Investing In a World of Make Believe
In recent years, a high degree of economic, financial and political uncertainty has resulted in acute volatility in stocks, real estate, commodities and precious metals. I believe that another aggravating factor has been the increasing skepticism through which the investing public views government statistics and statements.
To make prudent decisions, investors need to know key economic indicators such as economic growth, inflation rates, unemployment levels and the real cost and value of money. For the past 20 years or so, the key assumptions behind the calculation of these figures have been changed, or more accurately distorted, in favor of government image.
Perhaps the most important government statistic for investors is the inflation rate. The precise degree to which money is depreciating is the bedrock upon which all other financial determinations rest. The inflation rate is the prime input that determines the discount rate used for calculating the real present value of investment returns.
The basic US inflation rate is published in the form of the Consumer Price Index (CPI). This purports to represent items selected to represent the spending of the average US citizen. But a closer look reveals some troubling distortions. For example, health care expenditures are weighting at just one percent of spending. Americans who are struggling with obscenely high medical costs will recognize this as absurd on its face.
In addition to weightings, the actual price increases are largely arbitrary. For example, if the price of an automobile rises by 20 percent but is 'assumed' to have added technology that equated to three-quarters of the higher price, the price is deemed to have risen by only 5 rather than 20 percent. (See Peter Schiff's mid-January article that shows, among other things, that the government reported newspaper and magazine prices to have risen just 35 percent over the past 12 years while actual prices rose by more than 130 percent.)
For the past few years, the Fed has maintained that the US inflation rate, which is represented by the Consumer Price Index, or CPI, has hovered around two percent. Most consumers who buy food, goods and services such as health in the real world will find this figure derisory.
However, Shadow Government Statistics (SGS), an independent data service published by John Williams, calculates key US Government statistics according to the methodology used during the years before the election of President Clinton. Using those yardsticks, SGS shows the US inflation rate over the past few years has hovered around six percent, or three times the declared Government rate.
The inflation rate is key also to calculating the key economic growth rate, or GDP. By deflating the nominal GDP by the Government's 'official' 2 percent inflation rate, the US economy shrank by some 0.5 percent in the last quarter of 2012. But if a higher, and I believe more accurate, 4 percent inflation rate had been used, the US economy would have been seen to regress by 2.5 percent. At that rate of inflation the paltry yields paid on bank deposits, and by 10-year US Treasury bonds, are currently in deeply negative territory.
Regarding stock markets, the Dow passed 14,000 last week, to great acclaim. However, if discounted by the 'official' CPI of approximately two percent per year the Dow would have to reach about 15,400 to equal its October 9, 2007 high of 14,165. But discounted at a 4 percent per year inflation rate, the Dow would have to stand at more than 17,500 to pass its all time high in real terms.
Of course, the low inflation rate also provides the government with breathing room on the fiscal side. Low inflation keeps a limit on the increases that federal agencies are required to pay out to beneficiaries of programs such as Social Security. With the budget so tightly constrained by huge deficits, the low inflation data is essential to government planners.
More chicanery can be seen on the unemployment front. The government currently claims the unemployment rate to be at just 7.9 percent. But when calculating unemployment using the pre-Clinton methodology, SGS finds it to be around 22 percent. SGS does not exclude, as the Government does now, all those who have left the workforce out of despair of finding a job, or those who who have accepted part-time jobs in lieu of full-time employment.
A world of politically manipulated 'official' statistics and misleading Government statements makes investment decisions more difficult. The result is that, despite falsely negative 'real' short-term interest rates and an abundance of debased cash, consumers and corporations continue to hoard cash. While the Dow has in fact surged in nominal terms, the leading US equity funds continue to show significant outflows of investment funds. Rising stock prices have not convinced many Americans to get into the game. This should provide needed perspective on the current media euphoria.
John Browne is a Senior Economic Consultant to Euro Pacific Capital.
Posted by 1776 on 02/08/13 01:22 PM
Ron Paul: I'm Waiting for the Fed to Self-Destruct
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Posted by Friend_of_John_Galt on 02/07/13 06:21 PM
There is a huge amount of statistical bafflegab in the official statistics. They are highly unreliable.
As for inflation, Peter Schiff (in his newsletter) pointed out that in terms of gold, you could have "bought" the previous Dow peak with 19 oz of gold at the time. While the current Dow peak would only require 8 oz of gold...
In a previous career at a major rail carrier, at one point, management of the "rate quotation bureau" was added to my responsibilities. As I studied the ebb and flow of work there, I discovered that each month the Federal agency responsible for calculating the inflation rates submitted a list of a couple of dozen hypothetical movements of various commodities for the freight charges that would be assessed. Remarkably, not a single one of these hypothetical shipments involved movements where actual freight moved.
The importance of this fact is that where there is no actual movement, the basic "class" rates are used to calculate the freight price. Class rates are used as a basic "price for everything" system -- but are not intended to support market rates for actual freight movements. If new origin destination pairs occur, then shippers and rail carriers negotiate market level rates for the movement -- and following regulatory procedures eventually refund the difference between the class rate and the market rate as agreed. In other words, class rates are not intended to move any freight.
So, we provided these class rates to the Feds that they then put into their inflation statistics. The class rates were only adjusted (at that time) on the basis of "inflationary cost adjustments" allowed by the regulators -- based on the "inflation" reported by the government.
Before your head explodes, the clarifying point is that the numbers requested by the government were for fictional movements that nobody would ever use to really move any freight. And the rates would be increased by "inflation adjustments" based on the inflation reported by the government. In the end this was all meaningless number manipulation.