Thursday, May 8, 2008

The Economy Is Worse Than We Know: Check Out These Numbers!

Sorry to be the one to add more doom and gloom to an already rocky financial landscape, but the economy might be even worse than we think. According to Kevin Phillips from Harper’s Magazine, the government has been artificially fudging economic statistics for years by changing the way things are calculated. The main three government statistical calculations that Phillips points out are the unemployment rate, Consumer Price Index (CPI) and GDP. If we were to calculate these numbers in the manner in which we used to, before all the changes, things wouldn’t appear nearly as rosy as they do right now.

Here are the current numbers:

Unemployment Rate: 5 percent

CPI: 4 percent

GDP Growth: 0.6 percent (Q1 2008)

Now here are the estimates given by Phillips:

Unemployment Rate: Between 9 and 12 percent

CPI: Between 7 and 10 percent

GDP Growth: Minimal growth since 2001

Phillips also makes an interesting point about why the government needs to fudge the numbers. In his article, Phillips says that according to calculations from John Williams at, if the government had failed to make the changes to the CPI index, and stayed true to the old calculations, Social Security checks would be 70 percent greater than they are today.

As most people know, Social Security payments are tied to the CPI index, and as inflation goes up, so do the checks in order to compensate. Considering that the nation is already more than $9 trillion in debt, and that the government spends every dime of incoming Social Security payments, adding billions more in Social Security liabilities would not be helpful to the economy. In addition, if inflation was reported at the higher number, we would surely see much higher interest rates across the board--again, not a big booster to the economy. Phillips gets into much more detail, but for brevity's sake, I’m not going to get into that here. If you want to read the full article you can visit Harper’s (requires subscription) or you can read a free partial version at Mindfully.

I can see why the government felt they had to make the changes they did, and some of them even seem to be warranted, such as one pointed out in a recent New York Times article. “To take just one example, years would often pass before the index included new products — like cellphones — and therefore it missed the enormous price declines that occurred shortly after those products entered the mainstream.” In addition, it is much easier to change around some numbers that most people don’t understand anyway, and in doing so lower your liabilities, than to flat out tell them their Social Security benefits are going to be cut, or taxes are going to be raised.

Other changes, though, seem questionable at best. One change that was made, as pointed out by Phillips, is that the new calculations make adjustments to people’s assumed buying habits if certain products get too expensive. For example, if flank steak gets too expensive, people are assumed to shift to hamburger. At the same time though, nobody is assumed to move up to filet mignon when things are going well. So this is a change that can only make the CPI go further down, which seems a little biased.

No matter how we slice it, or how much we think we’ve been cheated, the government can’t afford to increase our social security payments by 70 percent, or to increase any other payments to us for that matter--even if they wanted to. They probably aren’t even going to be able to pay the full Social Security benefits as they are now for many more years, so we might as well give up that argument. Below is a chart that shows intragovernmental holdings, which essentially is money that the government is "borrowing" from other government agencies, the main one being Social Security.

The best thing we can do is understand that the government-reported numbers may not be as good as they say, and make the necessary adjustments to our own calculations. Instead of using 3 percent as the inflation number in your retirement calculations, maybe it makes sense to use 5 or even 7 percent. Sure, it would be nice if the government could actually be trusted and told us the truth now and again, but hey we can’t set our hopes too high, right?

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