Numbers Racket
Why the economy is worse than we know
KEVIN PHILLIPS
Harper's Magazine v.316, n.1896 1may2008
http://www.mindfully.org/Reform/2008/Pollyanna-Creep-Economy1may08.htm
Mindfully.org note:
This article is from the original. It is not complete. To obtain the
complete article, please go to Harper's Magazine.
Kevin Phillips's new book, Bad Money: Reckless Finance, Failed
Politics, and the Global Crisis of American Capitalism, was published
last month by Viking.
If Washington's harping on weapons of mass destruction was essential
to buoy public support for the invasion of Iraq, the use of deceptive
statistics has played its own vital role in convincing many Americans
that the U.S. economy is stronger, fairer, more productive, more
dominant, and richer with opportunity than it actually is.
The corruption has tainted the very measures that most shape public
perception of the economy=97the monthly Consumer Price Index (CPI),
which serves as the chief bellwether of inflation; the quarterly Gross
Domestic Product (GDP), which tracks the U.S. economy's overall
growth; and the monthly unemployment figure, which for the general
public is perhaps the most vivid indicator of economic health or
infirmity. Not only do governments, businesses, and individuals use
these yardsticks in their decision-making but minor revisions in the
data can mean major changes in household circumstances=97inflation
measurements help determine interest rates, federal interest payments
on the national debt, and cost-of-living increases for wages,
pensions, and Social Security benefits. And, of course, our statistics
have political consequences too. An administration is helped when it
can mouth banalities about price levels being "anchored" as food and
energy costs begin to soar.
The truth, though it would not exactly set Americans free, would at
least open a window to wider economic and political understanding.
Readers should ask themselves how much angrier the electorate might be
if the media, over the past five years, had been citing 8 percent
unemployment (instead of 5 percent), 5 percent inflation (instead of 2
percent), and average annual growth in the 1 percent range (instead of
the 3=964 percent range). We might ponder as well who profits from a low-
growth U.S. economy hidden under statistical camouflage. Might it be
Washington politicos and affluent elites, anxious to mislead voters,
coddle the financial markets, and tamp down expensive cost-of-living
increases for wages and pensions?
Let me stipulate: the deception arose gradually, at no stage stemming
from any concerted or cynical scheme. There was no grand conspiracy,
just accumulating opportunisms. As we will see, the political blame
for the slow, piecemeal distortion is bipartisan=97both Democratic and
Republican administrations had a hand in the abetting of political
dishonesty, reckless debt, and a casino-like financial sector. To see
how, we must revisit forty years of economic and statistical
dissembling.
A SHORT HISTORY OF "POLLYANNA CREEP"
The story starts after the inauguration of John F. Kennedy in 1961,
when high jobless numbers marred the image of Camelot-on-the-Potomac
and the new administration appointed a committee to weigh changes. The
result, implemented a few years later, was that out-of-work Americans
who had stopped looking for jobs=97even if this was because none could
he found=97were labeled "discouraged workers" and excluded from the
ranks of the unemployed, where many, if not most, of them had been
previously classified. Lyndon Johnson, for his part, was widely
rumored to have personally scrutinized and sometimes tweaked Gross
National Product numbers before their release; and by the 1969 fiscal
year, Johnson had orchestrated a "unified budget" that combined Social
Security with the rest of the federal outlays. This innovation allowed
the surplus receipts in the former to mask the emerging deficit in the
latter.
Richard Nixon, besides continuing the unified budget, developed his
own taste for statistical improvement. He proposed albeit
unsuccessfully=97that the Labor Department, which prepared both
seasonally adjusted and non-adjusted unemployment numbers, should just
publish whichever number was lower. In a more consequential move, he
asked his second Federal Reserve chairman, Arthur Burns, to develop
what became an ultimately famous division between "core" inflation and
headline inflation. It the Consumer Price Index was calculated by
tracking a bundle of prices, so-called core inflation would simply
exclude, because of "volatility," categories that happened to he
troublesome: at that time, food and energy. Core inflation could he
spotlighted when the headline number was embarrassing, as it was in
1973 and 1974. (The economic commentator Barry Ritholtz has joked that
core inflation is better called "inflation ex-inflation"=97i.e.,
inflation after the inflation has been excluded.)
I n 1983, under the Reagan Administration, inflation was further
finagled when the Bureau of Labor Statistics decided that housing,
too, was overstating the Consumer Price Index; the BLS substituted an
entirely different "Owner Equivalent Rent" measurement, based on what
a homeowner might get for renting his or her house. This methodology,
controversial at the time but still in place today, simply sidestepped
what was happening in the real world of homeowner costs. Because low
inflation encourages low interest rates, which in turn make it much
easier to borrow money, the BLS's decision no doubt encouraged, during
the late 1980s, the large and often speculative expansion in private
debt=97much of which involved real estate, and some of which went
spectacularly bad between 1989 and 1992 in the savings-and-loan, real
estate, and junk-bond scandals. Also, on the unemployment front, as
Austan Goolsbee pointed out in his New York Times op-ed, the Reagan
Administration further trimmed the number by reclassifying members of
the military as "employed" instead of outside the labor force.
The distortional inclinations of the next president, George H.W. Bush,
came into focus in 1990, when Michael Boskin, the chairman of his
Council of Economic Advisers, proposed to reorient U.S. economic
statistics principally to reduce the measured rate of inflation. His
stated grand ambition was to move the calculus away from old
industrial-era methodologies toward the emerging services economy and
the expanding retail and financial sectors. Skeptics, however,
countered that the underlying goal, driven by worry over federal
budget deficits, was to reduce the inflation rate in order to reduce
federal payments=97from interest on the national debt to cost-of-living
outlays for government employees, retirees, and Social Security
recipients.
It was left to the Clinton Administration to implement these
convoluted CPI measurements, which were reiterated in 1996 through a
commission headed by Boskin and promoted by Federal Reserve Chairman
Alan Greenspan. The Clintonites also extended the Pollyanna Creep of
the nation's employment figures. Although expunged from the ranks of
the unemployed, discouraged workers had nevertheless been counted in
the larger workforce. But in 1994, the Bureau of Labor Statistics
redefined the workforce to include only that small percentage of the
discouraged who had been seeking work for less than a year. The longer-
term discouraged=97some 4 million U.S. adults=97fell out of the main
monthly tally. Some now call them the "hidden unemployed." For its
last four years, the Clinton Administration also thinned the monthly
household economic sampling by one sixth, from 60,000 to 50,000, and a
disproportionate number of the dropped households were in the inner
cities; the reduced sample (and a new adjustment formula) is believed
to have reduced black unemployment estimates and eased worsening
poverty figures.
Despite the present Bush Administration's overall penchant for
manipulating data (e.g., Iraq, climate change), it has yet to match
its predecessor in economic revisions. In 2002, the administration
did, however, for two months fail to publish the Mass Layoff
Statistics report, because of its embarrassing nature after the 2001
recession had supposedly ended; it introduced, that same year, an
"experimental" new CPI calculation (the C-CPI-U), which shaved another
0.3 percent off the official CPI; and since 2006 it has stopped
publishing the M-3 money supply numbers, which captured rising
inflationary impetus from bank credit activity. In 2005, Bush
proposed, but Congress shunned, a new, narrower historical wage basis
for calculating future retiree Social Security benefits.
By late last year, the Gallup Poll reported that public faith in the
federal government had sunk below even post-Watergate levels. Whether
statistical deceit played any direct role is unclear, but it does seem
that citizens have got the right general idea. After forty years of
manipulation, more than a few measurements of the U.S. economy have
been distorted beyond recognition.
AMERICA'S "OPACITY" CRISIS
Transparency is the hallmark of democracy, but we now find ourselves
with economic statistics every bit as opaque=97and as vulnerable to
double-dealing=97as a subprime CDO. Of the "big three" statistics, let
us start with unemployment. Most of the people tired of looking for
work, as mentioned above, are no longer counted in the workforce,
though they do still show up in one of the auxiliary unemployment
numbers. The BLS has six different regular jobless measurements=97U-1,
U-2, U-3 (the one routinely cited), U-4, U-5, and U-6. In January
2008, the U-4 to U-6 series produced unemployment numbers ranging from
5.2 percent to 9.0 percent, all above the "official" number. The
series nearest to real-world conditions is, not surprisingly, the
highest: U-6, which includes part-timers looking for full-time
employment as well as other members of the "marginally attached," a
new catchall meaning those not looking for a job but who say they want
one. Yet this does not even include the Americans who (as Austan
Goolsbee puts it) have been "bought off the unemployment rolls" by
government programs such as Social Security disability, whose
recipients are classified as outside the labor force.
Second is the Gross Domestic Product, which in itself represents
something of a fudge: federal economists used the Gross National
Product until 1991, when rising U.S. international debt costs made the
narrower GDP assessment more palatable. The GDP has been subject to
many further fiddles, the most manipulatable of which are the
adjustments made for the presumed starting up and ending of businesses
(the "birth/death of businesses" equation) and the amounts that the
Bureau of Economic Analysis "imputes" to nationwide personal income
data (known as phantom income boosters, or imputations; for example,
the imputed income from living in one's own home, or the benefit one
receives from a free checking account, or the value of employer-paid
health-and-life-insurance premiums). During 2007, believe it or not,
imputed income accounted for some 15 percent of GDP. John Williams,
the economic statistician, is briskly contemptuous of GDP numbers over
the past quarter century. "Upward growth biases built into GDP
modeling since the early 1980s have rendered this important series
nearly worthless," he wrote in 2004. "[T]he recessions of 1990/1991
and 2001 were much longer and deeper than currently reported [and]
lesser downturns in 1986 and 1995 were missed completely."
Nothing, however, can match the tortured evolution of the third key
number, the somewhat misnamed Consumer Price Index. Government
economists themselves admit that the revisions during the Clinton
years worked to reduce the current inflation figures by more than a
percentage point, but the overall distortion has been considerably
more severe. Just the 1983 manipulation, which substituted "owner
equivalent rent" for home-ownership costs, served to understate or
reduce inflation during the recent housing boom by 3 to 4 percentage
points. Moreover, since the 1990s, the CPI has been subjected to three
other adjustments, all downward and all dubious: product substitution
(if flank steak gets too expensive, people are assumed to shift to
hamburger, but nobody is assumed to move up to filet mignon),
geometric weighting (goods and services in which costs are rising most
rapidly get a lower weighting for a presumed reduction in
consumption), and, most bizarrely, hedonic adjustment, an unusual
computation by which additional quality is attributed to a product or
service.
The hedonic adjustment, in particular, is as hard to estimate as it is
to take seriously. (That it was launched during the tenure of the Oval
Office's preeminent hedonist, William Jefferson Clinton, only adds to
the absurdity.) No small part of the condemnation must lie in the
timing. If quality improvements are to be counted, that count should
have begun in the 1950s and 1960s, when such products and services as
air-conditioning, air travel, and automatic transmissions=97and these
are just the A's!=97improved consumer satisfaction to a comparable or
greater degree than have more recent innovations. That the change was
made only in the late Nineties shrieks of politics and opportunism,
not integrity of measurement. Most of the time, hedonic adjustment is
used to reduce the effective cost of goods, which in turn reduces the
stated rate of inflation. Reversing the theory, however, the declining
quality of goods or services should adjust effective prices and
thereby add to inflation, but that side of the equation generally goes
missing. "All in all," Williams points out, "if you were to peel back
changes that were made in the CPI going back to the Carter years,
you'd see that the CPI would now be 3.5 percent to 4 percent higher"=97
meaning that, because of lost CPI increases, Social Security checks
would be 70 percent greater than they currently are.
Furthermore, when discussing price pressure, government officials
invariably bring up "core" inflation, which excludes precisely the two
categories=97food and energy=97now verging on another 1970s-style price
surge. This year we have already seen major U.S. food and grocery
companies, among them Kellogg and Kraft, report sharp declines in
earnings caused by rising grain and dairy prices. Central banks from
Europe to Japan worry that the biggest inflation jumps in ten to
fifteen years could get in the way of reducing interest rates to cope
with weakening economies. Even the U.S. Labor Department acknowledged
that in January, the price of imported goods had increased 13.7
percent compared with a year earlier, the biggest surge since record-
keeping began in 1982. From Maine to Australia, from Alaska to the
Middle East, a hydra-headed inflation is on the loose, unleashed by
the many years of rapid growth in the supply of money from the world's
central banks (not least the U.S. Federal Reserve), as well as by
massive public and private debt creation.
THE U.S. ECONOMY EX-DISTORTION
The real numbers, to most economically minded Americans, would be a
face full of cold water. Based on the criteria in place a quarter
century ago, today's U.S. unemployment rate is somewhere between 9
percent and 12 percent; the inflation rate is as high as 7 or even 10
percent; economic growth since the recession of 2001 has been
mediocre, despite a huge surge in the wealth and incomes of the
superrich, and we are falling back into recession. If what we have
been sold in recent years has been delusional "Pollyanna Creep," what
we really need today is a picture of our economy ex-distortion. For
what it would reveal is a nation in deep difficulty not just
domestically but globally.
Undermeasurement of inflation, in particular, hangs over our heads
like a guillotine. To acknowledge it would send interest rates
climbing, and thereby would endanger the viability of the massive
buildup of public and private debt (from less than $11 trillion in
1987 to $49 trillion last year) that props up the American economy.
Moreover, the rising cost of pensions, benefits, borrowing, and
interest payments=97all indexed or related to inflation=97could join with
the cost of financial bailouts to overwhelm the federal budget. As
inflation and interest rates have been kept artificially suppressed,
the United States has been indentured to its volatile financial
sector, with its predilection for leverage and risky buccaneering.
Arguably, the unraveling has already begun. As Robert Hardaway, a
professor at the University of Denver, pointed out last September, the
subprime lending crisis "can be directly traced back to the [1983] BLS
decision to exclude the price of housing from the CPI. . .With the
illusion of low inflation inducing lenders to offer 6 percent loans,
not only has speculation run rampant on the expectations of ever-
rising home prices, but home buyers by the millions have been tricked
into buying homes even though they only qualified for the teaser
rates." Were mainstream interest rates to jump into the 7 to 9 percent
range=97which could happen if inflation were to spur new concern=97both
Washington and Wall Street would be walking in quicksand. The make-
believe economy of the past two decades, with its asset bubbles,
massive borrowing, and rampant data distortion, would be in serious
jeopardy. The U.S. dollar, off more than 40 percent against the euro
since 2002, could slip down an even rockier slope.
The credit markets are fearful, and the financial markets are nervous.
If gloom continues, our humbugged nation may truly regret losing sight
of history, risk, and common sense.
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