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March 13, 2008

The Magic Mirror Economy
by Richard Benson

No one can ever be too rich, too thin, or too beautiful. We would all like to look into a mirror that tells us that. But in tough economic times like these when inflation is raging, unemployment is climbing, and the economy is falling apart, our government is forced to look into the mirror and create a magical image by reassuring the American people that everything is just fine with the economy, when it's really not. So how exactly do they go about doing this?

When the government releases economic statistics for prices and employment, a magic mirror is used to make numbers look much better than they really are. Both the Democrats and Republicans use this smoky mirror when they control the Presidency, and neither party dares to glance into it in fear it may shatter from the reflection. Washington is a company town and a political machine that spends trillions of our tax dollars to mislead the public. Sad, but true!

The inflation numbers are very important to the economy. Let's look at how the price indexes that measure inflation are contorted to keep the "flation" out of inflation. Years ago, the Bureau of Labor Statistics - with arm twisting and urging from the Federal Reserve - made two major changes to the price indexes: First, Hedonic (quality) adjustments were added. An adjustment for quality says that if my new computer runs faster and has more memory, I have a more valuable computer for the money, so the real price is only $1,000, even though I paid $2,000.

Next, weights for the goods in the price indexes were changed. In the old index, if the price of beef went up, the price you paid for it went up. Now, if I loved filet mignon but stopped buying it because the price was too high - and I began buying chicken instead - the price of beef didn't really go up because I "chickened out". Without magic, prices actually rose considerably and for the same number of dollars spent, my standard of living went down. If you would like to learn more about these inflation issues, please go to my article "Using the CPI to Rob Americans Blind" (April 14, 2004).

Also, if you would like to see what the inflation rate has really been doing, take a look at John Williams Shadow Government Statistics (www.shadowstats.com). Using the old inflation numbers (before the price indexes were fixed), the CPI would be more like eight percent year-over-year, not the reported 4.3 percent.

Why is it so important for the government to fudge and mangle the price indexes? Well, many government payments like social security and other benefits are tied to inflation, and America is broke. Fudging the price indexes to cut the level of reported inflation is a great way of directly sticking Grandma with a hidden tax increase.

Moreover, economic statistics such as the Gross Domestic Product, ("GDP") are reported by taking the inflated GDP numbers and adjusting them for inflation. So, if the inflation numbers are understated by even two to three percent, GDP will be overstated by the same percentage. If, because of underreporting for inflation they can overstate economic growth by several percent, not a single politician or government employee - including the staff at the Federal Reserve - would complain. Remember, Washington is a company town where the American people get to pay the salaries and benefits for all government employees!

Indeed, with all this price fixing, the US government, Federal Reserve, and Wall Street stock touts thought that a recession was impossible. In order to show negative GDP, the actual economy would have to be falling by more than three percent. (This means that the recession is actually much worse than the government admits to.)

The reports on employment and unemployment are also critical economic statistics. For employment, the Bureau of Labor Statistics ("BLS") has two surveys. The first is the Payroll Survey which queries businesses about how many people they employ. This survey has a special mirror called the BLS Birth/Death computer model. In February 2008, the computer model added 135,000 jobs to the total before seasonal adjustment. Without the computer model, February's payroll employment would have fallen by 198,000 jobs, not the reported drop of 63,000! If you would like to learn more about this, see my article "How the Government Creates Jobs" (May 24, 2007).

The second is the Household Survey. This survey is conducted by contacting people to inquire whether they are working, if they would like to be working, and when they last looked for work. (The Household Survey in February did show a sharp drop of 255,000 jobs.) The unemployment rate is calculated using the Household Survey data, but magical "smoke and mirror" tricks are used to keep the unemployment rate down when it's reported to the public. An example would be last month, when the Household Survey dropped 644,000 people from the labor force. If these workers had remained in the work force, the unemployment rate would have jumped to 5.3 percent.

If you dig a little deeper, the Household Survey also shows 1.6 million people marginally attached to the labor force. In this case, the magical logic is "If you haven't looked for work in the past four weeks, you're not included as unemployed! In other words, these workers are not just marginal, they're invisible!

Next, the employment numbers are bulked up. In February, there were 4.9 million part-time workers who would prefer working full-time. Again, the magical logic used is "if you worked an hour during the week, you're fully employed! (See chart below):

Without magic, the data above suggests that about nine percent of the labor force is really hurting on the employment front. But because I'm an optimist at heart, shouldn't I feel good about the government tactics of twisting, stretching and torturing the truth? Would it really be to my benefit to know the truth about these economic statistics?

The paternalistic government view that creating phony economic statistics is really good for the American people may be fine for the masses, but it's not fine for me. And since it appears that the economy is far worse off than the government lets on, I'll continue looking in my mirror and believe I can never be too rich, too thin or too beautiful. After all, it's only an image and what harm is there in believing? But when it comes to investing my money, I plan to stay short emerging markets in China, and I'm doing this because America's main export to the rest of the world (in the coming year) will be its big ugly recession. Yes, it's true, we're in a recession, but that won't stop the government from using magical smoky mirrors to conceal it.

Richard Benson
Benson's Economic & Market Trends
Specialty Finance Group, LLC

Prior to founding the Specialty Finance Group in 1989, Mr. Benson acted as a trading desk economist for Chase Manhattan Bank in the early 1980's and started in the securitization business in 1983 at Bear Stearns, and helped build the early securitization businesses at Citibank and E.F. Hutton.

Mr. Benson graduated from the University of Wisconsin in 1970 in the Honors Program in Math, and did his doctoral work in Economics at Harvard University. Mr. Benson is a member of the Harvard Club of New York and Palm Beach.

The Specialty Finance Group, LLC is a Florida Limited Liability Company and is registered with the NASD/SIPC as a Broker/Dealer.

Copyright © 2004-2008 Richard Benson

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