The Real Financial Numbers Behind the Lies

From http://moneycentral.msn.com/content/P146055.asp?Printer

The Real Financial Numbers Behind the Lies
Bill Fleckenstein
MSN Money
Friday, March 7, 2008

Fun with numbers.
Corporate America likes to play that game, the better to boost stock prices. Folks might be surprised to learn that "Governmental" America also plays the game in its compilation of macroeconomic data. Beneath the surface are undesirable, sobering consequences for us all.
Last weekend, the always-terrific Kate Welling published an interview with an economist named John Williams. It will be available on the free portion of her "pay" site via this link starting March 11. This article is the first one that I have seen in which all the flaws in the government data, pertaining to the Consumer Price Index, unemployment, Gross Domestic Product, etc., are disclosed in one piece by someone who's been following the data for a long time.
I have been aware of nearly all the statistical tricks used by the government since they were implemented. Nonetheless, seeing them collectively described in one article is incredibly sobering. Having said that, there is a bit more "black helicopter" insinuation and fewer data points than I would like to see in an article such as this. However, the main points are the math that most folks need to know, but likely do not.
(Article continues below)
Once you read it, think about it and understand it, you will see why so many thoughtful people -- like Jim Grant, Warren Buffett, Marc Faber, Bill Gross, Fred Hickey and Paul Volcker -- have grave concerns about the future of the dollar (due to the macro imbalances that exist today).
In fact, reading this article, you will conclude that there's no way out, short of running the printing presses. The problem with that end game: At some point, foreigners will revolt. One can only hope that, somehow, there will be a way out. But without an understanding of the issues, folks will have no way to react as events unfold, and adjust their assets as we get more clues as to how all this will play out.

Thus, I would encourage everyone to print out the article and read it as many times as necessary, in order to gain a full understanding of the issues. Since we don't know at what rate some of these problems will start to impact the markets, all we can do is be prepared -- by having our insurance policies (in the form of the metals and foreign currencies), and then being alert to signs that the beginning of a chain reaction may be under way. Meanwhile, to pique folks' interest in the article, I'm going to take the time to provide some "Cliffs Notes" here.
Jobs data don't count the down-and-outWilliams starts by discussing the headline economic data: "Real unemployment right now -- figured the way that the average person thinks of unemployment, meaning figured the way it was estimated back during the Great Depression -- is running about 12%. Real CPI right now is running at about 8%. And the real GDP probably is in contraction." (By "real," he means calculating the data the way they used to be calculated, not as inflation-adjusted.)
He then explains how the employment data are compiled, noting that 5 million chronically unemployed people are not included in the statistics. In fact, there are seven or eight different employment statistics. One called U-3 is the official one. The broadest one, U-6, currently shows unemployment as running around 8.4%. As he explains, the one that's the most historically consistent is running around 12%.
On the Potomac: Reverence for reverse-engineeringWilliams differentiates between two data-manipulation practices. One is "systemic manipulations, where methodologies are changed." That's done in order to align the government's view of the world with the world, i.e., make things look better than they are. The second practice is out-and-out fudging of the data to produce whatever result is desired. Williams describes instances where various administrations have literally reverse-engineered the data to achieve that result (though politics is not the main purpose of the article).
For those not familiar with "substitution," he explains the practice's evolution in the CPI calculations. The concept of substitution was a concoction of Alan Greenspan and Michael Boskin, who basically argued that if one item were too expensive, consumers would substitute that with a cheaper one. Williams' response: "The problem is that if you allow substitutions, you aren't measuring a constant standard of living. You're measuring the cost of survival. You can keep substituting down and have people buy dog food instead of hamburger. It happens. But that's not the original concept behind the CPI."
That ticking sound? Social SecurityWilliams says that the government's motive in all of this, if there is a motive (of the government collectively; don't picture a group of men cooking up something in a back room), is its desire to put a favorable spin on all the data.
Another motive? Transfer payments like Social Security are indexed to the CPI, and they would be far higher if the CPI were accurate. In fact, says Williams, if the "same CPI were used today as was used when Jimmy Carter was president, Social Security checks would be 70% higher." That's seven-zero.
Though Williams doesn't get much into hedonics, he does talk about the inflation-understating impact of geometric weighting versus arithmetic weighting in the CPI statistics: "Geometric weighting ... has the 'benefit' that if something goes up in price, it automatically gets a lower weight, and if it goes down in price, it automatically gets a higher weight."

Then for the ticking time bomb: Social Security. The proceeds from withholding do not go into a lockbox or trust fund. They are spent, thereby reducing the size of the stated deficit. More importantly, he notes that the government's accounting for the deficit doesn't include any accruals for Social Security or Medicare liability.
In fact, if that were done and the government used GAAP accounting, the deficits for 2003, 2004, and 2005 would each have been around $3.5 trillion. That's a trillion, not billion. In 2004 alone, the deficit on an accrual basis would have been $11.1 trillion, due to a huge one-time spike for setting up the Medicare drug benefits. In essence, as he points out, we're piling up additional liabilities in an amount roughly equivalent to our total GDP every three years.
Lots of these imbalances have existed for some time, and they haven't mattered. Such macro problems only matter when they matter. Once that point in time is reached, events have a way of swiftly getting completely out of control -- which is why one has to understand the nuances and be alert for potential signs of chain reaction, as I mentioned earlier.

FULL STORY: CLICK HERE