MOsanthrope

Posted by Chris on March 12, 2006 at 11:56 pm.

Our family took advantage of yesterday’s spring-like weather by attending a dinner party hosted by some close friends. It was a good time.

When their number reaches a certain critical mass, children who otherwise demand their parents’ unwavering attention permit the adults to relax and have conversations involving subjects other than SpongeBob, preferring instead to scatter toys and slam doors while in pursuit of the kid currently designated “it.” Meanwhile, per the standard protocol at these functions, the adult males in attendance quickly migrate to the backyard deck in order to safeguard the beer bucket and, in some cases, enjoy a cigar.

Our deck cabal is politically diverse: Shirking their parental responsibilities yesterday afternoon were a conservative, a more moderate conservative, a liberal and, well, me. You can imagine how things go when, emboldened by a few fermented vegetable beverages, some idiot inevitably steers the course of conversation from work, sports and movies to politics.

While discussing our President’s brand of big government conservatism, one friend dismissed the GOP’s recent spending spree, noting that the deficit as a percentage of the Gross Domestic Product (GDP) is less than five percent. According to the White House Office of Management and Budget, he’s correct:

Last year’s Budget estimated a deficit of 4.5 percent of Gross Domestic Product (GDP) in 2004, or $521 billion. Private and other forecasters had similar deficit expectations. Largely because economic growth generated stronger revenues than originally estimated, and because the Congress adhered to the spending restraint called for in the President’s Budget, the 2004 deficit came in $109 billion lower than expected, at $412 billion, or 3.6 percent of GDP.

In order to arrive at these figures, however, the OMB utilized some very creative accounting techniques.

Last week, another friend sent me a link to an interesting article by MSN Money’s Bill Fleckenstein. His column discussed a recent interview of economist John Williams by former Barron’s editor and Welling@Weeden newsletter author, Kate Welling. The interview is now available to non-subscribers at the Weeden & Co. web site. I urge you to read it in its entirety.

For the last quarter century, Williams has worked as a consulting economist to Fortune 500 companies. As he explains on his web site, one of his early clients used Gross National Product (GNP) data to forecast sales. When the company’s model suddenly stopped producing accurate data, it retained Williams to determine why. He “realized the GNP numbers were faulty, corrected them for [his] client… and the model worked again, at least for a while, until GNP methodological changes eventually made the underlying data worthless.” In the decades since, he’s become, “out of necessity,” an expert in U.S. Government economic reporting.

In the interview, Williams describes a federal government which has, for the past four decades, systematically manipulated its economic data. The changes were subtle and incremental: The Kennedy administration created a new category of persistently unemployed individuals, but nevertheless included these “discouraged workers” in its aggregate unemployment statistics. President Johnson repeatedly asked the Commerce Department to revise GNP figures until the department produced his desired results. The Nixon administration failed in its attempt to alter census data tabulation; the current administration succeeded. President Carter understated inflation and tweaked the government’s method of calculating the Consumer Price Index (CPI) — a practice which was repeated during successive administrations. The Reagan administration made “methodological changes” to the GNP and manipulated trade data. During the first Bush administration, sales data reported to the Bureau of Economic Analysis was overstated to create a “spike” in the GDP. The Clinton administration removed Kennedy’s “discouraged workers” from official unemployment statistics.

Williams agreed with Welling’s assessment that “massaging economic statistics is a bipartisan effort,” adding, “That’s why, generally, one Administration does not call the previous one on it. It is… a perk of office.” However, the cumulative result of decades of data manipulation and statistical adjustment is astounding:

Real unemployment right now — figured the way that the average person thinks of unemployment, meaning figured the way it was estimated back during the Great Depression — is running about 12%. Real CPI right now is running at about 8%. And the real GDP probably is in contraction…. [I]f the same CPI were used today as was used when Jimmy Carter was President, Social Security checks would be 70% higher.

In a column last week, Paul Krugman noted that the 2006 Economic Report of the President paints a picture of a dwindling American middle class: “[T]he real earnings of college graduates actually fell more than 5 percent between 2000 and 2004. Over the longer stretch from 1975 to 2004 the average earnings of college graduates rose, but by less than 1 percent per year.” Krugman contrasted that trend with exponential increases in the incomes of the wealthiest one percent of Americans during the same period.

For his part, Williams meticulously described how recent manipulations in the CPI, GDP and employment data have caused those statistics to dramatically overstate the standard of living for average consumers. In the nineties, for example, Alan Greenspan and Michael Boskin advocated the use of “substitution” in CPI calculation. The idea was that if a product becomes too expensive, consumers opt for a less expensive alternative. In other words, if steak becomes prohibitively expensive, consumers buy less expensive beef instead. The problem with that theory, Williams argues, is that “if you allow substitutions, you aren’t measuring a constant standard of living. You’re measuring the cost of survival. You can keep substituting down and have people buy dog food instead of hamburger. It happens. But that’s not the original concept behind the CPI.” The interview provides numerous other examples of statistical manipulation, including “hedonistic adjustments” to the CPI, which offset increases in a product’s cost by theoretical improvements in the product. For example, significant increases in gasoline costs caused by the addition of purportedly environmentally-friendly additives in the 1990’s were not included in CPI computation because a postulated improvement in air quality offset the additional per gallon cost. The interview is replete with such examples. Read the whole thing.

Perhaps the most disconcerting aspect of Williams’ analysis is his critique of the federal government’s deficit accounting. “The budget deficit numbers you hear announced at White House press conferences,” says Williams, “are from accounts kept on a cash basis, with no accruals made for monies owed by or due to the government in the future.” In other words, because revenue generated by Social Security taxes is not offset by future Social Security obligations, “Social Security taxes have been artificially lowering the deficit level for years.”

The net result is a grim assessment of the country’s economic outlook:

[In] 2005, the official deficit was reported at around $319 billion. Using generally accepted accounting principles, the 2005 Financial Report of the U.S. Government published by the U.S. Treasury, showed a deficit of $760 billion. That’s without considering Social Security and Medicare…. Where the official federal deficit in 2004 was reported at about $412 billion, and the GAAP-based deficit was around $616 billion, they said that if you added in the net present value of the underfunding of Social Security and Medicare, the one-year deficit in 2004 was $11.1 trillion. That’s trillion, not billion. That amounted to almost 100% of GDP at the time. Now, that $11 trillion included a one-time spike of about $8 trillion, to account for what Congress and the President did in setting up the Medicare drug benefit without funding it going forward. But you can see that if you back out that one-time charge, that on a GAAP basis, accounting for Social Security and Medicare, in 2003 the deficit was around $3.7 trillion; in 2004 it was $3.4 trillion; and in 2005 it was $3.5 trillion. We’ve had three years in a row here where the GAAP deficit has been basically $3.5 trillion. So the deficit and the total obligations of the federal government are increasing by roughly the amount of GDP every three years. In fact, the fiscal 2005 statement shows that total federal obligations at the end September were $51 trillion; over four times the level of GDP. It is unprecedented for a major country to have its actual obligations so far out of whack…. It’s beyond control.

To put these figures in perspective, Williams explained that if Congress were to raise the personal income tax rate to 100%, we’d still run an actual deficit. Unless the economy grows exponentially and Congress cuts Social Security and Medicare “drastically,” our children will likely face a profound economic crisis. Williams concludes that because the reduction in spending necessary to eliminate the deficit is not “politically feasible,” the Fed will address the problem using its engraved intaglio steel plate method. He suggests that the U.S. is already in the early stages of an inflationary recession and fears that we’re heading for an hyperinflationary depression. If our foreign investors panic and jump ship, Williams warns, the country’s economic situation will become dire.

In short, the economic time bomb we adults are assembling for our kids, nine of whom spent yesterday afternoon trashing my friend’s basement, is much more dangerous than we realize.

Happy Monday.

Filed under: Politics, U.S., Economy