The news yesterday was that the economy
grew by 2.5%. The general sentiment is that "a soft landing has a very high probability." What the average American doesn't know is that the numbers the government report are
bogus.
John Williams has a
business that is built around the idea that economic reports are changed by politicians to benefit their political careers. He spends his time sifting through the raw numbers to find out what the economy is doing in the real world.
Instead of the 2.5% growth reported for second-quarter 2006 GDP, the economy contracted. Growth fell by more than 0.5% when corrected for unusual inflation gimmicks used to understate GDP deflation. Previously reported GDP growth underwent meaningful downward revisions.
The first thing a person should understand is that the
markets are rigged. All of them.
Whether it is extensive
insider trading that is
never punished, or
international efforts to "stabilize" of the markets for large financial institutions, or simply the generally accepted gearing of the markets by The Federal Reserve with Repurchase Agreements and reserves regulations.
The one thing you should all be aware of is that the markets exist to seperate you, the average investor, from your money. You have just as good of chance to win big on Wall Street as you do of winning big in Las Vegas.
Control the flow of information
Most of you are already aware of how the Bush Administration likes to slap every piece of damaging information with the tag "classified national security". What many of you may not be aware of is how the amount of economic information has been restricted in just the last couple years.
Only five months ago the Federal Reserve stopped publishing the M3 monetary supply report (the broadest measure of monetary stock). I've found another web site that calculates the M3 from raw data and has found that the monetary supply is expanding at an accelerating rate - going from about 8% y-o-y to about 9.5% y-o-y in just the last four months.
What does this mean to you? Quite simply, there is more money chasing the same number of goods. That makes the cash in your pocket worth less. You see, inflation is a monetary phenomenon, not a price one. "In economics, inflation is a fall in the market value or purchasing power of money."
The M3 report you may have already heard about. What you probably haven't heard about is plans by the Commodities Futures Trading Commission to eliminate the Commitment of Traders Report (they will decide on August 21st). If you thought the M3 was an obscure report, this one is truly for econo-geeks only.
For those that have not heard the term "COT report," it is the Commitments of Traders report, which discloses the futures position of hedgers (commodity producers or buyers), big specs (hedge and mutual funds), and small specs (individual traders), and whether or not they are short or long and by how much they are short or long. That statement alone should be enough to tell you that certain players may not want their positions to be known. Rest assured that the big players will probably know it anyway, and not just once a week, either.
Quite simply, the ability of the average investor to make decisions about how to use their life-savings is being restricted by a lack of available information. This used to be the complaint used to avoid investing in 3rd world countries.
Which brings us to the economic information that
is still available.
Fun With Numbers
The next thing to understand is that the numbers the government releases to the public have been manipulated to the point that they don't resemble reality. The consistent themes, whether a Democrat or a Republican sit in the White House is:
* price inflation is understated
* economic growth is overstated
* unemployment is understated
* the federal deficit is understated
As John Williams explained in 2004:
As a result of the systemic manipulations, if the GDP methodology of 1980 were applied to today's data, the second quarter's annualized inflation-adjusted GDP growth of 3.0% would be roughly three percent lower (effectively netting to zero percent or below). In like manner, current annual CPI inflation is understated by about 2.7% against the pre-Clinton CPI methodology (would be about 5.7%), and the unemployment rate is understated by about seven percent against its original design and what many people would consider to be actual unemployment (would be about 12.5%).
As to the financial results of federal operations, the application of accrual accounting and generally accepted accounting principles to federal operations shows an actual fiscal year 2003 deficit of $3.7 trillion, as reported by the U.S. Treasury, versus the reported cash-basis $374 billion.
All of those numbers are much worse now. Using the same information-gathering methodology of the 1930's, price inflation is now around 9%, unemployment around 12%, and the GDP just went negative. How can this be? There are so many ways this is done that it is hard to list them all. So I will just give you the highlights. Let's start with jobs.
The BLS (Bureau of Labor Statistics) has created something called the
Birth/Death Model. It is supposed to "catch" the jobs that aren't counted in the jobs surveys. To put it another way, its jobs that the BLS can't prove exist, and have no intention of proving they exist, but they added them to the Employment Report anyway.
The Birth/Death Model typically adds more fictional "jobs" to the Employment Report than the BLS can prove exist with its standard survey. In other words, the employment report would be
negative almost every single month if it wasn't for the Birth/Death Model.
See, wasn't that Fun! Now let's look at
unemployment numbers.
Up until the Clinton administration, a discouraged worker was one who was willing, able and ready to work but had given up looking because there were no jobs to be had. The Clinton administration dismissed to the non-reporting netherworld about five million discouraged workers who had been so categorized for more than a year. As of July 2004, the less-than-a-year discouraged workers total 504,000. Adding in the netherworld takes the unemployment rate up to about 12.5%.
The Clinton administration also reduced monthly household sampling from 60,000 to about 50,000, eliminating significant surveying in the inner cities. Despite claims of corrective statistical adjustments, reported unemployment among people of color declined sharply, and the piggybacked poverty survey showed a remarkable reversal in decades of worsening poverty trends.
Now let's look at inflation numbers. These numbers have been played with for a very long time. probably the biggest changes were made in 1983 by the
Reagan Administration.
Before 1983, CPI measured housing inflation by looking at what it actually cost to own a home: house prices, mortgage rates, property taxes, even maintenance. After 1983, BLS changed the housing component, using the concept of "owner's equivalent rent." It's a measure of what homeowners could get for their homes if they rented them. It accounts for 23% of the overall CPI and about 30% of core prices, according to BLS.
Since the housing market began soaring, rental properties have languished. Vacancy rates rose, and rents came down in price. This had the surreal effect of pushing CPI measures down. At exactly the time housing became extremely expensive, the BLS measure of this component made inflation appear to be going lower.
On top of that, the BLS removes the value of any landlord-provided utilities in its calculation of owner's equivalent rent.
But the inflation numbers fun doesn't stop there. Under the Clinton Administration the BLS stopped measuring a basket of goods and started substituting. For instance, when the price of steak rose they would substitute hamburger. Cost of living was replaced with cost of survival. It was called hedonics. I assume that when the price of hamburger rises they will substitute dog food.
They then decided to change a straight arithmetic weighting of the CPI components to a
geometric one. In other words, the price of goods that are rising will be given less weight in the CPI than the price of goods that are falling.
Once the system had been shifted fully to geometric weighting, the net effect was to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology. The results have been dramatic. The compounding effect since the early-1990s has reduced annual cost of living adjustments in social security by a total of 30%.
Finally, we have the GDP. First of all, even the
government's own numbers don't balence.
The NIPA effectively is a double-entry bookkeeping system, where an item on the consumption side of the ledger, in the GNP/GDP accounts, is offset on the income side of the ledger, in Gross Domestic Income (GDI) accounts. In theory, the GNP and the GDI should be identical. In practice they rarely are, with the latest "statistical discrepancy" showing GNP to be $67 billion, or 0.6% higher than the GDI.
Secondly, the lower the price inflation rate, the higher the GDP. So with the price inflation rate so heavily deflated, the GDP is overstated by default. But that wasn't good enough for the federal government. In 1996 they shifted from a fixed-weighted to a chain-weighted basis. This increased the GDP by a further third of a percent.
And then there are the
numbers that simply vanish into thin air.
Over the last two decades, US residents have sold a total of about $5,500bn worth of IOUs to foreigners, yet the officially recorded net investment position of the US has deteriorated only by a little more than half of this amount ($2,800bn). The US capital market seems to have acted like a black hole for investors from the rest of world in which $2,700bn vanished from sight - or at least from the official statistics.
How can $2,700bn disappear?
There are lots of other numbers that can't be believed, like productivity, poverty, etc. But I don't have the time to explore all of them, and I think you get the point.
Fun with Bankruptcy
You may have noticed I didn't bother to address the federal deficit/debt. That's because the Federal Reserve Bank of St. Louis did for me just the other week.
This partial-equilibrium analysis strongly suggests that the U.S. government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.
[...]
The Gokhale and Smetters measure of the fiscal gap is a stunning $65.9 trillion! This figure is more than five times U.S. GDP and almost twice the size of national wealth. One way to wrap one's head around $65.9 trillion is to ask what fiscal adjustments are needed to eliminate this red hole.
The answers are terrifying.
The $65.9 trillion gap is all the more alarming because its calculation omits the value of contingent government liabilities and relies on quite optimistic assumptions about increases over time in longevity and federal healthcare expenditures.
You see, it really no longer matters what the federal government says about its deficits and debt, the outcome is already decided for us. So how is this all going to play out?
First of all, it's good to keep in mind that foreign lenders have been keeping our economy afloat during the Bush Administration. Just since Bush took office,
foreign holdings of our debt have gone from 35% to 50%. The average American family owes foreign governments over $30,000, most of this owed to Japan and China. With the current account deficit now reaching towards $800 Billion a year, its only a matter of time before foreigners decide that they own all of America that they want. What would cause them to sell dollars?
The
top reason for them to buy our assets in the first place was the strength of our economy. A secondary reason was the sluggishness of the Japanese economy. Well, our economy is going into a recession and Japan's isn't. Probably the scariest part is realizing just how vulnerable we are to a real estate downturn. Compare these two charts.
Notice how the places where Interest-Only mortgages coming due are most concentrated in areas where homes bought as an investment are also most concentrated. Then notice how the
glut of homes for sale has simply never been higher in this nation's history. Then add in the fact that the National Association of Realtors themselves are expecting
home prices to drop in the coming months.
What we are looking at is a real estate bubble that is approaching a pin. What will foreign investors do with all those dollar assets? I don't know. But you can probably bet that it won't be good for you and me.