Investors: Down the Rabbit Hole

In recent months, investors have been unjustly chastised for their lack of consistency. In truth, they have an unblemished record of drawing the wrong conclusions. Last week’s 2nd quarter GDP report provides the freshest evidence of market cluelessness.

In its report, the Commerce Department stunned economy watchers by showing a 3.3% annualized increase in 2nd Quarter GDP. The robust growth apparently wrong-footed those expecting further recessionary signals, lent further strength to the current dollar rally, and encouraged previously cautious investors to take another look at U.S. stocks. The strong number also bolstered claims by the Bush administration and the McCain campaign that a recession is primarily a psychological phenomenon. These conclusions would be at least quasi-logical if they were not based on a complete misreading of the report.

Without raising an eyebrow on Wall Street or in the press, the GDP deflator, used in the report to downwardly adjust GDP to account for inflation, was shown at just 1.2% annualized.... the lowest deflator in ten years. In other words, to arrive at a 3.3% growth rate, the government assumed that inflation is running at a ten-year low! In contrast, the latest reading on consumer prices [CPI] in the second quarter shows year-on-year inflation running at a 5.6% rate, a seventeen-year high! In fact, for the second quarter, the same time period measured by the GDP deflator, prices actually rose at an even faster pace of 8.0% annualized. How can it be that inflation is simultaneously running at a seventeen-year high and a ten-year low? Welcome to the Alice in Wonderland world of government statistics.

You would think that this statistical bombshell would raise the hackles of the press. Think again. Not only did the hawk-eyed media completely miss the story last week, they have totally ignored our subsequent attempts to show them the light (with the exception of the N.Y. Post’s John Crudele – who has long suspected a ruse). Although none of the reporters we spoke with could explain why inflation could run at a 10 year low and a 17 year high at the same time, they did not deem the anomaly sufficiently noteworthy. Having been ignored by reporters, I then tried the opinion pages. Unfortunately the piece that we prepared on the subject was rejected this week by all the leading national newspapers.

Reporter Michael Mandel did note the head scratcher on a Businessweek blog posting last Friday. As a partial explanation he pointed out the CPI measures the prices of what we buy, and the GDP deflator measures the prices of what we make. Although this certainly sheds some light, it offers no real explanation. Excluding imports and exports, both measures are determined by the same forces, and should move in relative harmony. If anything, the costs of what we make should be outpacing the costs of what we buy. Producer prices are now rising faster than consumer prices (the latest annual reading of the Producer Price Index ‘PPI’ being 13.2% annualized from the 2nd quarter), which helps explain why corporate profits have fallen drastically. In addition, from July 2007 through July 2008 (the latest data available) import and export prices have risen 21.6% and 10.2% respectively. In other words, no matter what numbers you use, the 1.2% GDP deflator simply doesn’t add up.

I have often argued that government statics are dubious, particularly those related to inflation. But here is an example where they are not even consistent! If we simply use second quarter CPI to adjust nominal second quarter GDP for inflation, the number would have registered a 3.5% annualized decline.

Such horrific GDP numbers are much more consistent with the anecdotal recession evidence that Wall Street and Washington want us to ignore (confirmed by today’s weak jobs report which included the unemployment rate spiking to 6.1%, a five-year high). However, with Orwellian propaganda, our government fabricates GDP growth out of thin air without the smoke and mirrors traditionally required for such an elaborate illusion. All that is required is to put out ludicrous statistics and hope no one notices. Given that this strategy appears to be working, expect future government numbers to get even more outrageous. After all, if they can get away with this, they can likely get away with anything.

Investors relying on this data and reacting to the global economic slowdown by buying dollars and other U.S. based assets while selling gold, commodities, and foreign assets, are jumping out of the frying pan right into the fire. My guess is that it will not be much longer before they feel the heat.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read my new book, Crash Proof: How to Profit from the Coming Economic Collapse.

More importantly, don’t wait for reality to set in. Protect your wealth and preserve your purchasing power before it’s too late.

Comments

[SW Richmond]

Peter,

We lied our way through the last recession, and we're trying to do it again since it worked last time.

This recession is much much bigger, so the lies have to become spectacular, and they certainly have. In fact, we're not even having one! [cough cough] We are on incredibly thin ice; any of quite a number of known problems could blow up, and that doesn't even count black swans.

I agree: protect your assets. This is a case of he who loses least, wins. Best case is this plays out over the next several years, worst case is something blows up.

2008 Sep 08 11:09 AM

[otbricki]

Why exactly do the CPI and GDP deflator have to have anything in common? One is a basket of consumer items, the other is prices for domestically produced goods and services in the economy, not based on a fixed basket.

Since the GDP deflator is based on the domestic economy the primary source of inflation in the US economy, oil prices, is factored out. That is why the rates are very different.

2008 Sep 08 11:10 AM

[inthemoney]

otbricki, following your logic , to put it in simple terms, we sell our goods cheaper (at 1.9% increase) and buy goods at higher price (5.6%). So, basically, somebody is eating 3% difference, because input costs are higher 5.6% and output is only 1.9 % more expensive. Who do you think is eating the difference? Coporations to some degree and consumers mostly. It means consumers are loosing purchasing power and corporations have lower profits. Has is this not a recession?
The way GDP is calculated, if we produce even more and sell it even more cheaply,we 'll have enourmous growth, except we won't be able to buy anything anymore. Does it make sense to you?
It doesn't make sense. Most people don't understand and don't try because they think it is due to their luck of financial education that they don't understand.
The lying needs to stop. The first step in correcting a problem is acknowledging a problem exists.

2008 Sep 08 11:32 AM

[cyclingscholar]

Hey Schiff. hedonic price adjustments to the CPI have been done for DECADES. Why are they only an issue when Republicans are in office? I got a great idea..put your money where your mouth is. Create/Start trading CPI futures based on your cockamamie idea of what the actual inflation rate is, and see how many people are interested in your contracts. NONE.

cyclingscholar

2008 Sep 08 11:33 AM

[inthemoney]

cyclingscholar , who said anything about republicans? Why everything must be turned into a partisan issue? Are you saying the economy is fine ?

2008 Sep 08 11:43 AM

[you_can_call_me_Al]

Why do you think anyone cares about you?

2008 Sep 08 11:46 AM

[sheryl]

I'm wondering who you endorse, no scratch that, I'm sure you don't endorse either of them, but who will you be voting for Mr. Schiff?

2008 Sep 11 12:23 PM