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Real Crash 2014
GDP
Posted by Peter Schiff on 05/06/2014 at 2:09 PM

After three months of consistently disappointing jobs numbers, the markets were as keyed up for a good jobs report as a long suffering sailor awaiting shore leave in a tropical port. The just released April jobs report, which claimed that 288,000 jobs were created in the U.S. during the month, provided the apparent good news. However, you don't have to go too far beneath the surface to find some troubling trends within the data. But even this minor excavation was too much for the media cheerleaders and Wall Street pitchmen to handle. 

The dominant narrative held that the prior reports had been so weak because the unusually cold weather (the 10th snowiest in the past 50 years) had prevented consumers from venturing outside to make purchases or employers from hiring workers. Time and again the winter was blamed for the disappointing jobs reports that came in over the 1st quarter. As a result, the consensus of economists predicted a rebound in April with 215,000 net new non-farm jobs. The 288,000 figure that greeted the markets last week - which helped bring down the unemployment rate to a post-crash low of just 6.3% - confirmed the weather hypothesis.

In reality, the desperation in which these tenuous data straws were grasped is a testament to our chronic economic weakness. Far more significant than the number of jobs that were created in April were the far greater number of jobs that were lost (806,000) because chronically unemployed Americans gave up on their fruitless quests to find work. This trend has been ongoing for years. The latest exodus of workers pushed the labor force participation rate down from 63.2% to 62.8%, an unusually sharp monthly drop. Apart from October and December 2013, also at 62.8%, the rate now is at the lowest level since March 1978. Each individual who drops out of the job market no longer contributes to our collective economic output, creates another lost taxpayer, and another individual who is more likely to receive government support. But the media coverage of the jobs data treated this stunning development as a mere afterthought.

What should have been of particular concern, but was not even mentioned, was that more than 80% of the 288,000 jobs came from birth/death assumptions the government makes about the net number of new companies that formed during the month and the number of people those companies would have been expected to hire. For some reason the statisticians always assign a disproportionally high number of these assumed jobs to April and May. The rationale for this is likely buried deep within bureaucratic small print, so we have to take that number with a grain of salt. But what if only 100,000 new jobs were added as a result of birth/death assumptions, as was averaged in February and March? The Labor Department may have been just as convinced as everyone else that the cold weather had restrained hiring during the winter. As a result they may have been inspired to make this year's April assumption the biggest in the last six years.

The story even gets worse when you consider the types of jobs that are being added. As has been the case for years, the new hires are heavily weighted to the lower end of the spectrum, particularly in low-paying service sector and retail jobs. The drop in the labor participation rate would not be so alarming if those who remained working were finding jobs that could support families. But that is not what is happening. We are replacing good jobs with bad jobs and getting poorer with each passing month.

This trend was confirmed on May 1 when the Bureau of Economic Analysis released its March Personal Income and Outlays report. As is typical, the pundits reacted positively to the .9% increase in consumer spending. But they couldn't be bothered to look at the other side of the coin to determine how that increase was achieved. With personal income up only .5% for the same period, Americans financed their extra spending with a drop in savings, which dropped to 3.8%, the lowest level since just before the 2008 crisis (with the exception of January 2013 at 3.6%). Contrary to the rhetoric coming from spending-obsessed economists and politicians, savings constitute the foundation upon which economic health rests. Of course, most Americans likely had little to show for the extra spending, as the money was not used to buy more stuff (other than Obamacare) but to pay higher prices for the things they would have bought anyway.

More bad news arrived recently with the release of first quarter GDP numbers, which showed the economy "growing" at a glacial .1% annualized over the first quarter. The results stand in stark contrast to the optimistic forecasts that continue to hold sway on Wall Street. According to Bloomberg's April Survey, a consensus of economists expect the US GDP to expand 2.7% in 2014. But so far the horse has stumbled badly from the gate. Just to reach the consensus estimate for the year, the economy would have to average 3.5% annualized growth over the remaining three quarters of the year. The odds of that are slim to none, and Slim has just dropped out of the workforce.

However, as we have seen in recent years, GDP estimates are more likely to be revised downward than upward in subsequent data releases. So there is a very good chance that the first quarter estimates will be revised into negative territory. This means that we may be already half way to a recession (which is defined as two consecutive quarters of negative growth).

As they have done with the recent jobs reports, most economists pin the bad GDP number on the hard winter. This is a dangerous game to play. If GDP now fails to respond strongly to the return of warmer weather, the truth of a fundamentally weakening economy will become that much easier for everyone to see. But with asset bubbles forming across many sectors of the economy, the truth can be a serious hazard. Nothing pricks a bubble quicker than a loss of confidence.

After last year's stunning 29% rally in U.S. stocks, Wall Street virtually assured investors at the end of last year that the good times would continue. Instead, stocks are virtually flat for the year, and the dollar is drifting lower against many major currencies. If not for the super-charged mergers and acquisitions market, which according to the Wall Street Journal accounted for $638 billion of transactions thus far in 2014 (the highest level of activity in almost 20 years), and the rock bottom long term interest rates provided by the Federal Reserve, markets could be tanking. What's worse is the fact that the first five months of the calendar are usually the best for market performance (hence the Wall Street adage "sell in May and go away.") If this is how we have fared during the seasonally strong part of the year, beware the latter as the summer doldrums set in and the Fed (in theory at least) is set to wind down its QE program.

While the darkening skies may not be visible to Americans, the foreign exchange markets have taken notice. Today the U.S. dollar hit a five-year low against the British pound, a nearly three-year low against the Swiss franc (notwithstanding three days in March that traded slightly lower). The weakness in the dollar portends a weaker U.S. economy and a strong likelihood for more Quantitative Easing from the Federal Reserve. It also confirms that Europe's strategy of limited "austerity" did not deliver the catastrophe that many on the left, including Paul Krugman, had predicted.

And so while there are plenty of reasons to be cautious about America's economic future (the growing geo-political tensions in Ukraine for instance - explored in detail in my latest newsletter), Wall Street has found ways to ignore all of them. My advice to investors is to ignore the swelling crescendo coming from the paid musicians. Take a look at the sheet music instead. They may play it like a fanfare but it is written like a dirge.

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Tags:  employmentGDPunemployment
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Debt Ceiling Delusions
Posted by Peter Schiff on 10/11/2013 at 12:38 PM

The popular take on the current debt ceiling stand-off is that the Tea Party wing of the Republican Party has a delusional belief that it can hit the brakes on new debt creation without bringing on an economic catastrophe. While Republicans are indeed kidding themselves if they believe that their actions will not unleash deep economic turmoil, there are much deeper and more significant delusions on the other side of the aisle. Democrats, and the President in particular, believe that continually taking on more debt to pay existing debt is a more responsible course of action. Even worse, they appear to believe that debt accumulation is the equivalent of economic growth.

If Republicans were to inexplicably prevail, and the federal government were to cut spending so that its expenditures matched its tax revenues (a truly radical idea) the country's financial mess would be laid bare. The government would have to weigh the relative costs and benefits of making interest payments on Treasury debt (primarily to foreign creditors) or to trim entitlements promised to U.S. citizens. But those are choices we will have to make sooner or later anyway. In fact we should have dealt with these issues years ago. But generations of mechanistic debt ceiling increases have allowed us to perpetually kick the can down the road. What could possibly be gained by doing it again, particularly if it is done with no commitment to change course?

The Democrats' argument that America needs to pay its bills is just hollow rhetoric. Paying off one's Visa bill with a new and bigger MasterCard bill can't be considered a legitimate payment of debt. At best it is a transfer. But in the government's case, it doesn't even qualify as that. Treasury debt is primarily bought by the Fed, foreign central banks, and major financial institutions. None of that will change with a debt ceiling increase. We will just go to the same people for greater quantities. So it's like paying off your Visa card with a bigger Visa card.

According to modern economists, an elimination of deficit spending will immediately cause a dollar for dollar decrease in GDP. For example, if the government stopped sending food stamp payments to poor people, then grocery stores would lose business, employees would be laid off, and the economy would contract. But this one dimensional view fails to appreciate that the purchasing power of the food stamps had to come from somewhere. The government can't create something from nothing.  Taxation transfers purchasing power from people living in the present to other people living in the present. In contrast, borrowing transfers purchasing power from people living in the future to people living in the present. The good news for politicians is that future people don't vote in current elections (and current voters don't seem to appreciate the cost to their future selves of current policy).

The Obama Administration has congratulated itself for turning around the contracting economy that it inherited from President Bush. But even if you take the obscenely low official inflation statistics at face value, we only grew at an anemic 1.075% annual pace from 2009 to 2012 (far below the between 3% and 4% that the U.S. averaged post World War II). Sadly, this growth pales in comparison to the accumulation of new debt that we are borrowing from the future.

U.S. GDP is measured at roughly $15 trillion per year. 2% growth means that each year the GDP is approximately $300 billion larger than the prior year. But in the less than five years since Obama took office, the federal government has added, on average, about $1.3 trillion per year in new debt, a pace that is four times higher than the growth. If the deficit were subtracted from GDP, America would be shown to be stuck in a severe recession that Washington can't acknowledge. But such a reality is more consistent with the dismal job prospects and stagnant incomes experienced by most Americans.

The belief that deficits add to the economy, and that debt can be dealt with in an imaginary future (that never seems to arrive) is the foundation upon which the President can chastise the Republicans as irresponsible suicide bombers. Using this logic, he can argue (with a straight face) that borrowing is the equivalent of paying. That the President can make this delusional argument is not so surprising (no lie too great for the typical politician to attempt). What is alarming is that the media and the public have swallowed it so willingly. As they call for limitless increases in borrowing, Democrats have offered no plan to reduce the current debt and they are unwilling to negotiate with Republicans on that topic. Yet somehow they have been perceived as the party of fiscal responsibility.

While the Republicans have a dismal track record of their own when it comes to budgetary management, it can't be disputed that the minor dip in that rate of increase in spending that resulted from the recent Sequester, happened only because they dug in on the issue. Without the 2011 debt ceiling drama, there is no chance that any spending would have been touched.

Democrats had warned that the $85 billion in sequestration cuts slated for fiscal year 2013 (about 2% of the Federal budget) would be sufficient to bring on economic Armageddon. But guess what? We survived. Recently, Senate Majority Leader Harry Reid continued with such rhetoric by declaring that there are no more cuts to be found anywhere in the $3.8 Trillion dollar federal budget. (Apparently he missed last week's 60 Minutes piece on the spreading epidemic of federal disability fraud.)

We have to acknowledge what even the Republicans haven't fully grasped. We are in such a deep debt hole that there is no solution that does not involve serious economic pain. Tea Party Republicans rightly believe that government spending is a drag on economic growth. As a result, they conclude that immediate spending cuts will help with the "recovery". But they are confusing real economic growth with the delusional expansion created by deficit spending (which is actually damaging the real economy). If they cut the deficit, this phony economy may likely implode and cause widespread distress. 

So even though a reduction in government borrowing and spending does help the economy, it won't feel very helpful tomorrow. The more we borrow and spend today, the more we will suffer tomorrow when the bills come due. Ironically, cutting government spending now helps the economy by allowing

the economic adjustment to happen sooner rather than later. But this type of long-term thinking is very difficult for politicians to consider. 

Unfortunately our debts don't leave us much in the way of choices. We can choose to pay now or try to pay later. But the longer we wait the steeper the bill.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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Tags:  debt ceilingDemocratsfederal reserveGDPrepublicans
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The Unfriendly Skies
Posted by Peter Schiff on 08/30/2013 at 11:19 AM
As if the federal government were not already doing enough to kill the U.S. airline industry with restrictive workplace rules, over-regulation, and a monetary policy that supports higher fuel prices, earlier this month anti-trust authorities at the Justice Department blocked the merger between American Airlines and US Air. (Unbelievably, the regulatory roadblock was thrown up more than a year after the two companies had agreed to terms, and after great expense has been incurred to integrate operations). Although long suffering investors had hoped that the merger would allow the beleaguered airline to finally exit bankruptcy, in the days after the surprise announcement, AMR stock almost fell as much as 60%.

Entire columns could be written on why the government had little reason to stop this particular merger, (the preponderance of other air carriers and transportation alternatives) or why the entire "anti-trust" apparatus of the government has done, and will do, nothing to support the living standards of average Americans, but the bigger story here involves the diminished scope of the airline industry in general. The difficulties that U.S. carriers face, which is the driver behind the current "urge to merge," provides us with clear insight into the health of the broader economy.

Over the last few weeks, I have made a few attempts to show how government sleight of hand may be making our economy appear to be healthier than it actually is. For instance, I showed how in recent years initial reports of GDP growth have consistently been far too optimistic, thereby creating a false narrative about the current recovery. I also pointed out how the inflation measures used to calculate GDP have been consistently below other inflation yardsticks, and may have led to overestimates of economic growth. Instead of looking at government yardsticks, I have suggested that the truth can be better observed by looking at the demonstrable changes in living standards.

For instance, compared to prior generations, Americans now save less, use less energy, and devote a greater proportion of their disposable income to meeting basic survival needs. Such outcomes suggest falling living standards. Air travel is another real world metric worth tracking. Americans also use far less air travel than our GDP growth rate would suggest we should.

It may not be too controversial to assert that wealthy working people tend to fly much more than poorer underemployed people. When we are employed (especially at high level jobs) we tend to travel more for business. When our jobs pay well, we have the income needed to travel more on long distance vacations. It should come as the least surprising fact ever that citizens of wealthy nations tend to fly much more than residents of poor nations.

As a result of this basic understanding, the number of airline tickets sold on domestic U.S. carriers should provide a decent barometer of overall economic health. The numbers reveal that more people are flying than in the past, but the increase is less than half of what may have been expected based on the official GDP growth figures. 

According to research by the Massachusetts Institute of Technology's Airline Data Center, in 1995 U.S. carriers had a total number of 470.2 million "enplanements" (which is defined by how many times a passenger takes a trip). In 2012 that figure had gone up to 565.1 million, an increase of approximately 20.2%. This doesn't sound too bad.

But over those 18 years, the government reported real GDP expansion (after adjusting for inflation) of 2.9% per year on average. That adds up to 52%of growth. At minimum, you might expect the airline industry to keep pace. Instead, the increase has been less than half that.

The Bureau of Transportation Statistics has another data set that doesn't go back as far but offers a similar trajectory. They report a total of 629.8 million passengers in 2004, and 642.2 million passengers in 2012. This works out to be a 2% increase over nine years. But according to the government, real GDP has risen more than six times that (12.3%) over those nine years. By that yardstick, airline travel is lagging significantly.

Believe it or not, this has happened despite the fact that ticket prices have come down in relative terms. According to the airline industry resource, Airlines.org, the average price for a round-trip domestic ticket was $277.37 (1995 dollars) in 1995. In 2012 that figure had gone up to $355.75 (2012 dollars), an increase of 28% (the U.S. Department of Transportation (DOT) reports a similar figure of 28.4%). In terms of ticket price per passenger mile, the increase is even more modest, just 9% (13.8 cents in 1995 vs. 15.1 cents in 2012). Yet inflation since 1995, as measured by the CPI, is up 55%. This means that in relative terms, the cost of flying on an airplane has actually gone down. The DOT puts the decrease at 14.7% in 2013 dollar terms.

So Americans' air travel has fallen relative to economic growth even while the cost of flying has fallen by a significant margin. This simply makes no sense unless you allow for the possibility that the economy really isn't expanding as rapidly as we are being told.  It is possible that the added security and inconvenience of flying  since 9-11 has deterred people from flying, but I doubt that it's a significant factor. Yes, many carriers now provide fewer amenities to travelers, and baggage charges, change fees, and food charges have certainly increased, but those factors can't be that determinative. I'll go with the simplest explanation: as Americans get poorer, our citizens fly less.

As the government takes more and more control of the economy, and as money printing, taxes and regulation become the biggest economic determinants, such an outcome is inevitable. The measurement tools can become distorted and the numbers can become fuzzy, but the outcomes are easier to see. We can't grow government and the economy at the same time. We must choose one or the other.

The truth is that our impoverished citizenry can no longer support the airline industry we once had. That's why American and U.S. Air had to merge in order to stay competitive and profitable. That is the sad truth behind the headlines. The government is correct about one thing, the merger would result in fewer choices and higher fares for customers. But given the reduction of our living standards that outcome is impossible to avoid. If our government really wants to protect consumers and allow for more affordable air travel, a better solution would be to reverse the destructive policies that made the merger necessary in the first place. Ironically blocking the merger could result in more flight reductions and larger fare increases than what might have been the case had the merger been allowed.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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Tags:  airline industryGDP
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The GDP Distractor
Posted by Peter Schiff on 08/20/2013 at 10:06 AM
Albert Einstein, a man who knew a thing or two about celestial mechanics, supposedly once called compound interest "the most powerful force in the universe." While the remark was likely meant to be funny (astrophysicists can be hilarious), it sheds light on the often overlooked fact that small changes, over time, can yield enormous results. Over eons, small creeks can carve large canyons through solid rock. The same phenomenon may be at work in our economy. A minor, but persistent under bias in the inflation gauge used in the Gross Domestic Product (GDP) may have created a wildly distorted picture of our economic health.

It would be impossible to measure the economy without "backing out," inflation. That is why economists are very careful to separate GDP reports into two categories: "nominal" (which are not adjusted for inflation), and real (which are). Only the real reports matter. The big question then becomes, how do we measure inflation? Just as I reported last week with respect to the biases baked into the government's GDP revisions, the devil is in the details. 

As it turns out there are a number of official inflation gauges that vie for supremacy. Most people tend to follow the Consumer Price Index (CPI) which is compiled by Bureau of Labor Statistics, a division of the Department of Labor. The CPI is regarded as the broadest measurement tool, but it has been changed many times over the years. Most famously, its formulas were loosened in the late 1990's as a result of the "Boskin Commission" which said that the CPI overstated inflation by failing to account for changes in consumer behavior. I believe those changes seriously undermined the reliability of the index. But the CPI itself has to contend for relevance with its stripped down rival, the "Core CPI," which factors out food and energy, which many believe are too volatile to be accurately counted. The core CPI is almost always lower than the "headline" number.

Another set of inflation data, the "GDP Deflator" is compiled by the Bureau of Economic Analysis (part of the Commerce Department), and is used by them to calculate GDP. The deflator differs from the CPI in that it has much more flexibility in weighting and swapping out items that are in its sample basket of goods and services. While the CPI attracts the lion's share of the media and political attention, it is the deflator that is relevant when looking at economic growth.

On a quarterly basis the two numbers are usually close enough to escape scrutiny. (However, the most recent 2nd quarter GDP estimates relied on annualized inflation of a ridiculously low .7%!). But if you look at a broader time horizon a very clear pattern emerges that makes a great difference in how we perceive the economic landscape.  

Available data sets for both the CPI and the GDP deflator go back to 1947. That 66 year period falls neatly into two phases. From 1947 to 1977 both yardsticks moved together almost identically, both rising 173% over that time. But in the ensuing 36 years (until 2013), the CPI is up almost three fold (292%) while the deflator is only up about two fold (209%). The CPI rising 40% more than the GDP deflator is an extremely significant factor. How did that happen? As it turns out, quarterly inflation assumptions have been, on average, .17% lower for the deflator than for the CPI since 1977. That is a small number. But as with compound interest small numbers add up to big numbers over time.

If you replace the GDP quarterly growth rates using the higher CPI rather the deflator, our current economy would be closer to $13 trillion than 16.6 trillion, about 28% smaller. Even if you were to split the difference between the CPI and the deflator you would still get an economy that is significantly smaller than it appears.

The $64,000 question ($188,000 adjusted by CPI inflation since 1977) is what happened in 1977 to make the CPI and the deflator diverge? Sadly, the details aren't really made public. What we do know is that the BEA took over the task in 1972, and that the separation occurred a few years later when inflation really started to run out of control. We also know that the deflator is more flexible than the CPI and that the interests of the government are better served by reporting low inflation and higher growth. So in other words, the deflator is likely lower for the same reasons that dogs lick themselves in intimate places: because they want to and they can.

If we had been growing as quickly as the official GDP indicates, why would our labor force have contracted so significantly? Why are we continuously replacing middle class jobs with lower paying ones? Why would we be using 3 percent less energy nationally than we did 10 years ago despite an 8.8% growth in population? Why would Americans be spending a higher percentage of their disposable incomes on basic necessities than they were 10 years ago? These trends don't conform to healthy GDP growth. So maybe the growth is largely an illusion?

When you take into consideration the likelihood that even the CPI drastically understates inflation, you get a much clearer picture of the true state of the U.S. economy. If you ever wondered how we went from being the world's largest creditor to its biggest debtor despite all this economic growth, now you know. As the growth was merely a statistical illusion, we have been forced to borrow money to maintain a life style our economy can no longer support.

So the next time you see a GDP report remind yourself that the "deflator" should really be called the "distractor." It's there to distract you from the truth.  

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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Tags:  CPIeconomyGDPinflation
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The Half Full Economy
Posted by Peter Schiff on 08/09/2013 at 10:20 AM

The marginal economic strength that was described in the most recent GDP release from Washington has caused many to double down on their belief that the Federal Reserve will begin tapering Quantitative Easing sometime later this year. While I believe that is a fantasy given our economy's extreme dependence on QE, market observers should have learned long ago that the Bureau of Economic Analysis (BEA) initial GDP estimates can't be trusted. A perusal of their subsequent GDP revisions in the last five years reveals a clear trend: They are almost twice as likely to revise initial estimates down rather than up, and the downward adjustments have been much larger on average.

As a result of this phenomenon, an overall optimism has pervaded the economic discussion that has consistently been unfulfilled by actual performance. The government is continuously over promising and under delivering. Unfortunately, no one seems to care.

Measuring the size of the economy accurately in anything close to real time is difficult, inexact, and messy. That is why the BEA has long pursued a policy of initial quarterly estimates (known as the "advanced estimate"), followed by two or three subsequent revisions as more thorough analysis comes to bear. The first estimates come out about a month after the conclusion of a particular quarter. The second and third revisions then come in monthly intervals thereafter. But in the minds of the media, the public and the politicians, the initial report carries much more weight than the revisions. It is the initial report that attracts the screaming headlines and sets the tone. The revisions are typically buried and ignored. This creates an unfortunate situation where the initial estimates are both the most important and the least reliable.

However, logic would dictate that revisions would fall equally in the up and down categories. After all, government bean counters are expected to report objectively, not to create a narrative or manage expectations. If anything, I believe that the public would be better served if they would adhere to the conservative playbook of under promising. That is exactly what they seemed to be doing before the economic crash of 2008. From 2002 to mid-summer 2008, the BEA revised initial GDP estimates a total of 25 times, 80% of which (20 revisions) were higher than their initial estimate. However, the average amplitude of the upward and downward revisions were equal at .5%. The difference may have been a function of the relatively strong economy that the nation saw over that time (which I believe was a result of the unsustainable and artificial housing boom). See the chart below.

But since mid-2008 we have seen a very different story. 67% of the revisions (12 of 18) have been downward, and those adjustments have been, on average, 50% larger than the upward revisions (.75% vs. .5%). Here's another way of looking at it: Since mid-2008, revisions have shaved a total of 6 points of growth off the initial estimates. This works out to be an average of 1.3 points of growth per year that some may have expected but that never actually happened.

The pattern of early optimism may stem from the lack of understanding in Washington about how monetary stimulus actually retards economic growth. Many of the statisticians may be former academics who take it as gospel that government spending and money printing create growth. As a result, they expect the initial boost created by stimulus to be sustainable. The evidence suggests that it is not.   

But there can be little doubt that these overly optimistic projections have worked wonders on the public relations front. The big Wall Street firms and the talking heads on financial TV set the tone by jumping on the new releases and ignoring the revisions to prior releases. That is precisely what happened last week when the better than expected 1.7% growth in 2nd quarter GDP overshadowed the .7% downward revision to 1st quarter GDP from 1.8% to 1.1%. The initial estimate for 1st quarter GDP, released back in April, was 2.5%. Since the consensus expectation for 2nd quarter GDP was just 1%, the media jumped all over the "good" news, while ignoring the revisions to the prior quarter, and discounting the strong likelihood that Q2 GDP will be revised downward. The nature of our short-term 24-hour news cycle is a big factor in this. Reporters are always looking for the big story of the day, not the minutia of last month. The lack of critical thinking and economic understanding also play a role.

Of course even if you have the discipline to focus on the final estimates, you still aren't getting the real story. All GDP estimates are based on imperfect inflation measurement tools, which I believe are designed to under report inflation and over report growth. The most recent GDP projection used an annualized .71% inflation deflator to arrive at 1.7% growth. Anyone who believes that inflation is currently running below 1% has simply no grasp of our current economy. Look for more analysis of this topic in my upcoming columns. In the meantime, don't get excited by initial reports of a healthy recovery. The reality is likely to be more sobering.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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Tags:  economyGDPquantitative easing
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Changing the Conversation
Posted by Peter Schiff on 04/26/2013 at 12:49 PM

Don Draper, Mad Men's master advertiser likes to say "when you don't like what they are saying, change the conversation."  When it comes to the current economic weakness, which was confirmed again today by the release of lower than expected GDP data, Washington would love do just that. Fortunately for them, they consistently outdo the master minds of Madison Avenue when it comes to misdirection. If the government doesn't like what people are saying, they don't bother just to change the conversation, they change the meaning of the words.

The latest example of this was revealed earlier this week when the Bureau of Economic Analysis (BEA) announced new methods of calculating Gross Domestic Product (GDP) that will immediately make the economy "bigger' than it used to be. The changes focus heavily on how money spent on research and development (R&D) and the production of "intangible" assets like movies, music, and television programs will be accounted for. Declaring such expenditures to be "investments" will immediately increase U.S. GDP by about three percent. Such an upgrade would immediately increase the theoretic size of the U.S economy and may well lead to the perception of faster growth. In reality these smoke and mirror alterations are no different from changes made to the inflation and unemployment yardsticks that for years have convinced Americans that the economy is better than it actually is.

Today's data release confirms that the economic "recovery" is weaker than expected and remains heavily dependent on Federal support. Personal spending was indeed up 3.2%, the biggest jump in two years, but real earnings were down by 5.3%, the biggest fall since 2009. Not surprisingly the buying was made possible by a drop in the savings rate, which came in at just 2.6%, the lowest since the 4th quarter of 2007. No doubt, rising home prices and falling mortgage rates (made possible by Fed stimulus) allowed Americans to refinance their homes and to borrow and spend the money that they did not earn.  With GDP continuing to disappoint, a statistical make-over couldn't come at a more convenient time.

In the simplest terms, GDP is calculated by combining a nation's private spending, government spending, and investments (while adding trade surplus or subtracting trade deficits).  Business spending on R&D, a portion of which comes in the form of salaries, has traditionally been considered an expense that does not explicitly add to GDP. But now, the United States will lead the rest of the world in redefining GDP. Washington has now declared that the $400 billion spent annually by U.S. businesses on R&D will count towards GDP. This equates to about 2.7% of our nearly $16 Trillion GDP. The argument goes that, for example, the GDP generated by iPhones has far exceeded the cost spent by Apple to develop the product. Therefore, Apple's R&D is not an expense but an investment.

The BEA also argues that the cost of producing television shows, movies, and music should count as investments that add to GDP. Supporters of the change often hold up the blockbuster television comedy Seinfeld as an example. Given that the show's billions in earnings far exceeded its initial costs, they argue that the production expenses should be considered "investments" (like R&D) and be added into GDP.

Economists who have staked their reputations on the efficacy of Keynesian growth strategies have argued that such changes will more accurately reflect the realities of our 21st century information economy. But their analysis ignores the failures so often associated with R&D and artistic productions. For every breakthrough iPhone there are dozens of ill-conceived gizmos that never get off the drawing board. For every Seinfeld, there are countless failures and bombs that leave nothing but losses.

In essence, the new methodology is an exercise in double accounting.   For instance, suppose a company employs an accountant who works in the sales department, who is then transferred to the R&D department at the same salary. He still counts beans but now his salary will be billed to the R&D budget rather than sales.  In the old methodology, the accountant's impact on GDP would come only from the personal consumption that his salary allows.  Going forward, he will add to GDP in two ways: from his personal consumption and his salary's addition to his company's R&D budget. The same formula would apply to a trucker who switches from a freight company to a movie production company (for the same salary). If he moves refrigerators, he only adds to GDP through his personal spending, but if he hauls movie lights, his contribution to GDP is doubled.  It makes no difference if the movie bombs.

These double shots are different from traditional investments, which inject savings (or idle cash) back into the marketplace. Until money from personal or corporate savings is invested, it is not adding to GDP.

Another change that will artificially boost GDP concerns how government salaries will be counted.  Unlike most private sector compensation, wages, salaries, and pension contributions paid to government workers are added directly to GDP. This distinction makes sense and eliminates potentially double accounting.  Profits generated by private companies add to GDP when they are ultimately spent or invested by the company. Wages reduce profits, and therefore reduce GDP. But that reduction is cancelled out by the consumption of the employee receiving the wages. Governments do not generate profits, so salaries are the only way that public spending adds back to GDP.

The new system magnifies the GDP impact of government pensions, which are a principal component of public sector compensation. Going forward, the pensions will be calculated not from actual contributions, but from what governments have promised.  Under the old system, if a state had a $10,000 pension obligation but only contributed $1,000, only the $1,000 would be added to GDP. Under the new system the entire $10,000 would be counted. So now governments can magically grow the economy simply by making promises they can't keep.

The bottom line is that now certain private sector salaries (in R&D and entertainment) will be counted twice and public pension contributions will be counted even if they aren't made.  The economy will not actually be any larger or grow any faster, but the statistics will claim otherwise.  With the stroke of a pen, our debt to GDP ratio will come down.  Will this soothe the fears of our creditors?  Will critics of big government take comfort that spending as a share of GDP may be lower?  My guess is that the government is confident that its trick will work, and that distracting attention with a statistical illusion is the sole motivation for the change.

A similar type of hocus pocus has been successfully used to make inflation appear much smaller. A few months ago I produced a video showing how changes in methods used to calculate the Consumer Price Index (CPI) have resulted in a widening gap between increases in real prices and the CPI. The changes, that incorporate such concepts as hedonic adjustments and substation bias, were made to make the CPI more "accurate," but have instead produced consistently lower results. Although I used a basket of 20 goods for that experiment, I gave particular attention to such things as newspaper and magazine prices and health insurance costs. But just recently I came across another data set that leads to the same conclusion.

Since the late 1980's, The Economist Magazine has compiled something called the "Big Mac Index,"(BMI) a global survey of the cost of McDonald's signature hamburger. Although the index is primarily used as a means to compare purchasing power parity around the globe, it also can be used to track the prices of Big Macs in the U.S. over many years.From 1986 to 2003 the U.S. BMI rose roughly in line with the CPI. Although the burger occasionally rose faster or slower, over that 17 year period both indexes increased by about 68% (or about 4% per year). But from April  2003 to January 2013 the CPI Index is up just 25% percent (from 183.8 to 230.28 or about 2.5% per year) while the BMI is up 61% (from $2.71 to $4.37 or about 6.1% per year), or more than twice the rate of inflation.

What could possibly account for the difference?  Has the Big Mac gotten bigger, better, tastier, or healthier?  As an iconic product, McDonald's has been reluctant to change a proven formula. If the Big Mac hasn't changed, is it possible that our inflation yardstick has?

It has been estimated that if the government used the same methodology to measure inflation that it used during the 1980's, we would be currently dealing with official inflation that would be many times higher than today's official 1.5% rate. The Big Mac appears to confirm this.

But now the government appears ready to distort the figures even further.  With little resistance from the media or the public, the Obama Administration and Congressional Republicans seem ready to switch the inflation measurements used for Social Security away from the CPI in favor of the even more attenuated "Chain Weighted CPI." This index, which is consistently lower than the CPI, looks to incorporate changes in spending patterns when consumers switch to more affordable products (in other words, it measures the cost of survival, not the cost of living). And while many admit that this is a manipulation, no one really seems to care.

Similarly clumsy tricks have been used to make our unemployment problem appear less severe. Over the years new methods have been introduced to factor out those who have "dropped out" of the labor force or to count part-time or temporary workers as employed.

All this takes us right back to Don Draper. If you can't change the conversation, change the words. If that doesn't work, just change the dictionaries.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show.

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Tags:  BEAGDP
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The Real Crash
Posted by Peter Schiff on 05/23/2012 at 10:36 AM

I first came to national attention back in 2008 and 2009 when the housing and credit markets imploded. I became known as the guy that other market "experts" laughed at when I warned of trouble brewing in the seemingly indestructible American economy. After the wheels ground to a halt in mid-2008, people noticed that my book Crash Proof, originally released in early 2007, read like a detailed preview of many of the events that eventually unfolded.

 

Three years later I am now catching heat from many who assume that my predictions actually fell short. They argue that I was able to anticipate the crash but that I severely underestimated the resiliency of the American economy. They admit that we took an "unexpected" blow to the chin, and that it left a lingering bruise, but they argue that we never hit the canvas like I predicted we would.

 

However, they mistakenly assumed that the crash I was warning about was solely a housing led credit bubble. While that was part of it, I never saw it ending there. The crash that most concerned me was the one that would result from the government's response to the initial crisis. My concern was not that our economy would succumb to the disease that I had diagnosed, but instead would be taken down by the "cure" that the government unleashed to combat it.  

 

When the government's delaying tactic, which involves continuous debt accumulation and money printing is no longer tenable, the dollar could collapse, borrowing  costs and consumer prices could soar and the U.S. economy could implode. That's the real crash that I was warning about, and the one we all need to be worried about now.

 

This is the subject of my new book "The Real Crash: America's Coming Bankruptcy, How to Save Yourself and Your Country." For now it is just a prophecy but as with my first book, it soon may be regarded as history. Unfortunately, the policies of both the Bush and Obama administrations, and the Ben Bernanke led Federal Reserve, have vastly raised the chances that my catastrophic view will come to pass.  However, it's not all gloom and doom - I devote a large majority of the book to solutions. The real crash may be inevitable, but what we do in response is not. We can follow on the path that I recommend back to prosperity, or we can continue on our current course which I believe will lead to economic ruin.

 

When looking back from a point in the future, I believe that the years immediately after the credit collapse of 2008 will stand out as a period of dangerous economic negligence. We have bought ourselves some time by sweeping enormous problems under the rug. Through a combination of political cowardice, economic ignorance, and false confidence, we are digging ourselves into a hole so deep that it may take generations to crawl out. 

 

Most people assume that half way through 2012 we have made some important positive strides since flirting with the brink of economic catastrophe in the dark days of 2008. Although no one is wildly celebrating the below trend 2 to 3 percent GDP growth, we are continuously reminded that we have turned the corner and that our situation is better than many other regions around the world. But what has really changed?

 

Immediately prior to the crash, the United States economy was experiencing unprecedented consumer debt levels, persistently high trade deficits, historically large government budget deficits, high-energy prices, and a moribund manufacturing sector. Four years later, all of these problems have gotten worse. And unlike four years ago, we are now saddled with the highest unemployment rate in generations and levels of public debt that would have been unimaginable then. Yes we are no longer technically in recession. But I believe that is just an illusion created by perhaps the cheapest, and most obvious, trick ever devised.

 

I had argued that our economic growth prior to the crisis was largely a function of the real estate bubble. When that bubble popped, I knew that the economy would have to shrink. And that's just what happened. From 2008 to 2009 our national GDP (of around $14 trillion) contracted by $212 billion. To prevent any further dips, the government aggressively spent, borrowing heavily to do so. To the relief of just about everyone, these moves did stop the nominal contraction. From 2010 to 2011 the U.S. GDP expanded by $502 billion, and from 2011 to 2012 it added an additional $508 billion. All told, from the end of 2008 the U.S. economy added a cumulative $798 billion in GDP. But those gains came at a very high price.

 

The combined federal deficits for the same time frame come in at a staggering $4.2 trillion! In 2009 alone the feds chalked up a chart breaking $1.4 trillion in debt (the deficit was a mere $161 billion in 2007). In other words, we borrowed five times more than we grew. This "strategy" for growth is no different from an individual who loses half his income, but continues to spend by running up credit card debt. Could this be described as economic growth? But that's just how we are describing our current economy, and for the large part, expert economists, politicians, investors, and academics all agree. 

 

I felt certain before writing Crash Proof that the government would never let the economy contract far enough to restore balance and sustainability. I knew the spending and deficits would head off the charts. I thought those realities would push down the dollar and cause foreign creditors to shun American government debt. However, I did not factor in the reprieve we have gotten from the false perception that Europe is in even worse shape than we.

 

As the curtain eventually falls on the drama unfolding in Europe, the world will refocus its attention on the more spectacular events in the U.S. The sovereign debt crisis that is now playing out in Europe will cross the Atlantic, and when it opens here the Real Crash may indeed finally begin. The average American will have a front row seat but will hardly enjoy the show.   

 

To save 35% on Peter Schiff's new book, The Real Crash: America's Coming Bankruptcy - How to Save Yourself and Your Countryorder your copy today

 

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Tags:  econfederal reserveGDPgoldinflationinvesting
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Pentonomics - The Chinese Have Stopped Laughing
Posted by Michael Pento on 07/29/2011 at 10:21 AM

The economy continues to prove that it didn’t need a stalemate between democrats and republicans over whether or not we should expand our credit limit in order to poop the bed. Gross Domestic Product climbed a paltry 1.3% in the second quarter of this year following a severely downgraded Q1 print of just 0.4%. Growth in the first quarter was revised down from a 1.9% prior estimate. Also today, the Institute for Supply Management-Chicago Inc. said its business barometer fell to 58.8 in July, from 61.1 in the prior month. And the Thomson Reuters/University of Michigan final index of consumer sentiment fell to 63.7 this month, which was the weakest since March 2009, from 71.5 in June.

Where are all those shills who assured us last year that 2011 would display a “V” shaped recovery in jobs and the economy? I know, I heard some of them today saying that the second half of this year is going to be great!  Their reasoning was the same as it always is. Earnings are going to be wonderful because half of S&P 500 companies' earnings are in foreign currencies. Then, thanks to our crumbling currency, those foreign earnings translate into a ton of U.S. dollars—those dollars don’t buy you very much, but who cares as long as we are able to say we beat Wall St. expectations.

The poor, lonely Tea Party is vilified as being inhuman and behaving as insane children for not allowing the country to bankrupt itself as quickly as possible—even by members of their own party (read here what John McCain had to say for yourself). I guess the philosophy of McCain and his friends is that we should raise the debt ceiling to infinity and beyond and just pay our creditors back with more printed money. After all, the National Debt has grown from $400 billion in 1971 to $14.4 trillion today, so what’s a few more trillion between now and 2013? The dollar has lost 98% of its purchasing power in the last 40 years, so why not keep on defaulting on our debt through inflation and destroy the last few vestiges of the middle class. Sounds like a plan to me. It’s just business as usual. They urge us to keep up the spirit of cooperation and goodwill that has served to render this country insolvent.

The only problem is that the Chinese have stopped laughing at Geithner’s so called “strong dollar policy” and are now allowing the Renminbi to rise against the greenback (up nearly 6% in the last year). If we continue down this road much longer the only buyer of U.S. debt will be the Fed. That’s the real down grade to come. Not from the credit rating agencies, but from our foreign creditors. Once we have a failed Treasury auction, it will engender a vicious cycle. Debt service expense will soar, which causes out of control deficits. The Fed will be forced to purchase more of the debt and inflation rates become intractable, thus destroying GDP growth. Runaway debt, interest rates and inflation is what  the Tea Party is trying so hard to avoid and it is a cause worth fighting for!



Tags:  Chinacreditdebtdebt ceilingeconomyGDPGeithner
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Pentonomics - Debt Ceiling Myths
Posted by Michael Pento on 07/22/2011 at 1:07 PM

The debt ceiling debate that has dominated the headlines over the past month has been thoroughly infused with a string of unfortunate misconceptions and a number of blatant deceptions. As a result, the entire process has been mostly hot air. While a recitation of all the errors would be better attempted by a novelist rather than a weekly columnist, I'll offer my short list.  

 

After having failed utterly to warn investors of the dangers associated with the toxic debt of entities like Enron, Fannie Mae, Freddie Mac, and AIG, as well as the perils of investing in mortgage-backed securities and sovereign debt of various bankrupt countries, the credit ratings agencies (CRAs) have now apparently decided to be more vigilant. Hence, many have offered conspicuous warnings that they may lower U.S. debt ratings if Washington fails to make progress on its fiscal imbalances. But then, just in case anyone was getting the impression that these rating agencies actually cared about fiscal prudence, Moody's suggested this week that its concerns would be lessened if Washington were to make a deal on the debt. The agency has even suggested that America's credit could be further improved if Washington would simply eliminate the statutory debt limit altogether. In other words, Moody's believes that our nation's problems are more a function of squabbling politicians rather than a chronic, unresolved problem of borrowing more than we can ever hope to repay.

 

With or without a deal, the CRAs should have already lowered their debt ratings on the $14.3 trillion of U.S. debt. In fact the rating should be lowered again if the debt ceiling IS raised. And it should be lowered still further if we eliminated the debt ceiling altogether. To lower the rating because the limit is NOT raised is like cutting the FICO score of a homeless person because he is denied a home equity loan.

 

Republicans are making a different misconception about the debt ceiling debate in their belief that they can dramatically cut government spending without pushing down GDP growth in the short term. In a recent poll from Pew Research Center for the People and the Press showed 53% of G.O.P. and 65% of Tea Party members said there would be no economic crisis resulting from not raising the debt ceiling.

 

They argue that leaving money in the private sector is better for an economy than sending the money to Washington to be spent by government. That much is undoubtedly true. But a very large portion of current government spending does not come from taxing or borrowing, but from printed money courtesy of the Fed. If the Fed stops printing, inflation and consumption are sure to fall. While this is certainly necessary in the long run, it will be nevertheless devastating for the economic data in the near term.

 

Over the last decade and a half our economy has floated up on a succession of asset bubbles, all made possible by the Fed. Our central bank lowers borrowing costs far below market levels. Commercial banks then expand the money supply by making goofy loans to the government or to the private sector. As a consequence, debt levels and asset values soar and soon become unsustainable. Ultimately, the Fed and commercial banks cut off the monetary spigot, either by their own volition or because the demand for money plummets. The economy is forced to deleverage and consumers are forced to sell assets and pay down debt. Recession ensues. That's exactly what could happen if $1.5 trillion worth of austerity suddenly crashes into the economy come August 2nd. Although they don't seem to realize it, this will create huge political problems for Republicans.

 

And then there is the deception coming from Democrats who argue that we need to raise taxes in order to balance our budget. This is simply not possible. The American economy currently produces nearly $15 trillion in GDP per annum but has $115 trillion in unfunded liabilities.With a hole like that, no amount of taxes could balance the budget. Raising revenue from the 14% of GDP, as it is today, to the 20% it was in 2000 would barely make a dent toward funding our Social Security and Medicare liabilities. Therefore, we need to cut entitlement spending dramatically. But the Democrats refuse to face the obvious facts. 

 

With the Tea Party gaining traction in Congress, and causing nightmares for incumbents, Republicans have little incentive to raise the debt ceiling (although they raised it 7 times under George W. Bush). Democrats aren't going to reduce entitlements without raising taxes on "the rich" and Republicans aren't going to raise taxes when the unemployment rate is 9.2%. There's your stalemate and anyone expecting a significant deal to cut more than $4 trillion in spending by the August 2nd deadline will be severely disappointed. Although there has been some movement by the so-called "Gang of Six" centrist senators in recent days, a substantive deal may be more unlikely than most people think. And even if a much smaller deal can be reached in time, the credit rating agencies may follow through on their promise to downgrade our sovereign debt. The fallout could be devastating to money market and pension funds that must hold AAA paper. But an even worse outcome will occur when the real debt downgrade comes from our foreign creditors, when they no longer believe the U.S. has the ability to pay our bills.

 

In my opinion, the best news for the long term future of this nation is the Republican "Cut, Cap and Balance" plan that just passed the House. It now heads to a much harder hurdle in the Democrat controlled Senate, and if it passes that, to a certain veto from President Obama. At least something so promising got to the table at all. However, I think the country needs some more tastes of brutal reality before such bitter medicine has a chance of going down.



Tags:  CRAcreditdebtdebt ceilingeconomyGDP
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Pentonomics - Selling Away Our Future
Posted by Michael Pento on 07/19/2011 at 7:01 PM

The U.S. trade deficit soared 15% month over month in May to $50.2 billion, which was the highest amount of red ink since October of 2008. Despite what some claim, we don’t have a diversified manufacturing base in this country and the percentage of our economy that is devoted to manufacturing has progressively slumped in the last 6 decades to the lowest level ever (11%). Year over year the trade gap widened 19% from the previous reading of $42.3 billion.

However, this data will not deter the economic geniuses to proclaim that a lower dollar can save the U.S. economy from hemorrhaging its wealth to foreigners.  The fact is that the greenback has lost 12% of its value Y.O.Y. and the trade deficit has surged. That’s because the lower dollar increases the prices of everything sold in dollars.  So foreigners can’t buy more of the stuff we make; but the lower dollar does make everything we still need to buy overseas more expensive. And the trade gap widens!

Is that a problem? Well, only if you care about selling away the future productive output of the economy with interest to people other than Americans or worry about the chronic weakness of the U.S. currency that could eventually lead to its total collapse.



Tags:  debtdeficitfederal reserveGDP
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