, which could happen if inflation were to spur new concern, both Washington and Wall Street would be walking in quicksand. The make-believe economy of the past two decades, with its asset bubbles, massive borrowing, and rampant data distortion, would be in serious jeopardy.”
For the individual, the moral to the story is one of self-reliance. That means reducing personal debt, spending less than you make, and taking government statistics with a large grain of salt. It also means investing in areas such as natural resources that are a hedge against higher levels of inflation. The music may stop playing one of these days and it would be a good idea to have a chair (or life raft) within reach.
U.S. stocks shifted lower Monday to cap a day that started with a rally and dissolved into a steep plunge, as concerns banks would be hit with credit-related losses competed with early optimism fueled by a large drop in the price of crude.
The Dow Jones Industrial Average was down 56.58 to close at 11,231.96. The S&P 500 Index was also lower, losing 10.59 to close at 1,252.31. The Nasdaq was slightly lower, ending at 2,243.32, down 2.06.
Crude-oil futures fell Monday for the first time in four trading sessions, leading a broad retreat in commodities as comments over the weekend from Iran's foreign minister on the country's nuclear program were perceived as more conciliatory. Crude for August delivery dropped $3.92, or 2.7%, to settle at $141.37 a barrel on the New York Mercantile Exchange.
Gold for August delivery closed down $4.80 to $928.80 an ounce on the New York Mercantile Exchange. Earlier in the trading day, gold prices had dropped as low as $916.60.
Wishing you a good evening,