Cinema is Dead! (Huh?) – Do Government Statistics Accurately Reflect the Economy?
I read a very dramatic statistic recently about the cinema industry and the effect that COVID-19 has had on it.
In March 2019, the Cinema industry had produced over $200 million in sales. In March 2020, this same industry had produced $5,000 in sales.
Regardless of how you do the math on those numbers, it works out to be an almost 100% decline in sales, year over year!
If you come up with any number less than negative 99.9975% you are probably a publicist, propagandist or qualified to be a statistician for the government.
Government economic indicators have become corrupted and distorted and I’ll show you the effect this has on those who rely upon them and the financial markets.
These deceptions were completely bipartisan and rose incrementally with every administration over the last 60 years. The end result was that the indicators which were to act like a report card on the government were always tweaked to put the administrations best foot forward and convince citizens that the economy which they were measuring was effectively being managed.
This is not rocket science. But the statistical measures which have been used certainly make the economy appear to be very complex.
Here are some of the misrepresentations that have occurred in the statistics that represent the economy:
The Kennedy administration in 1961, had relatively high jobless numbers that marred the image of the new administration. Kennedy appointed a committee to weigh changes. The result was that out-of-work Americans who had stopped looking for jobs—even if this was because none could be found—were labeled “discouraged workers” and excluded from the ranks of the unemployed. Compare this to the Reagan administration’s sleight of hand, who further trimmed the unemployment number by reclassifying members of the military as “employed.”
Think about these realities when you ponder the 26 million new jobless claims! At some point according to this logic they will no longer count, or we could just enroll everyone in the military to consider them fully employed.
Meanwhile, the Nixon administration began publishing Consumer Price Index numbers, excluding those troublesome sectors of “food and energy.” Publishing an inflation statistic less the troublesome inflationary sectors is like publishing a banking statement without showing any expenses.
If I were to ask you to create an Index of Price Inflation, the simplest thing you could do is decide what you were going to measure, place those items in a basket, and track the price changes of those items over time. This is exactly what the Farm Bureau did for many years. It is simple and its results are very understandable. The Farm Bureau took 30 shopping items, placed them in a shopping cart and compared their prices every month to arrive at a statistic that measured whether prices were rising or falling. If you spent $100 on these items last year and today they cost $105, the Index rose $5 or 5% showing an increase in price inflation.
Apparently, the simplicity of this approach and the results that it created were believed to not be representative of what was really going on in the economy. So large panels of experts were convened to decide how to best represent the economy in a shopping basket and to further study what was going to be purchased and measured and exactly how it would be measured.
Fasten your seat belts folks, because this is why and how so many government statistics have become a truly slippery slope and are completely disconnected from the true consumer experience.
The experts argued that if one of the items in the shopping basket became too expensive that people would stop buying it and would substitute something else.
So, the idea of substitution became a major focus for the statisticians putting together the Consumer Price Index.
If flank steak became too expensive, the assumption was that everyone would automatically move to hamburger, and no one would gravitate towards Filet Mignon. The experts would further argue that more items needed to be added to the shopping basket so it would represent technological items like phones and computers to reflect what was really taking place in the economy.
Naturally, these technological items are traditionally very deflationary in nature. For example, a 10-megabyte hard drive cost $1,000 in 1986. Today you can purchase a 32-gigabyte hard drive for $20. Based upon only these two perspectives you can imagine how complicated the process of measurement has become. Further complicating the debate was something referred to as geometric weighting. This means how much weight should be allotted to each item? As you might imagine, items that were falling in price like big screen tv’s which have always gone down in price were given more weighting in the index in comparison to those items that went up in price. Health care which represents 18% of the US Economy only has a representative 6% weighting in the index.
But by far the most deceptive practice within calculating the values in the Consumer Price Index is based upon something called “hedonics” which assumed that any improvements in an item were comparable to purchasing it at a discount. For example, lets say you purchase the latest greatest television model today for $700. It has the same price tag as last year’s model at $700 but this year you have a wider and higher quality screen and easier to use voice activated remote control. Based upon hedonic analysis, the improvements in the technology are comparable to you buying that television for several hundred dollars less than last year’s model, and that is how it is weighted in the current Consumer Price Index.
Even though you paid $700 it could be put into the calculation at a price of $450 based upon the improved technology.
If you find this confusing, you’re not alone. The hedonic adjustment, in particular, is as hard to estimate as it is to take seriously and it has completely distorted what it was intended to measure. What is evident is that the hedonic adjustment is primarily used to reduce the effective cost of goods, which in turn reduces the stated rate of inflation. The dark reality is that HEDONICS is used to adjust about 46% of the Consumer Price Index!
Why is this important?
Inflation measurements determine interest rates, federal interest payments on the national debt, and cost-of-living increases adjustments for wages, pensions, and Social Security benefits. But more importantly, these important statistics anchor the trust of its citizens in its institutions. It is easy to dismiss this as simply the “art of spin” on the part of bureaucrats. However, if you rely upon these statistics in any manner it is easy to imagine the harm they have done.
Here is a chart compiled by John Williams of ShadowStats.com. Mr. Williams takes the information published by the government and strips out all of the statistical gobbledygook to arrive at what he feels is a more realistic assessment of consumer prices.
You can clearly see how distorted the actual numbers are. Sometimes the inflation numbers are overstated by as much as 9% in a single year. Someone on Social Security over the last 20 years should be entitled to a cost of living adjustment of over 100%. Hospitals who rely upon the CPI for Medicare payments would also be entitled to huge increases to balance their budgets. These types of dislocations are quite serious.
Whether you are a shopper, citizen, investor or trader this information is all about protecting your bottom line from a loss of purchasing power.
Whenever prices go up, only one of two things are taking place: 1) the asset that is going up is becoming more valuable, or 2) your unit of purchasing power is decreasing in value. Do the math and decide for yourself.
As traders, our most important duty is to clearly define risk so that we can sidestep it as much as possible and locate better opportunities.
Today this statistical distortion of inflation has become so severe that when the CPI is announced monthly most traders fear the number outright because of its complexity. Is it Seasonally Adjusted? Geometrically weighted? Hedonically balanced? Efficiently substituted? What does it mean?
The end result is always the same, how do you make sense of something that is engineered to be very confusing?
If the CPI is inaccurate what then is the real rate of inflation?
The truth is that there is no good way to gain a true measure of inflation, especially in this era when the Federal Reserve System is flooding the economy with new trillions of new dollars. I read a report yesterday that because of COVID-19, that an additional 9 trillion of spending will be released into the economy.
This level of spending is unprecedented in our nation’s history.
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Let me lay it out for you in black and white.
Two traders looking at the same market at the same time.
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The other is not.
Who do you think is better prepared to win in this scenario?
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