Changing Sides

There was a time when I disagreed with the inflationistas and the gold bugs. In my view, they did not anticipate the deflationary flash flood that would rip through the global economy once history's biggest credit bubble began to burst, and they failed to understand that this was just the set-up needed to transform the last of the allegedly prudent policymakers into full-on Mugabes-in-the-making.

Now, though, as some deflationistas grow ever more confident that we are set for a replay of what took place 80 years ago, I am in the process of switching sides. As I see it, the combination of intellectual hubris and a relentless determination by central bankers and politicians to beat the GD 2.0 rap, as well as an increasingly contagious urge to embrace all manner of fiscal insanity, suggest we are nearing the point where people will begin to lose faith in those who control the pursestrings -- and the printing presses.

As that occurs, I believe the odds are good that we will see an inflationary episode like the one described in the following 321gold column, "Cycle Revisited," by Howard Ruff, editor of The Ruff Times.

John Williams publishes the Shadow Government Statistics newsletter (www.shadowstats.com). He is an amazing professional economist with a great grasp of the real economy. He and I have arrived at the same conclusions about almost everything in the economy, despite the fact that we approach it from totally different directions: me from the fundamentals, and he from a real technical and numbers point of view.

I am now in John’s home in Oakland, California, looking past the government numbers to get his views on the world as it really is. Shadow Government Statistics reconstructs published government statistics the accurate way we used to do it that reflects reality, rather than the way these numbers are now manipulated, and comes up with different conclusions about the economy, such as the Consumer Price Index (CPI), and other revealing areas published by government.

I trust John’s numbers because the government has been manipulating and restating these numbers for purely political purposes.

* * * * *

HJR: John is it necessary to recreate government statistics to show what you feel is reality, and how have you recreated them? I’d like some examples.

JW: Howard, I’ve been a consulting economist for about 27 years. I found early on that to make meaningful forecasts I had to have accurate information. It was evident early on that there were big inaccuracies in government reporting I surveyed at a convention of the National Association of Business Economists. Some economists have to make real-world forecasts, as opposed to economists who are employed by Wall Street to come to up with happy stories to encourage people to buy stocks and bonds.

I asked them what they considered the quality of government statistics to be. Most thought the numbers were very poor quality. Political manipulation tends to increase in election years.

I talked to the chief economist for a large retail chain, and he told me that the retail sales reports were absolutely no good, but he thought the money-supply numbers were pretty good.

Next was an economist for a major bank. He said the money-supply numbers were not very good, but he thought the retail-sales numbers are pretty good. The more someone knew about a given statistic, the greater the problems there were with the numbers.

Over time public perceptions increasingly varied from what the government was reporting because government kept changing methodologies, and usually tended to build an upside bias to the economic statistics of unemployment or the GDP – the broad measure of economies – and a downside bias in the Consumer Price Index, a popular measure of inflation.

When it became popularly used in auto-union contracts after WWII, the concept of the Consumer Price Index was fairly simple. But they wanted to measure changes in the cost of living, and they needed to maintain a constant standard of living. That was the traditional definition; the way the CPI had been designed.

That held pretty much in place until we got into the 1990s when Alan Greenspan and Michael Boskin, the head of The Council of Economic Advisors for the first Bush Administration, started talking about how the CPI really overstated inflation. The rationale was that when steak goes up in price, people buy more hamburger instead of steak; therefore you should reflect the substitution in the CPI.

That is not the concept of a constant standard of living; it is the concept of a declining standard of living that has no value to anyone other than politicians in Washington. They succeeded in reducing the reported level of inflation, which reduced cost-of-living adjustments in Social Security checks. Because of the changes in the 1990s, our Social Security checks are about half what they should be!

There have been different definitions over time. The government itself publishes six levels of unemployment from what they call “U-1” through “U-6.” The popularly followed measure is called “U-3.” Right now they say it is around 8.6 percent.

The broadest measure published by the government deletes “the discouraged workers” and people who are marginally attached to the economy. This is close to 16 percent. The key there is the “discouraged workers,” people who consider themselves to be unemployed. They know whether or not they have jobs. The Discouraged Worker hasn’t been out looking for work because there are no jobs to be had in his area.

Up until 1994, those discouraged workers wouldn’t have to specify how long they had been discouraged. After that, if they were discouraged, the government wouldn’t add them. I add them into my numbers, and it totals around 20 percent unemployment.

The popular number for the Great Depression is 25 percent unemployment rate and 34 percent among non-farm workers. We are mostly a non-farm economy.

HJR: During the Bush Administration, we heard all the happy talk about how well the economy was doing because of the cuts in tax rates. Is that really just happy talk or was the economy really doing well under Bush?

JW: We actually had a pretty bad recession in the early’90s, longer and deeper than popularly reported. Near the end of Bush’s first term at the time of the re-election race, a senior Commerce Department officer talked with a senior executive in the computer industry and asked him to boost the reporting of computer sales to the Bureau of Economic Analysis, which prepares the GDP report. They did; it boosted the GDP, the broad measure of the economy, and George Bush touted the strong economy. But some felt he was out of touch with reality.

The average guy has a pretty good sense of reality and knows whether or not economic conditions are good, or if inflation is up or down, which is why people have a difficult time accepting the government’s numbers. They have gotten so far away from common experience that people just don’t find them credible.

In terms of the GDP, clearly retail sales and industrial production were showing us a deepening recession long before the government reported it with the GDP. In fact, you didn’t show a contraction in the GDP until the second quarter of 2008. Officially the recession, according to the National Bureau of Economic Research, started back in December, 2007. If the GDP numbers accurately reflected what was happening, it would have at least shown the contraction two or three quarters before that. Other indications show that the recession really began in late 2006.

HJR: Let me get to a practical issue. What kind of economic activity should we support? For example, the conservatives will say we should cut tax rates to boost the economy. What does your research show?

JW: Cutting taxes is always a good idea. The private sector can do more with the money than the government can. Right now we are in a deep and deepening recession which will probably be called “a depression” before it ends. By depression, I mean a ten-percent contraction in overall economic activity.

When the government is reasonably solid, it can cut taxes. It can even increase spending without disrupting the system.

Right now we have a system where with the money poured into the banking system, and the “stimulus” by way of spending and tax cuts, is on top of record deficits.

If you look at the real numbers on the deficits, based on numbers published by the federal government, we really should look at it how it used to be. In the late ‘70s, the ten biggest accounting firms and congress said they could design an accounting system where the government will report its books the same way a company does. They finally got that into effect in 2000. Since then, instead of running deficits in the range of a couple of billion dollars, on a Generally Accepted Accounting Principal (GAAP) basis, the deficit has averaged $4 trillion a year. It was over $5 trillion in 2008 and will top $8 trillion this year.

This is unsustainable! You could not raise taxes enough to bring that into balance. If you wanted to bring it into balance, you’d have to eliminate Social Security and Medicare payments. It can’t be done.

HJR: Right now, Obama is spending money – I won’t say like a drunken sailor, because a drunken sailor spends his own money – but he is throwing trillions of dollars at the economic downturn, assuming it will stimulate us out. My personal opinion is that they are only stimulating government growth, and some day the average person may get a job, but his employer will be Uncle Sam.

What is the end result of creating all this money and throwing it at the problem?

JW: It will not stimulate the economy. The cost of all this is inflation. We will see inflation levels not seen in our lifetime by as early as the end of this year. Eventually we will see liabilities of $65 trillion – more than four times U.S. GDP, more than global GDP. There will be a hyper inflation where the dollar becomes worthless, where the paper is worth more as wall paper than as currency.

HJR: They couldn’t even use the money as toilet paper because it is a bad absorber of water. So we will have hyper-inflation. How can we protect the value of our assets, assuming that people have some discretionary money? Should they buy growth stocks because they are cheap, assuming “buy low, sell high?” Or are there better alternatives?

JW: We are headed into a hyper-inflationary depression that will become a Great Depression. When hyper inflation hits, it will disrupt the normal flow of commerce and turn it into a Great Depression.

What about paper assets based on the dollar? You want to get into something like gold or silver –physical gold or silver, not paper. Perhaps get some assets outside the dollar. It’s a time to preserve your wealth and assets, not to start speculating on the stock market. There is a lot of volatility ahead. Over the long term, gold and silver are your best hedges.

HJR: That sounds like the familiar tune I’ve been singing for several years. I’ve been publishing for 33 years. About 11 of those years I have been bullish on gold and silver as investments. When I abandoned gold in the early ‘80s, I was excommunicated from the gold-bug church because I was supposed to stay faithful to gold, but then the metals weren’t the right place to put your money. As a financial adviser, if I don’t have subscribers in the right investments, they will lose money and not renew their subscription to The Ruff Times. So I have a financial interest in being right. Yogi Berra said, “It’s déjà vu all over again.” the same thing is happening that I saw in the ‘70s that drove the prices of gold and silver to unprecedented highs – only more so now. They are creating more money than they ever thought of creating back then. We are using words like “trillions,” which we never used before. I’m not just looking at it as an investment and a place to make money. I am looking at it as a possible way to preserve the real value of your assets so you are not left destitute with a pile of worthless paper.

You showed me a display of Zimbabwe currency, where multi-billion dollar notes started out as $2-bill notes. We could face the same thing. The world is littered with worthless dead-paper currencies with an average life span of about 75 years. It’s always the same: we make too much of it ever since we created paper currency with the printing press, and creating too much of it to buy votes, diminishing its value.

A subscriber who wrote to me recently asking me that if the government and the bankers can manipulate the price of gold and silver, so couldn’t they do that for many years and gold and silver would go nowhere?

History doesn’t record a single example when a society inflated the dominant currency even near the quantities we are creating dollars now without destroying its value. Gold and silver, not being anyone’s debt or obligation, is where people ought to put their money.

I have been watching your work now for more than two years. I am amazed that you and I have arrived at the same conclusions from different sides of the street. I’ve learned a lot from your view of the numbers, and I’m a fundamentalist.

One reason I like you is because you agree with me. We like people who agree with us. Thanks so much for sharing your time and expertise with us.

JW: Thank you very much, Howard. I greatly appreciate the interview. I also appreciate your work. Indeed, we are in very broad and general agreement on where things are headed here. I have followed your work for many years; in fact, your writings back in the 1970s were part of my education as to the nature of the real world. Again, thank you, sir!

Shadow Government Statistics (www.shadowstats.com)

(Hat tip to The Coming Depression blog.)

Comments

[Greg H]

Howard Ruff???? HOWARD RUFF???? Dear sweet Lord!!! Please no!!! You are actually siding with THAT man? Sorry, sorry, sorry...In my opinion, you have now just blown ALL your credibility to smithereens!!!

[ll Street or the crooked bankers?]

A lot of the people concerned with inflation /deflation are
looking for the golden opportunities in investments or to
put it more bluntly how to make a killing without doing
meaningful work,what is the difference with the crooks
on wall street or the bankers mafia? either way it's a descent
in hell

[roger]

ll Street or the crooked bankers?DON'T KNOW HOW THAT GOT IN THERE
but it should read posted by roger

[Zitron]

Seriously, there is like zero real chance of hyperinflation this year or next. Unless we redefine hyperinflation to be like 10%, which is not by any reasonable definition. More generally, these gold bugs sound like Marxists predicting the end of capitalism. History proves them wrong once and again but, rather than accepting it, they shift their prediction to some distant point in the future. While reading Buffett's biography, I noticed these fears were already present in the 30's! I would not be surprised if it can be traced back much earlier. In the meantime, these Cassandras earn some money by preaching to the choir. Good for them we have the Internet, which increases their market and lets them get money.

[Shankar Khadye]

You are right, but probably early. Gold needs to correct further before it becomes a fantastic buy.

Yes, we'll see hyperinflationary conditions, but probably not before 2011-2012. Deflation needs to run its course, then the currencies get debased leading to a spike in Gold prices. (To be precise, Gold retains its value, its the paper money that loses it.)

[michael]

After reading Floyd Norris at the NY Times: "Subprime Loans, Corporate-Style, Will Fuel Defaults" I have actually changed into the deflation camp, at least for some more months...

[darkcloud]

Hi Michael,

Nice post. Hate to say it but I'm leaning with you.

Bottom line: via derivatives, financial banks, et al., have created their own money supply - "private currency" - which now dwarfs central banks' and governments' "public currencies" combined. Of course, hyperinflation (albeit "shadow") is close if not already here, in the form of (exponential) growth in derivatives.

The heavy-derivatives-handed financial banks and company now "own" central banks and governments.

Too big to sink? Ask the Titanic. Either way, we are damned if the financials do, and damned if they don't - fail, that is.

For a short summary:

http://darkcloudstlmo.blogspot.com/2009/04/derivatives-21st-century-currency-and.html

full discussion:
http://www.mi2g.com/cgi/mi2g/press/151108.php

Best regards, always, and thanks for your good work.

[farang]

I'd have to say some of these assertions by John Williams need qualifying. Some are dead on, some have no relation to reality.

One is that conservatives are correct that "cutting taxes are always a good thing."

No, they are not, if there are no corresponding cuts in program outlays (spending), which these faux conservatives like Reagan, Bush1, Clinton, Bush2 and now Obama do/did not do.

All these fakers have done is cut taxes on the very top income earners, who do not need their income boosted, nor does giving them tax cuts boost the economy, because they already have all the income they need to make all the purchases they wish. They simply hoard (save) the extra income. Or purchase a French vineyard, a million dollar Italian automobile, or an island somewhere you and I will never see, or stuff an off-shore tax haven account to the gills.

While these fake conservative politicians simply boost the Debt through borrowing by the Treasury to fund the programs needing radical surgery (DOD spending....not Social Security or Medicare, which is a very illuminating statement on John's priorities for cuts: hurt those already suffering, save the ultrawealthy.)

Notice, he doesn't mention WE PAY WITH TAXES for OUR Social Security that his conservatives have stolen and added to the General Fund, and stuffed the "Trust Fund" full of I.O.U.'s. More paper, soon worthless. Mr. Williams, were you asleep when Greenspan stated in 2003 we would simply "Monetize the Debt" when shit hit fan??? Precisely what Bernanke and the rest of the "need immediate hanging" crowd are doing at this very minute.

Yes, it is obvious an inflation storm is headed our way, why else would the criminal (and criminally insane) Greenspan halt the reporting of the M3? ONLY to hide the coming fallout from folks that can analyze and chew gum at the same time. Seems the Chinese can do both.

While our fake conservatives in Congress gave him standing ovations for spouting indecipherable gibberish labeled as "economic policy."

"Cassandras", what a riot: I suppose we aren't in a downward financial spiral now, and it is all in "our heads" that jobs are vanishing by the thousands daily, and that paper wealth, in assets from real estate to antiques, classic autos to stamp collections, is rapidly losing value? How about giving some contradictory stats proving we are NOT in said spiral to bolster your ridiculous assertions.

In other words, don't piss down my back and tell me it is raining. Don't tell me that Reagan led some kind of economic miracle, while taking us from the largest creditor nation to the largest debtor nation in just 8 short years..."tax cuts are always a good thing".....losing credibility there, John.

Please explain, if that is true, why, even with the manipulated stats under Clinton, there was a "surplus", yet that vanished, the budget went from black to red (using the same manipulated stats Clinton used) and huge deficits occurred in 2001 before the faux 9/11/01 "terrorists attacks" (domestic in reality) immediately after Bush2 and the "conservative" Congress pushed through tax cuts that in reality only benefited the ultrawealthy (his self-proclaimed "base").

It continues to this day: the bailout is simply the rats fattening up before they jump ship to their hideaways. Or behind their exclusive gated communities, with their own private police.

WHEN will this hyperinflation occur?

How long did it take in pre-WWII Germany?

I'd wager one could estimate from that, as we are more similar to that nation economy than Mugabe's Zimbabwe.

[farang]

One more thing: All this scenario could radically "change" if the Neocon's running the Obama administration are able to manipulate us into another World war, their obvious objective in Iran, Iraq, Pakistan, Afghanistan, etc.

I'd guess, wager even, we'll see another fake "terrorist attack" soon to be the triggering device to implement their plan.

Then we can have, in their criminal, feeble minds, another 50 years of manufacturing "prosperity" after we level all our competitors to dust again.

Because, just like after WWII, we'll be the one untouched by the aftermath of the war. At least, that is the very obvious plan.

But this time, I think Russia and China won't be "on our side."

Better watch what you hope for, all you Neocon sociopaths.....you can't even stifle a nation like Iraq, that one would assume would be grateful to have a dictator nutbag like Saddam removed. And why? because, like bad company, we come to "visit and rescue", but we don't leave...ask the French about how that worked after WWII. They had to ask us to leave. Over 60 years later, we haven't left Germany. Nor Japan. Geez, after 50+ years, we haven't even left the occupation of our ALLY South Korea.

[vivdvew]

So I guess I am a little confused as to how gold or "goldbugs" get thrown into the mix on this one. Gold would seem to do well in either the hyperinflation or deflation scenario. In the former for obvious reasons and in the latter as a currency of flight.

I am also a little confused as to the definition of inflation being used here.(seems to be a common problem as the word has become overloaded beyond all measure)

IMHO whether we are in deflation now does not seem debatable. We clearly are by either common use of the word.

1) Prices - dropping
2) Money supply including credit - All the helicopter drops in the world are so far dwarfed by the destruction of credit.

Whether we stay here does seem more debatable.

Most of the things here seem to speak to the stability of the dollar as the world currency reserve and exchange rates rather than growth in money supply and credit(the proper definition by my understanding). While a collapse of foreign demand for the dollar would inarguably have drastic effects on the purchasing power of the dollar for imported goods, does this count as inflation?

just 2 cents from a schmuck on the street trying understand the inflation vs. deflation argument.

-vividvew

[Eric]

I find this article confusing because it doesn't specify what is meant by inflation. Are these people predicting wage inflation? Price inflation? Monetary inflation that surpasses the losses that are occurring?

How will this inflation play out for the man on the street?

I think its obvious we've had price hyper-inflation the past 10 years, we just didn't call it that. Re-selling the same house every couple years for ever-bigger prices was inflation. Home-equity loans above the value of the already-bloated appraisal was inflation.

At the same time we've had wage deflation, necessitating massive amounts of credit to keep up with the price inflation of housing, tuition, health care, etc. All that credit was inflation -- money borrowed into existence. That phantom 'money' is now being defaulted, ie deflating back into the nothingness from whence it came.

So based on where we are now, what exactly is meant by the authors' prediction of a hyper-inflationary depression leading to a great depression?

[roger]

Economist play a lot of games with the definition
of value (inflation versus deflation) that's because
they don't have a solid base to make a judgment.
The way I see it it is the total # of hours society
has to work to buy back the goods/merchandise it as
produced that will define if there is inflation or deflation.
I know I know that' heresy

[Edward Charles Ponzi Jr.]

I LOVE this quote from James Howard Kunstler:

"The poor curious little monkey-humans stand on the beach transfixed by the strangeness of the event as the water recedes and the sea floor is exposed and all kinds of exotic creatures are seen thrashing in the mud, while the skeletons of historic wrecks are exposed to view, and a great stench of organic decay wafts toward the strand. Then comes the second stage, the tidal wave itself -- which in this case will be horrific monetary inflation -- roaring back over the mud flats toward the land mass, crashing over the beach, and ripping apart all the hotels and houses and infrastructure there while it drowns the poor curious monkey-humans who were too enthralled by the weird spectacle to make for higher ground. The killer tidal wave washes away all the things they have labored to build for decades, all their poignant little effects and chattels, and the survivors are left keening amidst the wreckage as the sea once again returns to normal in its eternal cradle."

[shayre]

If the government is willing to confiscate wealth through hyper-inflation, what makes goldbugs so certain that the next step won't be to confiscate gold? And besides, if the dollar does become worthless, where are you going to keep your gold safe? You may have gold, but what physical risk of harm do you potentially expose your family to? Will there be rule of law to protect you and your gold?

[m]

@shayre:
Aren't you confusing gold bugs with survivalists?