Several times a week the market stands transfixed in anticipation of some government statistic to be announced. Figures such as unemployment, CPI, PPI, or GDP often don’t correlate to my perception of economic realities. I’m going to walk you through a thought process to demonstrate the inconsistencies of government statistics to reality.
Reflect for a moment on how the temperature feels outside. I am writing this chapter in July—so I know it’s hot. I’m an economist and market strategist, not a meteorologist. But if I had to speculate, I would say it’s about 95 degrees. What if I glanced at the temperature gauge and it read 70 degrees? My first assumption would be that it’s broken. Then I get in my car and that gauge is also reading 70 degrees. I turn on the radio and hear “it’s a comfortable 70 degrees out.” Really? I don’t feel comfortable—it doesn’t feel similar to what I discern as 70 degrees. All my friends are complaining about the heat as well, but the official data doesn’t corroborate what we feel and know to be true. To us, it’s a heat wave! I pick up the paper and there is a headline that reads “Another day of moderate weather.” I go on TV and make mention of the heat and the weather pundits argue, “Pento, it’s 70 degrees out. What heat wave are you talking about?” I assume there is something wrong with me and my friends.
Why are we boiling when every official piece of data I hear or read about dispels this as truth?
I consult the Internet to investigate my problem and find in an obscure publication that the government has changed the way it gauges temperature. They have made adjustments to the methodology and instruments to get what they think is a more accurate measurement. Of course! More government manipulation of data—this is just like inflation. Gauges of temperature, just like government statistics, are useful. But I don’t need a thermometer to tell me it’s hot, just like I don’t need a government bureaucrat to tell me there is no inflation!
Take your family out to dinner and a movie. You don’t need an inflation index to tell you a modest night out for a family of four is expensive and getting more so. I don’t need some Washington number cruncher to factor in substitutions to make my grocery bill more palatable—I understand that feeding my family is becoming more expensive. I grasp the costs of my family’s health insurance, auto insurance, cable bill, electric bill, water bill, property taxes, and the future cost of my children’s college education. I know what my life costs—I live it! I inherently recognize that the cost of living my life is increasing in the same way I know that it’s hot outside.
When I look at measurements of growth and inflation disseminated by government agencies, those measurements don’t accurately reflect the reality I perceive. When I speak to people who are not in the profession of inundating themselves with government statistics, I garner their sentiment to be closer to mine. Therefore, I have set out to counter the myth of government measures of inflation—CPI—and growth
—GDP.
The CPI is the broadest measure of consumer price inflation for goods and services.
Over the past 30 years the government has shifted its method of reporting in an effort to depress reported inflation, making the CPI an inadequate measure of the costs needed to maintain a constant standard of living. A bias in CPI affects all sorts of things like estimates of growth in output and productivity, median income, and real wages; it alters the growth rates of government spending programs that are indexed to inflation like Social Security. CPI has major consequences for the prediction of government budget deficits and national debt. An incorrect calculation in CPI produces misleading estimates of inflation for monetary policy makers for whom the inflation rate is a critical target. CPI influences estimates of poverty rates, and it clouds comparisons of the comparative economic performance of nations.12
We hear all the time that fat has been replaced with the evil trans-fat, that sugar has been substituted for high fructose corn syrup, or that wheat isn’t the same as it was 30 years ago—it is hybridized. It may surprise you to learn that the CPI, much like fat, sugar, and wheat, isn’t the same as the CPI that you and I grew up with. This isn’t your father’s CPI. The ingredients in CPI have also changed.
In the early 1990s, Washington was inspired with the principled, albeit today novel, concept of a balanced budget. In an effort to reduce expenses, they moved to change the nature of the CPI. The Boskin Commission was established with the directive to prove that the CPI overstated inflation. The plan was to reduce cost-of-living adjustments for government payments to Social Security recipients and so on. The cuts in reported inflation were an effort to reduce the federal deficit without anyone in Congress having to do the politically impossible: to vote against Social Security. The changes afoot were publicized, albeit under the smokescreen of academic theories.
The 1990s was a decade of growth and prosperity, and a balanced budget was certainly a noble cause. However, this highlights the unintended consequences of government manipulation. Given the strong and stable dollar of the 1990s, it is unlikely that the Boskin Commission could have predicted that over a decade later we would have a counterfeiter at the reins of the money supply of the likes of Ben Bernanke. They may not have anticipated a Fed that would recklessly print money
using their now deflated inflation statistic as cover.
Muddling through the derivations of government calculations is about as dry as economics gets. So to have some fun with this, I am going to present a narrative in order to illustrate how CPI was doctored over the past 30 years.
Take a rather average man—we’ll call him Herb. Herb lives by himself and is a creature of habit. Every month Herb makes no changes to his consumption—he eats the same foods, lives in the same place, watches the same amount of television; he lives a completely monotonous life. If a new product is introduced in the marketplace, it takes Herb at least 10 years to adopt it. Herb’s consumption for this illustration is considered by the Bureau of Labor Statistics (BLS) to be a basket of goods. According to how the CPI had been calculated, if in 1980 Herb spent $500 a month to maintain his lifestyle and today he spends $1,000 a month to maintain that same exact lifestyle
—that would be an easy measure of his inflation—it now costs an additional $500 for Herb to maintain a constant standard of living under the old calculation.
The BLS know that few in this country, if any, live the life of my fictitious Herb, and they distort the national basket of goods to their advantage. The actual calculation is, of course, more complex; local and regional surveys are taken, but this is just an illustration. Let’s see how the new calculation of CPI affects Herb’s life.
Herb washes his clothes exclusively with Tide detergent. Every month he purchases the same size bottle of Tide detergent for $5. One day he goes to the store and his regular Tide detergent has been replaced with “New and Improved Tide.” The new and improved Tide also comes with a new and improved price of $6. Herb, being the creature of habit that he is, doesn’t want the new and improved—he prefers the old and outdated. But Herb has no choice; he must purchase the Tide with the so-called improvements that he doesn’t need and that don’t really work. So he pays the additional $1 out of pocket for all the superfluous improvements. To Herb, his out-of- pocket expense just went up by $1, but to the BLS his basket remains unchanged—
they don’t view improvements as an increase in Herb’s basket of goods.
Before the change, what a consumer paid out-of-pocket for goods and services reflected adjustments for quality changes that could be directly quantified in a monetary sense. So if Herb were to get an additional eight ounces of detergent—that increase in quantity could be directly quantified. The BLS expanded quality adjustments to include the concept of “hedonic” quality adjustments, altering the pricing of goods and services for nebulous quality changes that could not be priced directly and that often are not viewed or recognized by the consumer as a desired improvement. When the BLS deems a quality improvement, it adjusts the price lower to reflect the quality—even though the consumer may not deem the improvements to the product as improvements to their life.13
Poor Herb is still a little shaken from the improved Tide episode. He enters the meat aisle to get his favorite sirloin steak, and as he places his hand on his coveted steak, he comes to the shocking revelation that his sirloin has turned into chop meat. Herb, still stunned, notices there is a sign on the case that notes, “This item has been substituted in an effort to aid in the price moderation of your basket of goods.” But this isn’t a reasonable substitute for Herb. He loves his sirloin—he hates chop meat. Herb isn’t
pleased with his substitutions, but he is compliant. Unfortunately, this happens month over month and year over year, and soon Herb’s new basket of goods barely resembles Herb’s old basket.
Historically, consumer inflation has been estimated by measuring price changes in a fixed-weight basket of goods, in an attempt to measure the cost of maintaining a constant standard of living. Allowing for the substitution of lower-priced and quality goods effectively lowers the reported rate of inflation versus the fixed-basket method.
The BLS introduced geometric weighting—a purely mathematical ploy that automatically reduces the weightings of goods rising in price.14
All these substitutions and improvements have Herb very shaken. Unfortunately, things are about to get a lot worse. Due to high gas prices, the BLS is demanding that Herb drive only out of necessity. Herb is a recluse—so the only time he drives is out of necessity. However, the BLS has a broad definition of what qualifies as necessity.
When Herb attempts to utilize his car for his weekly excursion to the grocery store, which is already becoming very stressful, a bus pulls up. The driver instructs Herb to get in. Herb reluctantly complies, but to make matters worse, instead of heading to Herb’s regular store the driver heads to the “outlet store” on the other side of town.
The driver informs Herb that the BLS has determined that Herb needs to better utilize the discount and outlet stores in an effort to further reduce the cost of his basket.
Another change introduced was a reweighting of sales outlets (discount/mass merchandisers versus Main Street shops). The assumption is that consumers are making better use of discount and outlet stores, and therefore those price reductions need to be more appropriately applied to the price of goods in their CPI calculation.
As a result of government manipulation, Herb’s stable, monotonous life has become almost unrecognizable. Herb peruses the local paper and reads the headline—CPI remains little changed year over year. To Herb, the basket has changed considerably and his standard of living has decreased—but to the bureaucrats concocting the figure, the basket showed little to no change. Funny how the government feels there is no need to factor in reverse hedonics into the calculation.
This illustrates the modification in the new way the CPI is calculated that challenges the theory of the “constant-standard-of-living measure” in favor of what the bureaucrats would define as a “constant level of satisfaction.” The constant standard of living meant the consumer was able to consume the same goods in the same quantity, without having to trade off quality of living versus price. If you think things haven’t changed over the past 20 years in the CPI calculation, tell that to Herb!
Now, you may be thinking: maybe Herb should lighten up or just get treated for his obsessive-compulsive disorder—what does this have to do with me? According to John Williams’s Shadow statistics, an electronic newsletter service that exposes flaws in current U.S. government economic data and reporting, the true inflation (using the same methodology as 1980) runs as much as 7 percent above inflation calculated using today’s metrics.15 So a good “rule of thumb” is: When you walk outside and you perspire—it’s hot. And when your reach for your wallet and it feels like you’re paying more—its inflation!
A manufactured benign inflation number provides Banana Ben carte blanche to
counterfeit under the guise of low inflation. allowing him to perpetuate a huge bubble in the bond market. A modest inflation reading also obfuscates another government measurement: GDP. GDP is the gross domestic product—the output of goods and services produced by labor and property located in the United States. It’s a snapshot of a nation’s prosperity.
One of the reasons it is imperative to accurately calculate inflation is that you need a true reading on price increases in order to get a true reading on economic growth. If we used an accurate inflation rate to deflate nominal GDP, it would have certainly settled the argument as to whether the economy is in recession. According to my calculations, we have never escaped our recession. Since most investors are bound by official government data, it is important to realize that GDP is calculated using the chain-type price index, which is an even more tortured inflation measurement than the CPI. Even though the CPI is a flawed number, it is a better estimate of inflation than the chain-type price index because the chain-type index allows substitution between categories, while the CPI is limited to substitution within a specific category. Using the chain CPI, when Herb reaches for a light bulb, they give him a Bic lighter.
Consumers are cognizant that their individual rates of inflation are much higher than the official reported data. The two most important points to take from that fact is that the economy is much slower and inflation is much higher than what is generally accepted.
Using his license to counterfeit, Bernanke can influence an increase in nominal GDP without propagating true growth. However, it is unclear from statements that he makes that he understands the difference between inflation and growth.
It is a sad situation when everything the man in charge of our central bank professes to understand about inflation is wrong. Mr. Bernanke does not know what causes inflation, how to accurately measure inflation, or the real damage inflation does to an economy. He, like most central bankers around the globe, persists in conflating inflation with growth. The sad truth is that our Federal Reserve believes growth can be engendered from creating more inflation.
However, in reality, economic growth comes from productivity enhancements and a growing labor force. Those two factors are the only way an economy can expand its output. Historically speaking, the total of labor force and productivity growth has averaged about a 3 percent increase per annum in the United States. Therefore, any increase in money supply growth that is greater than 3 percent has historically caused rising aggregate prices.
That’s why money supply growth should never be greater than the sum of labor force growth plus productivity growth. Any increase greater than that only serves to limit labor force growth and productivity. Since Bernanke doesn’t understand that simple economic maxim, he persists in his quest to destroy the value of the dollar.
Perhaps that’s why the Fed head has decided to keep interest rates at zero percent for at least six years, despite the fact that the growth in the M2 money supply is already north of 10 percent year over year.
Maybe Bernanke believes that a replay of the entire productivity gains from the industrial and technology revolutions will both simultaneously occur in this year. Or
perhaps he feels that the millions of unemployed individuals laid off after the collapse of the credit bubble will all be rehired in the immediate future. What he also fails to understand is that consumers are in a deleveraging mode because their debt as a percentage of income is, historically speaking, extremely high. So regardless of how much money Bernanke counterfeits into existence, it won’t lead to more job growth or capital creation—just more inflation.
There is little doubt that global economic growth is faltering. Most of the developed world is mired in an incipient recession. If inflation were reported more accurately by our government, the United States would also be in recession.
But this is the age of a very dangerous global phenomenon, where central bankers view the market forces of deflation as public enemy number one and inflation as the panacea for anemic growth.
There is an all-out assault on the part of global central banks to destroy their currencies in an effort to allow their respective governments to continue the practice of running humongous deficits. In fact, the developed world’s central bankers are faced with the choice of either massively monetizing sovereign debt or to sit back and watch a deflationary depression crush global growth. It’s clear that Bernanke has blatantly chosen to ignite inflation, and his adamant proclivity for inflation is not only leaving our economy in the throes of stagflation, it has also created a colossal bubble in the bond market.
The myth that you can trust government statistics—BUSTED!