Those four words shaped the 1992 Presidential election when Bill Clinton successfully unseated Bush Sr.. I was listening to NPR earlier this week, there was an interview with Dan Heath, the author of Made to Stick: Why Some Ideas Survive and Others Die. James Carville, Democratic party strategist, wrote these famous four words on a white board and instructed Bill to speak of the recession and make voters think, It really is the economy.
I have wanted to do a blog on this subject for while, it is the reason why I don't give a DAMN about most economic numbers that are reported. This includes CPI, Unemployment, you name it. Often times, friends of mine will use numbers reported by major media outlets to support an idea, this is called Confirmation Bias. Robert Reich, in his personal memoirs wrote: "That they found in their polling that if you could overstate economic growth, understate inflation, tell people things were better that thy really were, it could help you win in a tight election." For the same reason that Mr. Kudlow defines God as "3% inflation and 4% unemployment" numbers are manipulated to overstate economic growth and understate inflation.
Bringing me to the topic of today’s advice, Do not be fooled! Often times I come across an article that really changes my perspective, I came across one early last year titled "Shadowing Reality" by John Williams, a practicing economist doing private consulting for the past 25 years. Originally, I wasn't surprised much, but I recently re-read it, and came to appreciate it more. For the sake of being un-bias and staying true to purpose of this blog (value investing) today will be the only time this blog has anything to do with politics. I apologize for the minor U turn today, but I think it serves a great purpose.
I will quote Mr. Williams frequently.
The two types of manipulation include:
- "A systemic manipulations where methodologies are changed. Again, the methodologies almost always have an upward bias in growth and a downward bias in inflation- and that's not coincidental.
- The other type of manipulation is when someone does something to the numbers to make them come out a certain way at a certain time."
That makes sense and I think most people realize that when CPI is around 3%, it is comical and there are reasons.
"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. There are in-fact reasons for the disconnect between official statistics and what the populous is feeling."
This is true because:
- "Elements of the CPI actually have roots that go back to 1888, when an index was created to measure the effects of a tariff act, and it was used in WWI to help in set wage scales for shipbuilders." and
- "Government thought process [is] "Well, we can get rid of the bad news here, or make it look a little better, and that might help us in the next election."
This is the part that gets really interesting, how every administration since Kennedy has tweaked numbers here and there to overstate economic growth and understate inflation, so let’s start!
- Kennedy Administration (61-63) - "[They] redefined "unemployment" and created a category of unemployed called "discouraged workers." if you were unemployed and you'd given up looking because there was no work to be had, you were counted a discouraged worker- but taken out of the unemployment count. They still counted you, at least until the Bill Clinton admin."
- Johnson Administration (63-69)- "One of my clients was an economist at the Commerce Department during the Johnson years and he says that when ever Johnson got the GNP report, he would look at it- and if he didn’t like it, he'd send it back. And he would keep sending it back until the Commerce Department got it right!"
- Nixon and Ford Administration (69-77) - "Mr. Nixon did not like the Labor Department. His thought- I don't want to get accused of insensitivity here, but quoting the NYT on this- Nixon thought there was a 'Jewish Cabal' at the Bureau of Labor Statistics."
- Carter Administration (77-81)- "Inflation was understated" (as a side note: this is greatly due to some of the problems we face now, back then oil shot up because of political turmoil)
- Reagan Administration (81-89)- "There were mythological changes made to the GNP- and there was an actual over manipulation of the trade data following the stock market crash in '87. At the end of that year, as the dollar was crashing, manipulating the trade data was part of an effort to turn the dollar to the upside. There had been a series of real bad trade numbers, and they psyched out the markets by coming up with a really good trade report. It amounted to a massive intervention but they succeeded in bottoming out the dollar and successfully turned the market. It was a very dangerous time and I guess you could justify that intervention on the basis of national security or economic security."
- Bush I administration (89-93) - He had a real tough reelection campaign. He had a recession weighing against him, what happened is that a senior commerce department official went to an old friend, a high-level executive in the computer industry, and said, "Gee, we've got to get the President re-elected. We want you to boost your sales reports to the Bureau of Economic Analysis." That happened. It spiked the GDP numbers. I knew people involved in getting it done, ones on the outside of the Bureau of Economic Analysis. And I've confirmed separately with people inside the bureau of Economic analysts that it happened."
- On Unemployment
- "Well, we really need to define discourage workers, so if anyone has been discouraged for more than a year, we're just going to take them out of all the number, take them out of the workforces completely". In doing so, they knocked about 5 million unemployed out of the broader measures of unemployment. Today there are seven or eight unemployment measures that are published each month.
- On CPI
- "They changed the weighing method of the CPI. It had been constructed using the arithmetic weightings, which meant doing things the way most people would add and subtract and divide. The BLS changed it to a geometric weighing, which 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. That change was implemented over a period of several years. The rationale was that it was a way of approximating the substitution effect. But it isn't. I mean it is just a pure mathematical game."
- On Unemployment
- "There was a period during the
- Bush II administration (2001-2009)-
- On CPI
- "They introduced what they called the chained, or C-CPI-U, as an alternated CPI measure. And this measure, the C-CPI-U, is a direct measure of the substitution effect. It is running a half a percent-to a percent blow the official CPI-which is running, oh, about 2.7% below where it was before the weighing changes were made in the Clinton Administration. All in all, 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. The difference that it makes is significant: if the same CPI were used today as was used when Jimmy Carter was President, Social Security checks would be 70% higher.
- On Social Security ("SS")
- "Back in the mid- 1979's, what were then the big 10 accounting firms (Now 4) decided in good public spirit that they would help the federal government set up its books on an accrual basis so that it could prepare financial statements and report its business the same way that a company does, but something was throwing the statements off-accruals for SS, SS got thrown into the footnotes. Every year since then, these statements have been published, and to the credit of the Bush II administration, the recent ones have even included indications of what the social security numbers would look like, if they were included in the accounting, similar to the way corporations show pension and retiree benefit liabilities."
If the subject is manipulation, no matter how incompetent he is, it would be a travesty to leave him out of this post, he would be Mr. Greenspan.
- There was a very deliberate effort in the early 1990's under the auspices of Michael Boskin, who at the time was the head of the council of Economic advisors, in conjunction with Alan Greenspan, who, of course, was Fed Chairman, to "fix" the CPI. The story, very simply, was that CPI was supposedly overstating inflation. The pitch was that if people go out to shop and find that buying a steak is getting expensive, they buy hamburger instead. Therefore, their cost of living is really less than it would be if they always had to buy a fixed basket of goods, which is what the CPI was originally designed to measure. That was the whole purpose of the CPI, to measure the change in the cost of a fixed basket of goods over time. You'd have a steak, a loaf of bread, and a gallon of milk, whatever. You'd price them out one year and then you'd price out exactly the same goods the next year. You'd look at the difference in the cost and that was your annual rate of inflation. It was a measure o how much the cost of a consistent and constant standard of living was going up. What Boskin and Greenspan argued was, "We should allow for substitution here because people can buy hamburger instead of steak, when steak goes up." the problem is that if you allow substitutions, you aren’t measuring the cost of living, your measuring the cost of survival. You can keep substituting down and have people buy dog food instead of hamburger. The reason substitution of the items in the CPI basket became a hot topic in Washington at the time- and it was talked about very openly- was because the CPI was (and is) being used to adjust social security payments to compensate for increases in the cost of living, and tamping it down would hold down Uncle Sam's outlays."
- "When it comes down to it, Mr. Greenspan fueled the remarkable credit and stock market expansions of the 1990's, which turned into bubbles, because he knew that there was a basic problem in the consumer not having adequate income to sustain economic growth from more traditional sources; he used the stock market to try to fuel the economy."
The next interesting part was the Hedonic Adjustments; I know Bill Gross wrote an expanded version of this a while back.
- The BLS says the price really isn't going up, as long as the product has been improved in the interim, because you're getting greater benefit from it. After they finished with their hedonic adjustments, the "price" might even be down, particularly for things like computers and other electronics. My favorite example of this, even though it has gotten a little old, is just a perfect illustration of how government works. Sometime in the 1990's, I don't remember the exact timing; federal air pollution regulations were put in place that mandated adding a certain additive to gasoline, which increased the price of gasoline by 10 cents a gallon. Now, because air quality was supposed to be improved by this additive, that 10 cents per gallon price rise was NOT counted in the CPI. That was a hedonic adjustment for the improved quality of the gasoline. The irony is that they later discovered that the additive did not work as advertised and had to pull it out of gasoline- and I'm pretty sure the price of gasoline didn’t go down by a dime a gallon when it was pulled out. " this is also because:
- When gasoline prices go up at the pump because of rising oil prices, they are very slow to show up in the CPI, yet when oil prices come down, immediately you see a drop in the CPI and the downward pressure on the gauge. Gas stations are generally slow to lower prices, but very quick to raise them.
So there you have it, I think anyone who reads this blog has above-average intelligence and should not be fooled by some of the numbers that are reported on a daily basis. I want to add a few thoughts that are more current.
With crude oil above 70, currently the OPEC countries have made statements regarding how mad they are of all the Green talk (renewable energy, ethanol, etc.). Thus, they have made plans to reduce capex (capital expenditures). This is important because now they have two headwinds coming at them from two different directions:
- Profit tax, which in my opinion is just stupid.
- Green energy
This means that numbers reported from here out will try hard to understate inflation, but I actually believe that now they are out of control because the Agricultures have joined the price increase party. For the past three years, farmers had a favorable view from the public because of the introduction of ethanol, that is about to change. Consider this, raw foods through April had increased 26%, and by May: 31% for the year, that means that processed foods will undoubtedly increase soon and the consumers will be hit in the pockets. But please, don’t wait for the CPI numbers to portray the true landscape.
Lastly, my last blog post Cancer and Random Gleanings had the number of lenders imploding (82) in relation to the Subprime mortgage problems. I want to update that number, currently it stands at 92! Take it for what its worth, three weeks ago I stated that problems were not over, and by luck I was right. Since then, the problems of Bear Sterns have hit Wall Street in the gut at a 12 to 1 leverage, they have yelled "Fire" in the movie theater, and we shall see who gets a chance to leave.
I also stated, "Currently, Financials represent a little over 20% of the S&P 500, with I.T. another 15%. I think that the financials could really feel some pain in the coming months and this isn't a forecast, I'm willing to go out on a limb and make it a guarantee. I think their models, based on credit spreads are not weighing the risks of credit contraction with enough emphasis. There is also that subprime mess that has been checked off as a non-concern, but with Mortgage rates rising, will be a problem." Because I thoroughly believed my research, I purchased some Puts on an index that tracks all the financials a week after. My search was for the most illiquid contracts as far out (Jan. 2009) deep out-of-the-money. Currently, it is up 30% net commission, this was an insurance purchase.
Have a great weekend everybody, hopefully I can get a chance to write another post next week. I will close with this quote:
"Liquidity is ultimately a coward. There's always too much when it's least needed and it's nowhere to be found when needed the most."
Thank you,
S.K.
