If you think the government is reporting the key economic statistics for our country in an honest manner, you aren't paying attention. Below are 3 charts from www.Shadowstats.com regarding CPI, Unemployment, and GDP. All three statistics have been systematically "tweaked" over the last thirty years to be more "accurate" according to our glorious leaders. You would think that accuracy would be for better or worse. Amazingly, all these key numbers show a dramatically better picture of our economy than the old calculations. John Williams has pulled the curtain back and revealed these numbers to be fraudulent. 

The reality is that Inflation is 7%, not the 0% reported by the government.

The reality is that unemployment is 20%, not the 9% reported by the government.

The reality is that GDP is -5% and we have essentially been in a recession since 2000.

Please read John's explanations of what the government has done to mislead you over the last few decades and make up your on mind. 

The CPI on the Alternate Data Series tab here, reflects the CPI as if it were calculated using the methodologies in place in 1980.

Payments to Social Security Recipients Should be Double Current Levels

Inflation, as reported by the Consumer Price Index (CPI) is understated by roughly 7% per year. This is due to recent redefinitions of the series as well as to flawed methodologies, particularly adjustments to price measures for quality changes. The concentration of this installment on the quality of government economic reports will be first on CPI series redefinition and the damages done to those dependent on accurate cost-of-living estimates, and on pending further redefinition and economic damage.

The CPI was designed to help businesses, individuals and the government adjust their financial planning and considerations for the impact of inflation. The CPI worked reasonably well for those purposes into the early-1980s. In recent decades, however, the reporting system increasingly succumbed to pressures from miscreant politicians, who were and are intent upon stealing income from social security recipients, without ever taking the issue of reduced entitlement payments before the public or Congress for approval.

In particular, changes made in CPI methodology during the Clinton Administration understated inflation significantly, and, through a cumulative effect with earlier changes that began in the late-Carter and early Reagan Administrations have reduced current social security payments by roughly half from where they would have been otherwise. That means Social Security checks today would be about double had the various changes not been made. In like manner, anyone involved in commerce, who relies on receiving payments adjusted for the CPI, has been similarly damaged. On the other side, if you are making payments based on the CPI (i.e., the federal government), you are making out like a bandit.

In the original version of this background article, I noted that Social Security payments should 43% higher, but that was back in September 2004 and only adjusted for CPI changes that took place after 1993. The current estimate adjusts for methodology gimmicks introduced since 1980.

Elements of the Consumer Price Index (CPI) had their roots in the mid-1880s, when the Bureau of Labor, later known as the Bureau of Labor Statistics (BLS), was asked by Congress to measure the impact of new tariffs on prices. It was another three decades, however, before price indices would be combined into something resembling today's CPI, a measure used then for setting wage increases for World War I shipbuilders. Although published regularly since 1921, the CPI did not come into broad acceptance and use until after World War II, when it was included in auto union contracts as a cost-of-living adjustment for wages.

The CPI found its way not only into other union agreements, but also into most commercial contracts that required consideration of cost/price changes or inflation. The CPI also was used to adjust Social Security payments annually for changes in the cost of living, and therein lay the eventual downfall to the credibility of CPI reporting.

Let Them Eat Hamburger

In the early 1990s, press reports began surfacing as to how the CPI really was significantly overstating inflation. If only the CPI inflation rate could be reduced, it was argued, then entitlements, such as social security, would not increase as much each year, and that would help to bring the budget deficit under control. Behind this movement were financial luminaries Michael Boskin, then chief economist to the first Bush Administration, and Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System.

Although the ensuing political furor killed consideration of Congressionally mandated changes in the CPI, the BLS quietly stepped forward and began changing the system, anyway, early in the Clinton Administration.

Up until the Boskin/Greenspan agendum surfaced, the CPI was measured using the costs of a fixed basket of goods, a fairly simple and straightforward concept. The identical basket of goods would be priced at prevailing market costs for each period, and the period-to-period change in the cost of that market basket represented the rate of inflation in terms of maintaining a constant standard of living.

The Boskin/Greenspan argument was that when steak got too expensive, the consumer would substitute hamburger for the steak, and that the inflation measure should reflect the costs tied to buying hamburger versus steak, instead of steak versus steak. Of course, replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that.

The Boskin/Greenspan concept violated the intent and common usage of the inflation index. The CPI was considered sacrosanct within the Department of Labor, given the number of contractual relationships that were anchored to it. The CPI was one number that never was to be revised, given its widespread usage.

Shortly after Clinton took control of the White House, however, attitudes changed. The BLS initially did not institute a new CPI measurement using a variable-basket of goods that allowed substitution of hamburger for steak, but rather tried to approximate the effect by changing the weighting of goods in the CPI fixed basket. Over a period of several years, straight arithmetic weighting of the CPI components was shifted to a geometric weighting. The Boskin/Greenspan benefit of a geometric weighting was that it automatically gave a lower weighting to CPI components that were rising in price, and a higher weighting to those items dropping in price.

Once the system had been shifted fully to geometric weighting, the net effect was to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology. The results have been dramatic. The compounding effect since the early-1990s has reduced annual cost of living adjustments in social security by more than a third.

The BLS publishes estimates of the effects of major methodological changes over time on the reported inflation rate (see the "Reporting Focus" section of the October 2005 Shadow Government Statistics newsletter -- available to the public in the Archives of www.shadowstats.com). Changes estimated by the BLS show roughly a 4% understatement in current annual CPI inflation versus what would have been reported using the original methodology. Adding the roughly 3% lost to geometric weighting -- most of which not included in the BLS estimates -- takes the current total CPI understatement to roughly 7%.

There now are three major CPI measures published by the BLS, CPI for All Urban Consumers (CPI-U), CPI for Urban Wage Earners and Clerical Workers (CPI-W) and the Chained CPI-U (C-CPI-U). The CPI-U is the popularly followed inflation measure reported in the financial media. It was introduced in 1978 as a more-broadly-based version of the then existing CPI, which was renamed CPI-W. The CPI-W is used in calculating Social Security benefits. These two series tend to move together and are based on frequent price sampling, which is supposed to yield something close to an average monthly price measure by component.

The C-CPI-U was introduced during the second Bush Administration as an alternate CPI measure. Unlike the theoretical approximation of geometric weighting to a variable, substitution-prone market basket, the C-CPI-U is a direct measure of the substitution effect. The difference in reporting is that August 2006 year-to-year inflation rates for the CPI-U and the C-CPI-U were 3.8% and 3.4%, respectively. Hence current inflation still has a 0.4% notch to be taken out of it through methodological manipulation. The C-CPI-U would not have been introduced unless there were plans to replace the current series, eventually.

Traditional inflation rates can be estimated by adding 7.0% to the CPI-U annual growth rate (3.8% +7.0% = 10.8% as of August 2006) or by adding 7.4% to the C-CPI-U rate (3.4% + 7.4% = 10.8% as of August 2006). Graphs of alternate CPI measures can be found as follows. The CPI adjusted solely for the impact of the shift to geometric weighting is shown in the graph on the home page of www.shadowstats.com. The CPI adjusted for both the geometric weighting and earlier methodological changes is shown on the Alternate Data page, which is available as a tab at the top of the home page.

Hedonic Thrills of Using Federally Mandated Gasoline Additives

Aside from the changed weighting, the average person also tends to sense higher inflation than is reported by the BLS, because of hedonics, as in hedonism. Hedonics adjusts the prices of goods for the increased pleasure the consumer derives from them. That new washing machine you bought did not cost you 20% more than it would have cost you last year, because you got an offsetting 20% increase in the pleasure you derive from pushing its new electronic control buttons instead of turning that old noisy dial, according to the BLS.

When gasoline rises 10 cents per gallon because of a federally mandated gasoline additive, the increased gasoline cost does not contribute to inflation. Instead, the 10 cents is eliminated from the CPI because of the offsetting hedonic thrills the consumer gets from breathing cleaner air. The same principle applies to federally mandated safety features in automobiles. I have not attempted to quantify the effects of questionable quality adjustments to the CPI, but they are substantial.

Then there is "intervention analysis" in the seasonal adjustment process, when a commodity, like gasoline, goes through violent price swings. Intervention analysis is done to tone down the volatility. As a result, somehow, rising gasoline prices never seem to get fully reflected in the CPI, but the declining prices sure do.

How Can So Many Financial Pundits Live Without Consuming Food and Energy?

The Pollyannas on Wall Street like to play games with the CPI, too. The concept of looking at the "core" rate of inflation-net of food and energy-was developed as a way of removing short-term (as in a month or two) volatility from inflation when energy and/or food prices turned volatile. Since food and energy account for about 23% of consumer spending (as weighted in the CPI), however, related inflation cannot be ignored for long. Nonetheless, it is common to hear financial pundits cite annual "core" inflation as a way of showing how contained inflation is. Such comments are moronic and such commentators are due the appropriate respect.

Too-Low Inflation Reporting Yields Too-High GDP Growth

As is discussed in the final installment on GDP, part of the problem with GDP reporting is the way inflation is handled. Although the CPI is not used in the GDP calculation, there are relationships with the price deflators used in converting GDP data and growth to inflation-adjusted numbers. The more inflation is understated, the higher the inflation-adjusted rate of GDP growth that gets reported.
 

The SGS Alternate Unemployment Rate reflects current unemployment reporting methodology adjusted for SGS-estimated "discouraged workers" defined away during the Clinton Administration added to the existing BLS estimates of level U-6 unemployment. The popularly followed unemployment rate was 5.5% in July 2004, seasonally adjusted. That is known as U-3, one of six unemployment rates published by the BLS. The broadest U-6 measure was 9.5%, including discouraged and marginally attached workers.

Up until the Clinton administration, a discouraged worker was one who was willing, able and ready to work but had given up looking because there were no jobs to be had. The Clinton administration dismissed to the non-reporting netherworld about five million discouraged workers who had been so categorized for more than a year. As of July 2004, the less-than-a-year discouraged workers total 504,000. Adding in the netherworld takes the unemployment rate up to about 12.5%.

The Clinton administration also reduced monthly household sampling from 60,000 to about 50,000, eliminating significant surveying in the inner cities. Despite claims of corrective statistical adjustments, reported unemployment among people of color declined sharply, and the piggybacked poverty survey showed a remarkable reversal in decades of worsening poverty trends.

Somehow, the Clinton administration successfully set into motion reestablishing the full 60,000 survey for the benefit of the current Bush administration's monthly household survey.
 

Introduction

The Gross Domestic Product (GDP) is one of the broader measures of economic activity and is the most widely followed business indicator reported by the U.S. government. Upward growth biases built into GDP modeling since the early 1980s, however, have rendered this important series nearly worthless as an indicator of economic activity. The analysis in this Installment will indicate that the recessions of 1990/1991 and 2001 were much longer and deeper than currently reported, and that lesser downturns in 1986 and 1995 were missed completely in the formal GDP reporting process. Furthermore, the current economic circumstance is suggestive of an early-1980s-style double-dip recession.

The distortions from bad GDP reporting have major impact within the financial system. For example, Alan Greenspan's heavy reliance on productivity gains to justify some of his policies is equally flawed, since the methods applied to GDP estimation influence the numerator in the productivity ratio. As with the CPI distortions discussed in Installment III, the Federal Reserve Chairman knows better.

With reported growth moving up and away from economic reality, the primary significance of GDP reporting now is as a political propaganda tool and as a cheerleading prop for Pollyannaish analysts on Wall Street.

Reporting Basics

The GDP is compiled and reported by the Bureau of Economic Analysis (BEA) of the Department of Commerce. Quarterly estimates are updated monthly, with the "advance" estimate published at the end of the first month following the close of a quarter. The first and second revisions are called the "preliminary" and "final" estimates. In turn the "final" estimate is revised in annual revisions (usually in July), and every five years or so a benchmark revision is published that revises all data back to 1929, the first year of formally estimated economic activity.[1]

The popularly followed number in each release is the seasonally adjusted, annualized quarterly growth rate of real (inflation-adjusted) GDP, where the current-dollar number is deflated by the BEA's estimates of appropriate price changes. It is important to keep in mind that the lower the inflation rate used in the deflation process, the higher will be the resulting inflation-adjusted GDP growth.

Due to a lack of good-quality hard data, the "advance" GDP report is little more than a guesstimate. The BEA comes up with three estimates of growth, a high, low, and most likely. The numbers then get re-massaged so that the reported growth rate is moved closer to whatever the economic consensus is expecting. There actually is a belief at the BEA that there is some value to economic consensus estimates.[2]

The estimation process does not improve much with the "preliminary" and "final" estimates. The BEA reports that 90% of ultimate revisions to the "final" estimate fall within a range of +3.1% to -2.6%. Where average growth has been about 3.5% over the years, that means that most reporting is not statistically significant. The upward bias shown in the revisions is due to what I call "Pollyanna Creep," where methodological changes regularly upgrade near-term economic growth patterns. These patterns will be explored shortly.

The GDP is a large component of the National Income and Product Accounts (NIPA), representing "the output of goods and services produced by labor and property in the United States."[3] The NIPA was the concept and development of the National Bureau of Economic Research, a private organization founded in 1920. The NBER work evolved into the BEA and the current NIPA accounting.

The NBER remains a consultant to the process and retains the position as official arbiter of U.S. recessions. At one time, the NBER did define a recession as two consecutive quarters of negative GNP/GDP growth that were not distorted by an event such as a truckers' strike.[4] The NBER used trends in indicators such as industrial production and payroll employment to time a recession's beginning and end, to the month. More recently, though, the NBER has abandoned the GDP as a recession indicator and has relied instead on those other economic series. My presumption is this change resulted from an unofficial recognition of the declining value of the GDP reports. In theory, the NBER is apolitical, although the timing of some of its recent calls on the ends of recession are suspect. Specifically, there is no such thing as a jobless recovery. If jobs are being lost, the economy still is in recession.

There Is a Problem in the Basic Structure

As part of the NIPA, the construct of the GDP is heavily reliant on economic theory for composition, unlike other data series such as retail sales or the trade deficit, which are relatively simple surveys that end up contributing to the GDP estimations.

The related Gross National Product (GNP) is the broadest U.S. economic measure and includes the GDP plus the balance of international flows of interest and dividend payments. For net debtor nations such as Guinea-Bissau and the United States, GDP usually will show the stronger growth than GNP, since the outflow of interest payments does not get charged against economic activity. For this reason, the United States switched its primary reporting from the GNP to the GDP in 1991. Put in perspective as of the "final" estimate of second-quarter 2004, annualized real GDP growth was 3.3%, down from 4.5% in the first quarter, while GNP growth for the same period was 1.9%, down from 3.9%.

I respect the intellect and creativity of those who have anchored their careers in academia. Frankly, though, most economic theories have little practical use in the real world. Concepts such as free trade being a boon to the world's economy [5], a weak currency helping turn a nation's trade deficit[6], or personal income including what the average homeowner would receive from himself in rental income if he charged himself to live in his own house, fall in to the "not in the real world" category.[7]

Varied academic theories, often with strong political biases, have been used to alter the GDP model over the years, resulting in Pollyanna Creep, where changes made to the series invariably have had the effect of upping near-term economic growth. Whether the change was to deflate GDP using "chain-weighted" instead of "fixed-weighted" inflation measures, to capitalize rather than expense computer software purchases, or to smooth away the economic impact of the September 11th terrorist attacks, upside growth biases have been built into reported GDP with increasing regularity since the mid-1980s.

The accompanying table shows the net impact of these changes over time. The GNP level for various years from 1929 through 1980 and GDP for 1980 and 1990 are shown in billions of current dollars. Once set, these GNP/GDP levels should not change. With redefinitions and methodological shifts, however, earlier periods have been restated so as to be on a consistent basis with the latest reporting. Accordingly, the GNP/GDP levels are shown as they were reported variously in 1950, 1984 and at present.[8]

What becomes evident when looking at these data is that the biggest reporting changes have taken place since 1984 and have accelerated coming forward in time. For example the 1980 GDP that had been reported as $2.708 trillion in 1992 had crept up by 2.9% to $2.786 trillion based on 2004 reporting. The 1990 GDP, however, had Pollyanna Creep of 5.3% over the same period.

----------------------------------------
POLLYANNA CREEP
----------------------------------------
                               Change in
                               Reporting
Year   1950    1984     2004   2004/1992
----------------------------------------
    GNP (Billions of Current Dollars)  
----------------------------------------
1929  103.8    103.4    104.4    +0.97%
1933   55.8     55.8     56.7    +1.61%
1940  101.4    100.0    101.7    +1.70%
1950  284.2    286.5    295.2    +3.04%
1960   --      506.5    529.5    +4.54%
1970   --      992.7   1044.9    +5.26%
1980   --     2631.7   2823.7    +7.30%
----------------------------------------
    GDP (Billions of Current Dollars)
----------------------------------------
                               Change in
           As Reported         Reporting
             in 1992    2004   2004/1992
----------------------------------------
1980          2708.0   2785.5    +2.86%
1990          5513.8   5803.1    +5.25%
----------------------------------------
Double-Entry Bookkeeping

The NIPA effectively is a double-entry bookkeeping system, where an item on the consumption side of the ledger, in the GNP/GDP accounts, is offset on the income side of the ledger, in Gross Domestic Income (GDI) accounts. In theory, the GNP and the GDI should be identical. In practice they rarely are, with the latest "statistical discrepancy" showing GNP to be $67 billion, or 0.6% higher than the GDI. This is due to the BEA's inability to reconcile the two series.

Part of the problem is that source data often are estimated without regard to actual numbers otherwise available. As an example of how far from reality the GNP/GDP/GDI reporting has gone, consider data from a high quality and unbiased resource: the Internal Revenue Service (IRS).

Based on its analysis of income tax returns, the IRS reports that, "For the second consecutive year, Adjusted Gross Income (AGI) fell, decreasing by 2.3% to $6.0 trillion for 2002. This represents the first time since prior to 1950 that total AGI reported on individual tax returns has fallen for two successive years."[9] 

While one might expect to see some parallel income reporting in the GDI, it only happens by coincidence. Although the BEA considers the IRS data, it never has been able to reconcile the differences between GDI assumptions and IRS reality. Of course, the BEA sticks with the GDI assumptions, which have income rising in 2001 and 2002. The following table shows some of the specifics of comparable income components. Where wages and salaries are the single largest component in the GDI, they grew by 6.8% in 2002, according to the BEA, but the IRS reports a 0.4% contraction. 

-----------------------------------
INCOME GROWTH 2002/2001
-- IRS VERSUS BEA
(Not Adjusted for Inflation)
-----------------------------------
Income Category       IRS      GDI
-----------------------------------
Wages & Salaries     -0.4%    +6.8%
Interest Income     -20.9%    -6.4%
Dividend Income     -14.9%    +5.1%
-----------------------------------
Part of the difference is in imputations, which gets back into the theoretical structure of the NIPA. Any benefit one receives, either living in one's own house, or receiving free checking from a bank has an imputed income component. Free checking, for example, is calculated as imputed interest income. Not only did imputed interest income account for 21% of all personal interest income in 2002, but also it grew at an annual rate of 8.3%! As an aside, renting the house you own from yourself gets imputed as 62% of total rental income.

Another issue is distortion in underlying series. The bias factors (now reported as net business birth/death modeling) inflate reported payroll employment, as discussed in this series' first installment. GDI estimates of wages and salaries are calculated off the payroll numbers and are inflated on a parallel basis. 

Deflation Wonders

As emphasized earlier, the lower the inflation rate that is used to deflate the GDP, the higher will be the resulting inflation-adjusted growth.

One of the deflation stars is the computer. While computer prices have come down over time, the quadrupling and re-quadrupling of memories provided with a standard computer have, through hedonics and quality adjustments (see Installment III on the CPI), enhanced the decline in prices used in deflating computer consumption in the GDP. According BEA deflators, $1,000 computers bought in 1990, 1995 and 2000 would cost $48.63, $95.84 and $526.58, respectively, today. I bought computers in each of those time frames and could not replicate any one of them for the suggested proportionate price in deflated dollars, regardless of free memory enhancement.

One of the more significant changes to GDP inflation was made in 1996, when the deflator was shifted from fixed-weighted to a chain-weighted basis. The chain-weighted basis weights inflation for a two-year grouping of a related GDP component, rather than using the weighting of the benchmark year. One happy side effect of this change is that the components of inflation-adjusted GDP do not add up to the total, with the difference being allocated to the residual category. As of the "final" second-quarter 2004 real GDP, the residual was a negative $35.6 billion, or 0.33% of total GDP. The residual usually gets worse the more removed it is from the benchmark year, which is 2000 at present. As of the fourth-quarter 1990, for example, the residual is 13.4% of GDP. Before 1990, the BEA does not publish the detailed breakout of accounts, because of the large residual. For some reason, this bothers a number of well-reputed economists. 

A Tempting Target for Manipulation

In the introduction to this series on government reporting, I mentioned political manipulation of the GNP/GDP in the Johnson and first Bush administrations that went beyond overly positive methodological changes. In both instances, my sources were consulting clients who had been involved directly in the process. In the latter instance, an individual at the BEA also confirmed the situation.

Few people argue with the GNP/GDP reports, so when Lyndon Johnson kept sending the initial GNP estimates back to the Commerce Department for correction, he eventually got what he wanted, and the media dutifully reported stronger than actual economic growth.

Near the end of the first Bush administration, an outside-the-system manipulation was worked. A senior member of the Executive Branch approached a senior officer of a large computer company and requested that reporting of computer sales to the BEA be inflated. This was done specifically to help with the reelection effort. The request was granted, and thanks to the heavy leverage of computer deflation, reported GDP growth enjoyed an artificial spike.

There are suggestions of other direct manipulations over time, specifically involving the Clinton administration and the current Bush administration. Most recently, a bizarre annual revision to the GDP data eliminated the 2001 recession, at least as traditionally defined with two consecutive quarters of real GDP contractions. 

Where little public attention is paid to the GDI, however, it is interesting to note that the revisions did not follow the same pattern on the inflation-adjusted income side of GDP. Pre-revision numbers showed quarterly real GDP contractions in third-quarter 2000 and the first- through third-quarter 2001. In the 2004 annual revisions, second-quarter 2001 GDP growth turned positive (from -0.6% to +1.2%), breaking up any consecutive quarterly GDP declines. The patterns were repeated in revisions of the GNP. Following the latest annual revisions, however, the GDI-same as GNP in theory-showed contractions in fourth-quarter 2000, second- through fourth-quarter 2001 and third-quarter 2002.

Estimating Economic Reality

Based on my analysis of the GDP/GNP revisions and redefinitions over time, over-deflation and economic reporting as published before later political corrections, reporting of real GDP growth at present is overstated by roughly three percent per year against a more realistic, pre-Pollyanna Creep period. 

Where the period of bloated GDP reporting began after the severe double-dip recession of 1980 and 1981/1982, it includes the last two recessions that were severe enough to generate reported GDP contractions. Both the 1990/1991 and 2001 recessions were deeper and longer than currently estimated. The recession from July 1990 to March 1991 (timing per the NBER) really began in late-1989 and persisted into 1992, perhaps even 1993. Such was evident in the underlying data of the time. Due to the NBER's early call of the recession's end, however, the first "jobless recovery" was seen.

Similarly, the recession that was timed from March to November 2001, began in late-2000 and persisted into 2003. Again, because of an early call to the recession's end, a "jobless recovery" was seen.

There also were economic downturns in 1986 and 1995 that were evident to most companies dealing in real world economic activity at he time. Although the contractions showed up in a number of measures, they were not severe enough to turn bloated GDP growth negative.

As the economy once again appears to be faltering, or losing traction, risk is high of renewed or a double-dip recession, of which the 2001 downturn eventually will be counted as the first leg.

I have only touched upon some of the highlights in problems with GDP reporting. Unfortunately, though widely followed, the series is probably the least meaningful of the major economic statistics followed by investors and the financial media.