The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, they added 500 extra billion dollars to our GDP just by changing the accounting in August. The first thing that you and I said was, “We need to get John Williams on and have him explain just why this is more real than it seems.”
David: And lo and behold, all of a sudden the depression in the 1930s was not as bad as we thought it was, neither was any recession moving forward. We’ve had more growth in the economy, and we just didn’t appreciate how good we had it.
Well, this is one of the reasons why we continue to read and have conversations with John Williams, because he is looking beyond and behind the government statistics and helping to clarify what has been utterly politicized and what can still be relied on as a healthy reference point in the decision-making process that each individual listener, and of course, we, ourselves, are making, as it relates to our finances.
To look at economics today, unfortunately, it’s not the dismal science, that would be complimentary, it’s becoming the stupid science, where we have so much confidence in numbers that actually have so little relevance and truth to them.
Yes, we need a John Williams to just pencil it out and say, “Here is what has changed, and why, and if you want to look back over the decades, these are the points at which it has changed, whether it was in 1999, or 1984, or 1970, but these are the things that have changed.” It’s helpful.
With that in mind, let’s go right into our conversation.
John, I’ve heard you say that nothing today is normal. In a nutshell, maybe you could explore what you see is the real economic backdrop, and comment on the mind games that are being played with the general public. You have the governing elites, you have the Fed, and they are playing these perception-oriented games. Maybe you can paint a more accurate picture.
John Williams: Sure. Right now, I will contend that we are still living with the aftershocks of the panic that took place in 2008, and the problems go well back before that. The economy started to turn down, in reality, about 2006 to 2007. You saw that in the housing sector, which helped to trigger the credit crisis. As the economy turned down and the credit crisis broke, you had a financial panic, which intensified the economic downturn, and it has taken us into the deepest and most protracted economic downturn seen since the Great Depression.
The official version of what has happened is that the economy tanked into the middle of 2009 and as of June 2009 the economy started to turn up, and has continued upward ever since, fully recovering, meaning that it had reached its pre-recession level back in the 2nd quarter of 2011. That’s nine quarters ago, more than two years ago, and now it is 4-5% above where it was before the recession started.
The problem with that is that there is no other major economic series that shows that pattern. In theory, the GDP is supposed to reflect other economic reporting. The series is the theoretical construct that came out of academia back in the 1920s, as with many things like this that are trying to model the economy, it had to be simplified in order to make it work, and in the simplification you find that the numbers move away from economic reality, the real world experience.
So there are basic reporting flaws within the GDP, itself, but more recently, in the last couple of decades, the government has exacerbated the problem by changing the way inflation is reported, and inflation is an important factor in the GDP reporting.
The GDP number is reported net of inflation. You are trying to see what the economy is doing, not whether or not, for instance, retail sales are rising because prices are rising, you want to see what retails sales are doing net of inflation. If you understate the inflation that you use in adjusting the GDP, and this government does, you end up over-stating that inflation-adjusted growth, and that’s why we’ve seen the economic recovery in the official GDP reporting.
It’s also a part of the reason we haven’t seen it in things such as payroll employment, which is still well below where it was going into the recession. That has no inflation factors in it, whatsoever. If you correct for the inflation distortion, what you will see is that the actual GDP started turning down in 2006. The official is that it starting turning down right after December of 2007, that was the peak, it plunged into the middle of 2009, that’s consistent, but instead of recovering, it has been bottom-bouncing, basically, ever since, very stagnant, and in the last couple of quarters, it started to turn down again.
I will contend that is a lot closer to common experience, so that the official recovery is basically a statistical illusion, and this has all sorts of implications, ranging from the Fed’s programs to what the government is doing, and can do. If you look at the deficit projections, they are based on economic assumptions going forward. All the economic projections going forward on the budget are based on positive economic growth. We’re not going to have that for some time, and there’s a good reason for it that I’ll get back to in a minute.
The estimates of the federal budget deficit are based on positive economic growth going forward. Nothing is quite as it appears, and the biggest issue, as I see it, remains that the system, itself, is not stable, the banking system is not stable. All the Fed easing actions have been aimed at providing liquidity to the banking system.
The Fed’s primary function is to keep the banking system afloat. Granted, there is a mandate by Congress that the Fed needs to contain inflation and maintain sustainable economic growth the best it can, but there’s very little the Fed can do right now to stimulate the economy. The Fed can always contract the economy, and it can always increase inflation, but it is difficult to bring inflation down once it’s up, and it’s difficult to get the economy up when it’s down, so that when you have the Fed talking about all the possible qualifications as to what economic conditions would lead it to cut back on its easing, that’s largely nonsense.
The Fed’s primary concern in the easing is maintaining the stability in the banking system, and it is using the weakness in the economy, which continues, as political cover for doing so. The reason that you have ongoing economic weakness, and the reason we have no recovery in place, and none that is about to hit us, is largely tied to the consumer.
There are numbers that are put out by a private company that was started by a couple of senior Census Bureau officials, where they report on a monthly basis, the median level of household income, adjusted for inflation using the government’s consumer price index. It’s very interesting, if you look at it, where the government publishes an annual number, they have this broken out monthly, and what the monthly data show you is that as the economy plunged off a cliff, and we came to the so-called recovery in June of 2009, median household income continued to plummet, and then it hit a low level of stagnation. And it is still there, it hasn’t recovered.
There is no way that you can have a sustainable economic recovery, you cannot have sustainable consumption, without sustainable growth and income. That’s a basic. Income will drive consumption. Now, you can borrow some growth from the future through debt expansion, and going back a couple of decades, when Alan Greenspan was Fed chairman, he recognized that there was a fundamental problem here in terms of consumer income. What you are seeing today if you look at the government’s last estimate of median household income, which is for the year 2011, and that is, again, adjusted using the CPIU, it was below where it was back in 1967. The average guy is not making it.
And the reason that we’ve had the terrible decline in income is because jobs, basically, have been lost to offshore competition, the higher-paying jobs, the production jobs. That kind of constraint on household income, where back in the 1970s, when this really began to develop, where you had, more commonly, a household where the mother would stay home with the children and the father would go out and work, today it’s much more common that you have, at least, two income-earners in the household. And even so, the households are not staying even.
Greenspan, seeing that there was a problem here that was going to impact the economy, began very actively encouraging debt growth, and indeed, we saw a period of debt expansion that was unprecedented in modern times and debt leverage was built upon debt leverage, and then we had the crisis in 2008 where, effectively, we had the debt collapse.
So what’s happened now, what we see with the consumer, is that, number one, he or she still has the same limitations in terms of income as before the crisis. In fact, that has intensified, but they no longer have the ability to expand their debt the way they did before, to make up for the shortfall in their living standard. And until something is done to address the basic consumer liquidity problem, there is no hope of a sustainable economic recovery. That’s not in the works.
David: As you know, many deflationists argue that, given the total stock of liabilities outstanding, what you just suggested, Greenspan helped promote a massive amount of debt growth through his 20-year tenure. They contend, the deflationists do, that there is a deflationary contraction ahead, a shrinkage of credit, and that dollars will be in high demand, forcing a major move higher in the dollar.
By contrast, I believe, you see heavy dollar selling, more likely with dollar-based commodity prices rising, in turn leading to price inflation, domestically. How would you, John, address the deflationary concerns, given the total stock of debt out there, and the monetary machinery that we have in place?
John: In order to have a deflation of the type that some people fear, such as we had in the 1930s, we need to have a collapse in the money supply. What happened in the 1930s was that we had bank failures, where people actually lost the deposits at the banks. They would have their savings at the local bank, the local bank went under, there was no FDIC insurance, the cash was just gone. And as the banking system began to implode, so, too, did the money supply, because those deposits were not there. There was no way to recover them.
Back in 2008, Bernanke and crowd were very fearful of a massive deflation like we saw in the 1930s when the banking system crashed. They were afraid we were on the brink of a collapse, and we were. I mean, they weren’t kidding. At that point in time, they spent, created, whatever money they had to do, guaranteed, they loaned whatever money they had to loan, in order to keep the system afloat. Whatever they had to do, they did. They weren’t too concerned about the long-term impact, they were just trying for short-term survival of the system.
What they succeeded in doing was buying a little time and pushing the problems down the road. But there isn’t a thing they did that fundamentally resolved the problems in the system. Those systems are still there. I don’t think we’re going to have a collapse in the money supply, because I would fully expect that they’re going to do whatever they have to do to insure the domestic depositors.
The collapse of debt does not, by itself, contract the money supply. Some people say if there is a crash, the money supply is going to go with that. If I’m a bank and let’s say I lend you a million dollars. In normal times, that million dollars would then maybe expand to 10 million dollars, and the money supply, you would spend the money anywhere, or you deposit it in your bank, you’d spend the money, and as the cash got deposited at different banks, all those banks would, in turn, lend more money, creating maybe a ten-fold increase of the money that you had.
Now, you go under. You say, “I can’t pay back that million dollars.” I’m the bank, I want the million dollars back. I can’t go into the system and pull that million dollars out of the system. It has already spread throughout the system. If I could pull that money out of the system, that would create a reverse expansion of the money supply. When I can’t do that, I have to take a hit on my balance sheet and as my balance sheet gets hurt, that limits my ability to lend money.
That’s what happened here. We saw a slow attrition of the pace of growth in the money supply. We actually went negative, briefly. We saw some negative inflation, nothing worse than we saw back in the 1950s. This is, again, based on official government reporting. If it weren’t for the gimmicks they put into place to understate inflation, the low rate of deflation that we actually had in this post-crisis period, and now we’re back up in an inflationary area, would never have been deflation. It would have been 3-5% higher than we are now in terms of annual inflation.
The reason that we’re going to have a hyperinflation is tied to the basic insolvency of the U.S. government. This was in place before the crisis of 2008. Some people say, “Oh Williams, you’ve been talking about a hyperinflation for years.” Yes, I have, but I’ve been talking about it in the future. I’ve been talking about first, initially, toward the end of the current decade, and then after the crisis of 2008, pulling in the forecast horizon to next year.
This issue here is that the federal government is beyond control, in terms of its fiscal policy. It is evident when you look at the games the politicians played back in July of 2011 and all the gimmicks, trying to balance the budget off until after the election, and the resulting sequester, and now we have a debt ceiling and another fiscal crisis that are going to come to a head in September, which is when I think they are going to see very heavy selling pressure against the dollar.
Heavy selling pressure against the dollar here is also tied to the monetary policies of the Fed. What the Fed has done is it has tried to debase the dollar. Nobody in their right mind, that I see, wants to hold the dollar. They are doing it for political reasons, they want to get out of it as soon as they can, minimize their losses. But as people start to dump the dollar, you will see the dollar’s exchange rate value decline. That becomes very inflationary.
This is not inflationary from the standpoint of, “Oh boy, we’ve got a strong economy.” You will hear a lot of people saying, “Oh yes, we need to see some inflation here because that means strong economic growth.” There are two types of inflation. There is one, and people like to think that this is the more common type, although it isn’t, it hasn’t been in the last couple of decades, in which you have a strong economy, demand is up, there are not enough goods, so as the excess money chases the goods, the prices rise, production increases, people get hired. That is a relatively healthy inflation. That’s where the economic demand is pushing the prices higher.
The type that we are seeing is one where the commodity prices are being driven higher by a weak dollar, a direct relationship between the weakness in the dollar and the spiking of oil prices. What happens with higher oil prices? We get higher gasoline prices. The great volatility that we have seen in the year-to-year change in inflation recently has been tied largely to swings in gasoline prices, and you can largely tie those to the Fed’s institution of quantitative easing, or actions taken directly at weakening the dollar.
I think we’ve got a major dollar crises ahead here. September is when the debt ceiling crisis will have to be resolved. Right now the Treasury is playing games, avoiding breaking the debt ceiling, but there will come a time, right after Labor Day, when they will have no choice, and Congress will have to act, and how it goes I can’t tell you, but I do think there is going to be some terrible contentiousness, re-raising all the issues that the world is looking at in the global markets, in terms of the long-term solvency questions, sovereign solvency issues, of the United States.
You may hear, “The budget deficit is coming down this year.” Nonsense. That is a cash-based deficit. They have some gimmicks where they have had dividends out of Fannie Mae and Freddie Mac, which the government effectively has guaranteed and should be putting on its balance sheet and should be putting their debt on its balance sheet instead of just claiming dividends, and such.
If you look at the government’s financial condition, the way a corporation does, using generally accepted accounting principles, GAP, what you will see is that the deficit in the last fiscal year, which ended September 30, 2012, was 6.6 trillion dollars, not 1.1 trillion, which is the cash base. 6.6 trillion is beyond containment. We’ve been averaging 5 trillion dollars a year actual deficit for the last 5 years. It gets worse by that amount each year.
Let’s say in one year you just wanted to eliminate that deficit. You run into serious problems. From a tax standpoint, you could raise taxes and take 100% of people’s wages and salaries, and you’d still be in deficit. You could cut every penny of government spending, including defense spending, but not touch Medicare or Social Security, and you’d still be in deficit.
In order for the United States to become solvent, where it has the ability to meet its future obligations without just printing money, which is where it is headed right now, and that is what gives you the hyperinflation, you have to have severe cutting of the budget, in all sorts of areas, but the social programs, like Social Security and Medicare, in particular, have to be altered so that they are functionally solvent, that they cover themselves.
That is very difficult to do over time, and you have no political will, whatsoever, in Washington, that I have seen, by the people currently controlling the government, to do that. I don’t see that happening. That is what is threatening the long-term solvency of the United States. That is what is going to cause a terrible sell-off in the U.S. dollar in the months ahead. I can’t give you precise timing on that. But the fundamentals are there, and as the dollar weakens, you are going to see significant inflation, as foreign holders of the dollar increasingly dump dollars. They will dump dollar-denominated paper assets, such as treasuries. The Fed is going to have to intervene to prop up those markets, and all of a sudden you are going to see the money supply starting to explode.
David: John, if I understand you correctly, it’s not really the issue of quantitative easing, either a continuation of that, or an expansion, which will bring about higher rates of inflation, the direct monetization of assets we have seen of late, but you are saying it’s much more basic than that. That may be icing on the cake. It’s the fiscal policies that are beyond control.
John: If the fiscal policy were sound, and the world had confidence in it, the Fed wouldn’t have to be buying treasuries. The primary reason is trying to provide solvency to the banking system, but I think to a certain extent they are also trying to make those treasury auctions go well.
Right now, based on the expansion of QE-3 that went into effect in January of this year, when they started the buying, again, of the U.S. Treasury securities, and that’s the significant one in terms of the monetization, since the beginning of the year, the Fed has now bought more than the total net issuance of the U.S. government of its treasury debt since the beginning of the year. That means the Fed has basically absorbed all the treasury issues. And yet, interest rates are going higher.
Part of the reason is that you are seeing some dumping of foreign-held treasury securities, and that is something of a balance due to the Fed’s efforts to keep interest rates low. But if you buy up all the supply, at least for a while, you have some pretty good control over the pricing, and of course, the pricing here is interest rates. They are going to continue trying what they are doing now.
I don’t see that they have an alternative. I don’t see how they could possibly end the easing if they are looking to keep the system afloat. They’re just trying to buy time, hoping they will somehow find a way of working the system out, getting the economy growing, bringing the deficit under control. I just don’t see it working, which gets you to a point which is, I know, very discouraging for people, and believe me, it’s discouraging for me, too. But you get to a point where if you don’t see them having a happy solution, you still have good news, and that is that being aware of what is happening, you can take actions to protect yourself.
David: John, earlier we were talking about GDP, and we’ve changed some of the variables that go into GDP, adding credence to what I thought I heard you describing earlier as a highly politicized number. How have we changed it? Did the Commerce Department further skew the lens we look through, or have they brought us closer to economic reality and real-world activity?
John: The GDP, over time, just keeps moving away from real-world activity. Again, the concepts are very heavily simplified to make the numbers work. Every ten years or so they go through what they call a comprehensive revision and they redefine the series. The problem is, each time they redefine the series they restate prior economic history and up the level of activity.
We just had such a revision, and if you look at the reporting for, let’s say 1929, which was the beginning of the historical series and what they publish now versus where it was reported in 1950, and the latest reporting, that is now 1.2% higher than it was estimated in 1950. If you go to 1933, the depths of the depression, that number today is 3% higher than it was in 1950, so we’ve seen some mitigation of the depth of the Great Depression, and this is just because they’ve redefined the series, they’ve come up with ways of making the economy look stronger, but they always carry it back in time to try to have it on a consistent basis.
But they also make changes that will help the current period and accelerate the growth, because what you see is, let’s say you look at the reporting of 1960 on the economy, as it was reported as recently as 1984, that is now roughly 8% higher than it was, 1970s, it is now 9% higher than it was, 1980 it is 10% higher than it was. And it just gets worse and worse as you go along.
David: John, it feels like this is just outright, unmitigated balderdash. It is revising history, and it feels like the kind of thing that you would expect to see out of communist Russia. You burn the old textbooks, you send the professors, the dissidents, to the gulag, and you completely rewrite history. How is it that students of tomorrow will appreciate that the numbers that they are looking at are entirely bogus, and cannot be trusted?
John: What they do is with academic backing, and there is some theoretical structure to it, but let me give you an example of the absurdity. The National Income Accounts, of which the GDP, the Gross Domestic Product, is part of, is effectively an accounting system. You have the GDP, which measures consumption, then you have the GDI, which is the gross domestic income, as opposed to the gross domestic product, but along with saving, will, theoretically, be exactly equal to the GDP. They can’t get them close. They are lucky to get them within 10% of each other, and part of the reason has to do with all the simplifying assumptions.
For example, I’ll bet the average person who owns a home doesn’t realize that they are earning rental income on the homes that they own, from themselves. Of course not. But that’s the way the government works it. They have what they call homeowners equivalent rent. If you own your house, they will impute that, as an owner of the house, you rent your house from yourself, they will estimate how much that is, and they will also estimate how much you are raising the rent on yourself each year. So that only adds to your income, and you will see that in the personal income number. The same concept is included in the consumer price index. So depending upon how much you rent your house to yourself for and how much the rent you are raising on yourself is, that is the single largest component of the CPI, about 23% of the CPI. That is absolute nonsense.
Or the markets will concentrate on the GDP numbers. I’ll call it the most worthless number around. They may put statistical significance around the quarter-to-quarter changes, and they annualize it. Most of the time, historically, you have had positive economic growth, so if you annualize it, you magnify the growth. Average annualized orderly growth over time runs around 3%. That’s net of inflation. The error margin around the quarter-to-quarter estimate is a little over 3%. So, on average, you don’t know if the economy is expanding or contracting, but nobody pays any attention to that.
David: John, are economists all around the world convinced of the academic integrity of these kinds of moves? Or is it fair to stay that our foreign creditors should be concerned when they see us massaging our official statistics, like they did in communist Russia during the Cold War?
John: Well, there certainly have been disagreements, but for example, with the inflation changes that our government has introduced, what they call hedonic quality adjustments, but from an inflation standpoint, quality adjustments for inflation are very standard. People go out and survey prices of all sorts of goods, and they look at a variety of factors that you can directly measure.
For example, you have a candy bar that’s in an 8-ounce wrapper, next month it’s the same size package but it’s a 6-ounce candy bar. They are supposed to notice that and physically adjust the calculations for it. But if you have a textbook that now has a colored picture in it, or you have a dryer that has a digital readout instead of a mechanical dial that tells you how much time you have, that is a quality improvement that there is no direct way of measuring, but the government has developed models that will estimate it for you. It has nothing to do with what the average guy is looking for, or thinks he is spending on things, but it has the effect that when they use these systems they reduce the inflation rate and that boosts inflation-adjusted growth.
When we first introduced hedonic quality adjustments into the GDP, countries such as Japan and Germany didn’t follow along. And as a result, our economy started booming along while Japan and Germany were lagging behind, Japan in particular. If you look at the lost decade that Japan had, that never happened. The difference was largely in who was using hedonic quality adjustments in their GDP calculations.
It is something that people who are familiar with what is reported, what is involved in the international standards, are familiar with. Usually the U.S. standards get adopted as the international standards, and that is pretty much the case now. But there are other areas where it still doesn’t happen. For example, Canada will count discouraged workers, people who aren’t actively looking for work, but they are otherwise unemployed, they would take a job in a minute if it were available. They are able and willing to work, they want the job, they’ve just look so long they can’t find one. In the United States you aren’t counted as a discouraged worker if you have been looking for more than a year. In Canada, there is no time limit.
David: In other words, you fall out of the statistic altogether in the U.S., but you stay in the statistic in Canada.
Well, we’ve talked about inflation and deflation, we’ve talked about the GDP changes, we’ve talked about a number of the statistics which are massaged, in addition to GDP, U3 and U6. One thing we haven’t talked about, which you do give comment to here and there, you have commented that the rise of gold was fundamental, but that the intermittent selling of gold has not been. Is your pro-gold position directly tied to your position on the dollar, and where you see the dollar going, which would be lower, over the next several years?
John: Gold is the ultimate hedge, and silver is, but I would look at basically physical gold as the ultimate hedge against extreme dollar debasement that lies ahead of us. I think that is fairly well recognized. The thing is, you are going to see a lot of manipulations by governments and central banks.
We’ve seen that. We’re likely to be seeing that further, but as long as we are headed for the ultimate debasement of the currency, it doesn’t make too much difference if you get your gold at $250 an ounce or $5000 an ounce, or if you get it at $5000 and it goes down to $3000. When it gets up to $100,000 an ounce, it will be doing its job of preserving the purchasing power of the dollars that you put into it, and that’s where I see the ultimate value in gold, it’s an insurance policy, but it isn’t any good if you don’t hold the insurance policy.
The way I look at it is that people who have assets and want to preserve them through what is going to be an extraordinarily difficult time ahead, where the paper dollars, the dollar-denominated paper assets, the physical currency, will become virtually worthless. To the extent you get that into gold or some hard asset that will retain its value, you can preserve the purchasing power of your assets and your wealth, and you ride out the storm, and when the storm is over, hopefully you will have a circumstance that is relatively positive going forward and have some of the best investment opportunities that anyone has ever seen. But you need the assets, and liquid assets, in order to do that.
I look at holding gold as a longer-term proposition to get you through the crisis, not to play the day-to-day market. There are people who do that, and God bless them, and you get into the day-to-day gambling, that’s fine, just as long as you know what you are doing. I would always have my basic hedge in place, and then whatever money you want to play with beyond that, you play with in stocks, or the futures markets, whatever, but again, you need to know what you are doing. You don’t want to have open-ended exposures and such. The basics, though, you need to insure your fundamental asset base.
David: John, we’ve always benefitted from our conversations with you, and continue to benefit from the tireless work that you do, putting together the analysis at Shadow Government Statistics, as you say, analysis behind and beyond government economic reporting. How important it is to have a clue what reality actually is when the goal posts are constantly being moved, when words are being changed, semantics are manipulatable, when reality, as we thought we were dealing with, is shifting all around us.
So, thank you for helping clarify and elucidate these issues, whether it’s the GDP revisions, whether it is the July jobs gains, whether it is CPI, PPI, new and existing home sales, you look at so many different things, and you do a great job of it.
I would encourage our listeners to visit your website, shadowstats.com, and if you don’t read John Williams, you don’t know what you’re missing, and unfortunately, you probably do believe, along with the general public, that what you are being told, in terms of government statistics, has the veracity which you really believe them to have, and that’s unfortunate, because the decisions that you are making are ill-informed decisions. That doesn’t have to be the case. Spend some time at shadowstats.com. Spend some time getting to know John Williams’ work.
John, thanks for joining us today.
John: Thank you so much for having me.
Kevin: As always, David, it is enlightening to have John on. I had to laugh when he was talking about the homeowner equivalent rent. How much am I renting my own house from myself for, and how much income is it bringing me? I would be rich if I accounted the way the government does.
David: Well, like I started by saying, this is beyond the dismal science, this is the stupid science.
Kevin: It’s snake oil.
David: What I don’t appreciate is the complete revision of history. As a student of history, and many in this office spend endless hours reading, whether it is the Civil War, or World War I, or World War II. What if someone came along and completely rewrote that history? And yet, that’s what we are seeing happen, on an economic basis.
And the advantage that we have had of higher growth rates, and of a more stable dollar over the last 20-30 years, it appears to be fiction. It appears to be a manipulation of reality. We stood head and shoulders above the rest, on what basis? On the basis of figuring out how to effectively lie, and communicate those lies to a large audience, globally, and not get caught at it. That is tragic. That is absolutely tragic.
Well, another conversation with John Williams, and I look forward to the next one, as hopefully, we begin to see numbers get better, not worse, at least in terms of what we understand them to be, their truth, and not their fiction.