Gross Distortion of the CPI and the GDP

originally posted 2008-07-05 12:04:17 -0500. Bumped by Carol. Didn't want to loose this one just yet. A lively and informative discussion on the meltdown, with no bottom in sight as far as I can see. Kudos Cho for the post.

I have been reading Bad Money, the latest book by Kevin Phillips (Phillips, Kevin. Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. New York, New York: Viking Press, 2008 ISBN 978-0-670-01907-6). More about the entire book later, specifically about the Government's Plunge Protection Team (or more formally the President's Working Group) and how they rigged the casinos during the Savings and Loan bailout, the 1987 crash, and most recently the subprime August 2007 meltdown. For now, I want to share some quick notes about nine key pages. The pages occur in “Chapter 3. Bullnomics: Its Favoritism and Fictions” -- the Bingo! Chapter outlining for me the whys and the hows of the deliberate ruining of the tools used to measure of our economic health. The nine pages in question (80 -89) are in the section subtitled “The Consumer Price Index and Statistical Debasement.” As I have summarized elsewhere, it boils down to simply ….
If you can’t shave the silver coin, put your thumb on the scale. Here, Phillips lays out exactly what the folks who have to actually pay for the items in the so-called market basket which makes up the inflation indexes -- core or otherwise -- have known for a long time… the government statistics are a crock. I am no student of economics, just an ordinary citizen trying to run my household, and as such, even I could tell that something was seriously amiss if the government could exclude energy and food from its calculations of inflation (Consumer Price Index -CPI) but include them in its calculations of how productive and rich we are (Gross Domestic Product - GDP). I just didn’t know how, why, or even what. But like about every other common person on the street, I knew that inflation was no 2% -- how could it be when in just one year I was paying 3 times as much for gasoline at the pump which I had to have --- seems pretty “core” to me – and twice as much for milk, eggs, and other basic essentials of the food grocery bag? Phillips, in clear, easy to understand prose, lays it out. In the past, governments countered inflation by debasing currency: They either printed more (infamously Germany in the 1930s) or reduced the amount of precious metal in the coin (sandwich quarters of the 60s --where only the outer layers of the 25 cent piece remained silver, the “core” became cheaper copper). Phillips explains that the government “clipped silver coins or reminted them with a lower finess – less silver, more of something else.” But, as Phillips suggests, by the 60s, the US had exhausted this technique, since it had already removed silver from its coinage and gold from the backing of its dollar. So instead of changing the coin, they changed the scale.

Until the 1990s, the CPI quite straightforwardly measured the cost of a fixed basket of goods using prevailing market prices. No statistical opportunity for clipped coinage or reminting to a lower standard existed in that constant. (81-82)

The why.

In the 90s, Greenspan was worried about the COLAs (cost of living adjustments) attached to social security outlays which attempted to ameliorate for senior citizens the declining value of their fixed incomes (because of inflation eroding purchasing power). But there was no way that politicians or the country would stomach reducing social security checks, so Greenspan had to find another way. One way was to shorten the spacing between the inch marks on the tape measure, but to still keep calling what they measured "inches." In order to justify lowering COLA adjustments,

"Greenspan and Boskin charged that the CPI overstated inflation…and the Boskin Commission recommended a set of revisions to the Bureau of Labor Statistics, which generally concurred. These changes were implemented between 1997 and 1999, while the public and the politicians were preoccupied by the bull market euphoria and the actions in Congress to impeach" President Clinton. (83)

Side note: A journalist from California, John Williams, (Shadowstats.com) calculated the CPI using the old measuring stick and published those figures beside the new measurements: “if the methodology used in 1990 still held sway, the government would have been reporting 5 to 7 percent inflation between 2005 and 2007” (84)

The How

According to Phillips, the sleight of hand seems to have succeeded by using three to four deceptions. Geometric weighting
In geometric weighting, prices going up (such as the price of hamburger) automatically received less weight in the overall computation of inflation. Despite this obvious technique of using one hand to lift up one side of the scales to distort inflation numbers, no one seemed to squawk. To make matters worse, nobody even notice the thumb of the other hand on the other side of the scale to make sure that prices going down (such as corn in a bumper crop year) received more weight. All these new-fangled statistics erased the impact on the indexes of the long-recognized habit of consumer substitution – in downturns, consumers buy down: instead of hamburger, they buy the cheaper chicken. Yet now that “trend” was magically factored to reduce even further the evidence on inflation numbers. Hedonics
Hedonics is the name for the government’s attempt to measure “pleasure” and factor it into the inflationary statistics. Essentially, hedonics attempt to show that the value (because something is now more pleasurable) of the same item produced previously (say, a television set) is now intrinsically more and thus its higher price isn't solely inflationary, there's more more. So a new television set in 2000 priced at a 10% increase over a similar television set in 1999 must have the inflation factor ameliorated because the 2000 set has technological advances that provide more pleasure, and thus it isn’t really as inflationary as the straight numbers indicate. But as Phillips points out, “Caught out on a limb, the government dropped its large-sale hedonic reduction of computer prices in 2003 after a critical letter from the National Science Foundation’s Committee on National Statistics.” (84) Hedonics falsely

ballooned computer sales and thereby artificially enlarged GDP growth. The government, it seemed, decided that between the second quarter of 2000 and the fourth quarter of 2003, real tech spending had risen [from $446 billion to $557 billion] by $111 billion. However, in nominal (price tag) terms, it had climbed only from $42 billion to $88 billion. The BEA [Bureau of Economic Analysis] hypothesized the rest to represent the added value it perceived in computer quality!” (85)

Phillips points out that although there is a legitimate argument for hedonics, it makes comparative data useless. As he surmises: we didn’t include hedonics in our computations for the 50s…so doing so now is to compare apples to oranges. Owners Equivalent Rent
The “third fiddle,” as Phillips calls it, has to do with how home ownership numbers are calculated. Housing represents 40 percent of the CPI – but the new “silver shaving” technique, their housing costs were calculated are now based on what a homeowner can get if s/he rents the house out. This new figure does not consider adjusted mortgage rates as having any impact on housing costs. It does not include the interest rate on mortgage debt. It doesn’t consider rising taxes or insurance on housing cost. So Phillips posulates: if the Smiths bought a house they rented for 2000 and now had to pay 3000 a month when including interest, taxes and insurance, as far the CPI is concerned … its cost is 2000. Again, not the real dollar amount that ordinary folks have to pay in the marketplace. Under the aegis of “Removing Volatility” from the CPI -– those Bush administration guys are a laugh a minute, that’s like “Removing Nutritional Benefits” from Food -- even the soaring costs of health care premiums can be reduced to look manageable, despite still appearing steep. Phillips notes John Wasik (of Bloomberg News) comments

Since 2001, health premiums have risen 78 percent while wages have only gained 19% The government’s inflation measure during that stretch was 17 percent.

Fortunately, though sadly, the government’s numbers are finally being openly mocked in the financial press. As Michael Shedlock wondered in an analysis:

“TOAD – the Total of All Distortions – in the U.S.GDP (Gross Distorted Procedures) and surmised that the real TOAD is far uglier than what the government admits.” (88)