Chapter 2: Signs of Destruction (Part I)
When future historians look back on our way of curing inflation, they’ll probably compare it to bloodletting in the Middle Ages.
– Lee Iacocca
To understand money, it is necessary to study the values we use to measure how much we make, invest, save, and spend, and how those decisions affect our overall well-being. When we talk about personal finance, we will look at the statistics to tell us how we are doing. We monitor stock fund prices and bond yields on our investments, tax rates on our income levels, and income versus outgo for our budgets. These are some of our normal, everyday activities.
But we rarely look at statistics on how the economy is doing. What are the interest rates that we get on our national investments? What amounts do we have coming in and how are we spending those on the most important programs? What numbers tell us that our economic engine is firing on all cylinders? Without understanding how the country is doing, it is very hard to gauge how we personally measure up; it is very difficult to forecast our personal growth if we don’t know how our national economic growth engine is doing. After all, if the nation’s economy is down, we expect less income and job security. We may tighten our belts at home, pay down some debt, and save a little more for that rainy day. Statistics are used everywhere. They are used in government data, scientific studies, advertising, and in the media. It is hard to escape from the endless parade of numbers marched in front of us. We catalog and store more information now than at any time in our history.
The hard part is sorting through the statistics we need and throwing away the ones that don’t matter. For example, if we try to determine what our economic production as a country is, we might look at GDP. If we want to know what inflation will be, we look at CPI. We can find the quoted number for unemployment rather easily online or by watching our local or national television news program.
That was easy to figure out, so we can wrap up this chapter of the book, right? Well, there is one more point we need to make. That is, most of the really important financial statistics you will see, such as the aforementioned CPI, unemployment, and GDP, aren’t entirely accurate. In fact, when you look at them long term, we find that they do not accurately measure what they are supposed to. That certainly changes the picture of our national economic growth engine. Not only do we need to sort the statistics we pay attention to, but we also have to question the validity of the ones we rely on.
It is well understood that statistics can be massaged to support any position. But a simple data point on levels of employment shouldn’t be subject to much confusion. It’s a relatively straightforward concept. How many people are working in the country, and how many aren’t?
We have had good statistical measures for things like unemployment in the past. But they aren’t used in that simple format anymore. Academic institutions have taken the ordinary numbers and turned them into great lab experiments. Often times they do this at the request of politicians, who are the greatest abusers of statistics. Politicians look for ways to manipulate and slice the numbers in as many ways as possible to support their stated need for this or that legislation. Politicians get elected now mostly based upon how much money they can get from our national budget, not based on how many problems they resolve. Using statistics manipulated to support their arguments has become a required path to getting re-elected.
Once we, as the people, figure out the measures have been changed, we realize that the numbers we counted on to take the temperature of our national financial health don’t actually measure what we want them to. What do they measure? How is core inflation different from CPI? How do we compare these more obtuse statistical measures from the simple ones we used in the past?
For example, if we consider that energy prices are no longer part of the national measure on inflation, then how do we know if current inflation levels compare to the 1970s inflation prices, and whether we are doing better or worse in this generation? Do our trend measurements tell us the whole truth, or are they influenced by the new statistics our government wants us to accept?
It is important to note here that we don’t assume the superiority of our measures because they are more complex. After all, it is easy to believe that as our societal knowledge progresses, we always use better approaches in collecting and categorizing data. We may have more ways of examining the data, but we also have more ways of manipulating that data to cover up negative trends.
More often than not, the simple measurements are the most valuable because they take all values in the data into account. We get a better big picture, instead of a more precise but incomplete one. Likewise, the simple measurements are the best ones to use in personal finance. If you want to set a budget, you start with everything coming in and everything going out. Without that big picture, how would you know if you have savings or losses? Once this is understood, you can chop the data up and look at the individual parts.
The main objection to government published data this chapter raises is that the government has already chopped up the data before you get it, so you cannot see the big picture. The government is supposed to be working for the people. However, once a democratic government makes unilateral decisions on what to tell its people, it is no longer serving the best interests of the people.
The good news is that we can actually come up with current numbers using tried and true measures, and we can make solid comparisons to the past to tell us where we are going. It just takes a little work, which is what we do next.
CPI and Core Inflation
Why does CPI matter? First, it reduces what a person can purchase in the long term. In addition, the CPI is the index by which government programs are attached. Today, nearly one-third of the federal budget is indexed to the CPI. Therefore, if the CPI is not accurate, then payments in welfare programs will not track changes in actual inflation. In addition, cost of living adjustments (COLA), such as for wage increases, are often tied to the CPI index. Thirdly, the federal tax bracket is also indexed to the CPI to account for inflation. If CPI is understated, then real incomes will rise faster than the brackets can be adjusted, causing more people to reach higher tax brackets more quickly.
Core Inflation is the new government price indicator which takes out food and energy prices. One reason given for such a change is that these prices fluctuate wildly and lead to misstatements in inflation.
Government Inflation Modification
Substitution
CPI rates have been amended since the Boskin Commission recommended that CPI values were overstated in the 1970s. The Commission concluded that four factors affected CPI rates.
The Boskin Commission told us that the real observed CPI is lower than stated, government-issued CPI because of 1) quality-change bias, 2) outlet-substitution bias, 3) new product bias, and 4) product substitution bias. Let us examine these concepts further.
Quality-change bias: Failure to take into account the improved quality of machinery and technology and only accepting an increase in price of a unit of a product.
Outlet-substitution bias: When consumers go to discount or outlet stores where prices are cheaper than in retail outlets.
New product bias: Not taking into account other substitutes, such as watching a DVD at instead of going out to the movies.
Product substitution bias: Consumers buy cheaper items when higher-end items get more expensive.
The first and most obvious point to make about Boskin is that all four issues reflect the trend of consumer to purchase downward as inflation affects their pockets. I don’t understand in what parallel universe that the members of the Boskin Commission existed when they made these recommendations as a reason to LOWER the CPI. Look, if prices are going higher so that we are not able to afford the same goods we used to buy, then that means we are losing purchasing power. That is not a reason to understate the stated CPI numbers. When you modify CPI to take these into account, you obscure the fact that the prices are not actually falling, resulting in lower inflation. The prices are RISING (in fact faster than incomes are rising), and the consumers are just adjusting their purchases to inferior goods because they have no choice in many circumstances.
For example, the product substitution bias data point seems to confirm this. As items get more expensive, consumers are required to downgrade. This should not adjust the CPI level down at all! It should be recognized by our government, and more importantly by the people, that inflation has become a problem that is eroding our purchasing power.
The quality-change bias emphasizes the increased efficiency of machinery, but ignores why the overall price of the unit may still be higher. If the unit price is higher despite better efficiency, then one can reason the prices of other inputs have subsequently risen. Otherwise, prices would fall with all other inputs being equal! The total inflationary impact is therefore correct when all input factors are taken into account. The quality-change bias is not a bias at all; the Boskin Commission just did not examine all price input factors and instead chose to concentrate on only one of them.
A common public criticism of the Boskin Commission is that it did not take into account that while buying inferior items reduces costs, it also reduces quality of life by the same amount. If the Commission removes this from the CPI value, then the CPI value should have no value in measuring quality-of-life services (e.g., social services), should not be used to adjust tax brackets, and should not be used in cost-of-living wage adjustments. Basically, the Boskin-adjusted value of CPI should be scrubbed completely because it is useless.
Another argument against Boskin is that only the wealthy can buy the new substitute items when they first come out; for example, buying a new DVD or Blu-ray player to play DVDs. This effect may also be muted by lack of market acceptance until the prices of new items come down.
Further, when prices of electronic goods do come down, we should note that they are only periodically purchased by Americans. Left as they are in CPI calculations, these electronic item prices exert a downward pressure on the overall CPI that may actually understate the overall rate because we do not buy them every day like we do food, shelter, and energy. Once a family purchases a DVD or computer, they get declining value on the next one so there will be a true limit on how much electronic prices affect consumer wallets.
Geometric Weighting
Another way in which the government had manipulated inflation numbers is through a process called geometric weighting. When certain goods get more expensive, they are weighted less in the government CPI numbers because it is assumed by planners that people will buy less of said product. The items suffering less inflation are also weighted more heavily in the calculation. Geometric weighting keeps total reported inflation down, regardless of true market choices of consumers and sellers. And like substitution, it hides the obvious fact that if some goods continue to rise in price, higher inflation is a result, which leads to lower quality of life over time.
Hedonics
This is where CPI manipulation gets really subjective and ridiculous. Hedonics is the made-up measure of the additional happiness of a good we get from technical innovation. Say, for example, that a 30” flat screen television cost $600 in 2007. If one buys another television of the same size in 2009 for $650, then we can say we had inflation of $50 in two years. However, the government does not see it this way. The government estimates that because the 2009 television has quality improvements, such as increased resolution, our benefit from the television increases. The government will then reduce the real purchase price of the TV to a made-up value, which is then used in official CPI measurements.
The government-adjusted price of the television may be $450, which, in their view, would reflect a 31% decrease in value for the CPI. The government does this for many products, not just televisions. This lowers the reported inflation rate even though the actual prices of the products we buy are rising.
In a 1997 Business Week article, Gene Koretz states: “Since the start of 1995, for example, Labor Dept. statisticians have modified their treatment of rents, hospital prices, and generic drugs and altered sampling methods for food and nonfood items. These and other changes… have cumulatively lowered the current rate of consumer inflation by 0.2 to 0.3 of a percentage point. What’s more, the process will continue in 1998 and 1999 as the government updates the weights for items in the consumer price index, changes the treatment of computers, and makes other modifications to reflect the prices of new goods.” 1
Consequences
What are the effects of revising the CPI downward? Well, welfare payments, such as Social Security, are reduced. This is a benefit to the government in terms of declining welfare payments in relation to the real dollar value. If the historical CPI index since the 1970s were changed using the new modifications, the data would show that the US has experienced relatively modest inflation and that real wages were not falling. Therefore, it is in the best interests of government to do this to create the illusion that our current economic model promotes prosperity.
The CPI modifications will add up over time. Remember that interest rate changes are cumulative, meaning that a change in year one is thereby multiplied by the next year change and the next year and the next. The real effect is felt over time and indicates why inflation is not felt as hard in the early years but really makes its effects known in later years as all of the small increases have multiplied together into a really large increase.
How Big of a Difference?
The following formula is used to calculate the price increase (P) modified by a rate of interest (R) over a period of time (T).
P = (1 + R) ^ N
Note that the interest rate (R) is added to the beginning value price (set equal to 1), and then raised to the power of number of years (N). As the number of years (N) increases, the factor of price increase gets exponentially larger. So if we had a set inflation rate of 4%, then the increase in one year would be from 1 (100%) of price to 1.04 (104%) of the beginning price. When N = 2, the price increases to 1.0816 (108.16%) times the beginning price. When N = 18, the price increases to 2.025 (202.5%) of the beginning price.
Therefore, prices double in 18 years at a yearly inflation rate of 4%. If the inflation rate were not exponential (meaning raised to the power of), then we would simply calculate 4% increase times 18 years, which would result in a 72% increase.
But, when a price rises 4% in year one, the new price in year two is 1.04 times the year one price. Then a subsequent year two inflation rate of 4% would include both 4% in year one MULTIPLIED BY 4% additional rate in year two, and then multiplied by 4% in year one and year two times year three and so on.
Inflation is not felt heavily at first, but its effect is magnified over time. This is a good incentive for the government to systematically reduce the inflation rate, to slow down the exponential effects of interest rates over time. This means that a very small manipulation in the CPI made in a given year will have a tremendous impact to the reported inflation rates of prices over time. Considering that the government has modified the CPI many times, these changes have completely nullified the value of the CPI that the government reports.
The Business Week article goes on to note:
“As a result of all these adjustments… the reported rate of inflation in 1999 will be about three-quarters of a point below what the old 1994 yardstick would have shown — and perhaps more. But since the government is not going back and fixing the past data as it makes its changes, the effect is to bias inflation downward. This helps explain the current situation where growth seems high and inflation seems low.” 1
The changes will understate inflation in prices and overstate growth. Inflation is used in the calculation of GDP, so when the government understates this number, growth appears larger than it really is. If the government did not remove inflation from GDP statistics, then it would be impossible to tell if growth comes solely from the rise in the prices of components in production or from growth in production itself. And, as the article notes, the change in inflation numbers are not retroactively applied to past inflation rates, making prior period comparisons hard to make. This obscures the real story of how rising prices affect purchasing power over time.
Which Prices Have Been Changed
Indeed, the strongest argument against both CPI and subsequent core inflation measures are that they understate increases in housing costs. Instead of including mortgage payments, the government uses rent as the only measure of housing cost. This would not adequately reflect changes in property taxes, insurance rates, repairs, and other potential costs of housing as they occur. Rent rates tend to be set for multi-yearly periods, thus reducing the volatility of increases of housing on inflation, and delaying when many cost increases will be recorded.
In many commercial rents, leases may be for five or more years and may not include provisions for periodic rent increases to accommodate cost increases such as insurance, taxes, and repairs. Lastly, rents may actually fall during harsh economic times, such as we are experiencing now, when families consolidate into multi-generational households. As more vacant real estate appears on the market, the overall rental rates will fall owing to reduced overall demand.
The largest decreasing factor in CPI calculations comes from infrequent purchases, such as computers, clothing, DVD players, and microwaves, as discussed in the previous Boskin Commission analysis. If we leave out fluctuations in energy and food prices because they occur too often, should we not also adjust the CPI (or core inflation) measures in a similar manner for infrequently purchased goods?
During this decade, it is estimated that food prices have had double digit yearly inflation, which means that they will double about every six to seven years. 2
Solutions
The real answer is to the inflation measurement dilemma is to include all items, and weight them according to the frequency of purchase so that we know what our total rises in costs will be over time for everything that we purchase. It should not be hard to figure out the average lifespan of computers, cars, and clothing from available data and include a periodic survey of American people, facilitated done by a research committee, formed for this purpose. Otherwise, any CPI number the government purports to reflect the rises in cost cannot be considered accurate compared with what Americans face each and every day in the market. And after all, that is the only number that matters.
This leads us to look at alternate measures of inflation. Several viewpoints are presented which tend to fall within the same range of values.
Alternate Inflation Measurements
Government inflation rates do not include taxes, which are a major expenditure for everyone. An independent estimate from Now and Futures calculate CPI to be understated by half in 2009. Therefore, they estimate that 3.3% reported inflation would actually equal 6.6%, when adjusted for taxes. 3
Shadow Stats, which reverses substitution, hedonics, and geometric weighting manipulations performed by the government, estimates inflation to be 6% in 2009, and 9.5% so far in early 2010. 4
As a comparison, let us go back to our inflation calculation formula to determine how a 6% inflation rate would change overall prices.
Remember, P = (1 + R) ^ N, where P = inflated price, R = rate of inflation, and N = number of years of given inflation rate.
For one year at 6% inflation, the new price is 1.06 times the beginning price. For ten years, the new price is 1.79 times the beginning price. For twenty years, the new price is 3.207 times the beginning price.
We compare time values for 6% and 9% rates of inflation with a 4% rate of inflation in the table below.
Chart 2.1
The table includes the multiplier value to apply against the beginning price to figure out the inflation adjusted price at that time in the future for both rates. So, if you want to figure out what a basket of fruit will cost in twenty-five years at 4% and 6% interest, take the multiplier value for that year and rate, and multiply it against the today’s price.
Notice that in Year 25, prices with 6% annual inflation approach doubling the prices with 4% annual inflation. In Year 50, the 6% rate has more than doubled the 4% rate. This is how a modest 2% yearly change in the inflation factor can dramatically change real prices over time.
Now let us examine the 9% inflation rate that we are currently experiencing, expanded out over time. At Year 10, 9% inflation leads to prices almost double what a 4% inflate rate would yield; at Year 25, prices are triple what they would be with only 4% inflation; and at Year 50, 9% inflation brings prices 10.5 times higher than they would be with only 4% inflation. It is easy to see that relatively small yearly changes in inflation add up to big changes in prices over time.
Looking at the chart, how long do you think we could stand 9% yearly inflation before we could no longer afford the basic necessities of life?
If the government wants to slow the reported inflation rate over time, they don’t have to make major changes to the inflation number. Subtle differences in reporting will make substantial changes to perceived prices over time. Since the government plans their budgets, issues debt, and pays their bills over time, modifying the reported inflation rate helps them mask the true inflation rate while they pay off past debts by taxing the people’s purchasing power.
Go back and read that last sentence again until you fully understand the impact of the statement. It is critically important to understanding why the government has manipulated the reported rate of inflation to the people in an effort to hide the true inflation rate they artificially create.
Even though the government does not control market prices of goods and services with their inflation measurement, they DO change the benefits in entitlement programs, putting downward pressure on future benefits payments that are indexed to low CPI and core inflation indexes. In addition, the government stated inflation rate is used to adjust tax brackets over time and an understated inflation rate forces more people into higher tax brackets, thereby increasing tax revenues over time.
Government increasing tax revenues while decreasing entitlement payments will reduce the deficit at the expense of tax payers. But even that does not always happen. The government is not decreasing their debt, but increasing it. Any gains to be realized from inflating away existing debt are instead being spent on new programs.
The Gold Standard
According to Alan Greenspan (1966), “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation,” he concluded. “There is no safe store of value.” 14
It should be noted here that while there was a gold standard, we saw very little inflation for 129 years. Now, inflation is very strong and getting stronger as more money is printed. If your income is not keeping up, then you are able to buy less and less over time.
We took the liberty of examining CPI rates since 1800, available from the Minneapolis Federal Reserve Bank. We added a column for a running total to show the trend of increase over time, not just from year to year as shown in their chart. See Chart 2.2.
Chart 2.2: Rate of Inflation and Significant Economic Events
Note that prior to the creation of the Federal Reserve System, the nation enjoyed almost no inflation; instead, deflation occurred. Small amounts of deflation will raise the standard of living for wage earners; as prices go down, their dollars will buy more. This is a true indication of efficient productivity gains and not substitution of inferior goods. In 1913, with the creation of the Federal Reserve, we note that the velocity of deflating prices slowed precipitously for four years, at which time an inexorable and almost uninterrupted period of inflation to the current period began. For only five years between 1913 and the present have we not had inflation, including the above mentioned four years immediately following the creation of the Fed in 1913 and in 1933.
In 1933, the US government renounced rights of individuals to own gold, and we have had inflation every year since. In 1971, President Nixon removed the US dollar from convertibility into gold, which means that the government would no longer redeem paper money for gold. This is the day on which we were completely taken off of the gold standard.
What could be the relationship between the creation of a central bank and a movement away from the gold standard with inflation rates? This will be discussed in sections later.
The Relationship of Inflation, Minimum Wages, Living Wages, and Unemployment
We pulled the minimum wage rates from the World Almanac since 1950. We analyzed the changes in the minimum wage rate and annualized them as a percentage. These rates show that since 1950, the annualized average rate increase has been 3.92% in the minimum wage. The minimum wage is set by the government as a base wage rate that businesses should adopt.
Chart 2.3. Annualized Average Rate Increases Since 1950
How has the minimum wage rate compared to the poverty rate? According to an Oregon State study, minimum wages have not kept up with poverty levels. Minimum wages were closest to poverty in 1968 at 90% of the poverty level, but have since fallen back to 59% of poverty level. So in other words, even with periodic increases in the minimum wage, one-worker families working at that rate would have fallen farther below the poverty level. This implies that the poverty level is now moving up faster than the increases in the minimum wage rates, which indicates inflation is rising faster than the annualized rate of 3.92% that the minimum wage rate has grown since 1950. 5
In response to the government minimum wage and poverty level, some local municipalities have developed a “living wage.” Living wages account for local cost of living differences and attempt to estimate what a family needs to pay for basic essentials.
Living Wages
In an analysis of living wages in Los Angeles, Elaine McCrate notes that “regular minimum-wage protection for workers is ‘grossly inadequate”. 6 Working for minimum wage ($5.15/hour) during the time of the study was below the basic-needs budget for pretty much all areas. McCrate goes on to note:
Supporters also took a hard look at the long-term picture of economic development in the United States and were greatly disturbed by a pattern of growing wage inequality, with stagnant or falling inflation-adjusted earnings for the bottom 80 percent of men and the bottom 20 percent of women. A worker at the twentieth percentile of the male wage distribution saw his hourly wage fall, in 1999 dollars, from $9.32 to $8.12 between 1979 and 1999–despite the longest economic boom in 25 years in the 1990s. Wages for women at the twentieth percentile of the female wage distribution fell from $6.89 to $6.83. 6
Also note that female workers get paid less than male workers at the same percentile, indicating that two earner households do not have twice the buying power as single earner households. It is also noted in the above article that minimum wages will raise costs of business, causing layoffs and increasing unemployment. “A living wage 60 percent above the minimum wage reduces their employment by about 6 percent.” Therefore, it is fair to say that inflation of labor rates causes rising business costs that affect the ability of businesses to employ the same amount of people over time.
Bruce Bartlett analyzes minimum wage rates versus unemployment for the poor in a Wall Street Journal article. According to studies on changes in minimum wages versus unemployment, a raise of 10% in the minimum wage would increase youth and poor unemployment by 2.1%. So minimum wage increases have an inverse effect to those it is trying to help. Now, many economists now believe that rises in the minimum wage reduces employment levels. 7
Examining the Trends in Real Earned Wages and Unemployment
According to a study by Walter Russell Mead, unemployment figures of recent times are considerably higher than they used to be. The average unemployment of the 1980s, 7%, was higher than all but two years unemployment between 1950 and 1979. During the expansion of the 1980s, unemployment never fell below 5%. While in the previous generation, unemployment of 5% could be considered a recessionary time. (8)
Between 1947 and 1973, in inflation-adjusted 1983 value dollars, real wages rose from $196 to $315. Over time, the average worker’s wealth increased, which meant a higher standard of living overall. But from 1973 to 1990, the average real wage fell back to $258. This reduced the standard of living overall by about 50% of the gain realized since 1947. In addition, Gross National Product (GNP) growth fell from 45% during the 1960s to 30% in the 1980s. 8
While people were earning more dollars, what they could buy with them began shrinking in the 1970s and has not stopped today. In addition, the growth of the overall economic output of the country is in decline.
Note: It should be mentioned that the research above, used in the 1990s, focuses on GNP and not GDP. GNP accounts for everything produced by American owners, whether here or elsewhere. Gross Domestic Product (GDP), the figure used today, accounts for everything produced in the US regardless of ownership.
The argument of GNP vs GDP has been fought before. But suffice to say that GNP of American companies may shrink and GDP of US and foreign countries on our soil could grow at the same time. Which figure do you feel is more important?
If you think that foreign earnings made on US soil are mostly retained as foreign earnings, then GNP is a more accurate measure of American wealth. However, GDP estimates money spent on infrastructure and payroll in the US, and is therefore an important consideration in the discussion of American wealth. In any case, the comparison of GNP produced across the different decades applies to our discussion on domestic production precisely because it was the value used by our government before the use of GDP was adopted.
Further, Walter Russell points out: “The ’90s could be worse. The earning power of married women-more women working longer hours-has protected family incomes from the effects of falling wages. But with a record percentage of women in the labor force now, the cushion is wearing dangerously thin. Recession or no, the ’90s could become the first decade since the Great Depression in which a majority of American families suffer declining real incomes.”
What he is saying is that with more women entering the workforce, families are earning more, resulting in an increase in the standard of living even though real wage rates overall are falling. But because wage rates and overall production is falling so precipitously, the standard of living is in danger of falling off of post-WWII levels, even with both spouses working. Now that is an astounding statement!
We can determine, from the information examined, that overall unemployment rate has been rising over time, real wages are falling over time, and the government measures of inflation are not consistent with findings in the “real world” and are thus understated. And even including a second full time worker in the family is not keeping up with rising costs. Once costs have risen far enough to eclipse the benefit of the second household worker, the only option most families will have to cope with rising costs is to include eligible children as additional workers. Even with their inclusion in the workforce, the standard of living for American families will eventually be reduced systematically every year if current living costs continue to rise at the same pace.
The only way to stop this process is to reduce the rate of inflation we experience. Because we know that inflation is caused by the printing of money, this means the size of government will have to shrink voluntarily, or eventually collapse under its own weight. The people cannot continue to support the spending habits of the current government much longer. At some point, the spending through taxes, and through inflation as a hidden tax, will cause the people to reject the current government policies for fear of a widespread poverty epidemic.
Why the Unemployment Statistic is Understated
We have reviewed why rising levels of unemployment are taking place. The inequality between rises in prices versus wage increases has caused employment to shrink over time. Costs are simply too high and there are not enough revenues to cover them. Labor is usually the most expensive portion of business costs, so it makes sense that labor is then reduced to compensate for rising costs of materials used in production and minimum labor rates.
Similar to the changes in calculation of inflation, changes in calculation of unemployment have reduced the quoted number from previous levels. The first problem is that even if we assume the new numbers are more useful, which would require an unsupported leap of faith at best, we cannot then compare our current values to past values with any meaningful resulting conclusions.
Most thinking about the current recession stems from lessons learned during the Great Depression seventy years ago. Our data values, however, are not comparable to that time and therefore when politicians use current unemployment numbers as justification for spending decisions, dangerous results can occur.
If we are understating unemployment and overstating GDP growth, then our decisions may be rendered not effective enough. For example, the government has been spending trillions of dollars on stimulus measures and bailouts. These measures are to increase credit liquidity, create jobs, and keep the economy from shrinking. If our unemployment numbers are not correct, then the stimulus measures may not be hardy enough and won’t prevent a double dip back into recession.
On the other hand, if our inflation numbers are understated, then the effects of spending these trillions on stimulus measures to our long term inflation and ability to finance debt levels may be understated. This could lead to a catastrophic rise in prices, known as hyperinflation, which erodes the value of our currency even more. If we do not get a similar vault in growth to cover these rising costs, our economy will suffer a fateful shock.
This is an outline of the possibilities for making decisions on bad data. Some of these possibilities will be explored further as we go on.
So, let us go back to unemployment. How is this understated? Well, as you read in the opening chapter, the government has changed the way it measures unemployment since the Great Depression. In the new measure, people who have given up finding employment, who were previously employed full time, will be rotated out of the unemployment numbers as they run out of unemployment benefits. This does not mean the effects of the joblessness are not felt for these people, just that they are not counted in official unemployment statistics anymore.
Secondly, those who find part time employment are not counted as unemployed. After all, some income is better than none. While this line of thinking is true, it does not stop foreclosures on homes that people cannot afford, repossessed property, faults on credit lines, inability to pay back taxes, and reliance on social programs to make ends meet. Without counting these people in unemployment rates, we get a rosier picture of the economy than is actually true.
As shown by Shadowstats.com analysis, using Depression era techniques for counting the unemployed gives us an unemployment rate of close to 22%. This 22% comes from the U6 category designation number published by the government which includes recently unemployed workers; and also U7 category designation numbers of those long-term discouraged workers who have not been able to find work for a year or more. 9
The research indicates that although those placed by government definition into the U7 category were fit and able to work, they could not find work after extensive searches and were said to have given up. In the government’s reasoning, then, they do not “count” as unemployed person. 10
After all, if the economy doesn’t support these willing and able workers, then why would we bother to count them? In fact, the US government doesn’t even keep statistics on the U7 category anymore. It has been removed from government accounting, just like that.
Unemployment during the Depression era reached the 25% level, and it is generally considered the worst financial period in American history. So if we are within a few percentage points of that number now, the question must be asked: Are we emerging from a recession, or are we mired in a large-scale depression that may take fifteen to twenty years to recover from? Unemployment numbers support the idea of a depression.
It is worth mentioning that the economic problems of the ‘30s and ‘40s were not the only depressions in American history, even though they are often the most examined. Bank failures, large drops in currency value, joblessness, and stagnation in the economy are all common characteristics of depressions. A detailed examination of the history of depressions and recessions is outside the scope of this book. But you are encouraged by the author to explore these as a matter of your financial education.