THE BLOG
07/25/2008 05:12 am ET | Updated May 25, 2011

Lies, Damn Lies and Government Inflation Statistics

Describing the decade that began in 2000 as the "naughties" or "oughties" offers a useful shorthand -- and particularly for people interested in discussing the U.S. economy's perilous dual pathway of rising commodity inflation coupled with financial assets deflation.

Ought and naught, of course, are two old-fashioned ways of saying "nothing" or "zero," appropriate for a painful decade that stretches from ought-one and ought-two to ought-nine.

But the term's negativism is also appropriate. As financial economists have begun to point out, between 2000 and mid-July 2008, the leading stock market yardstick, the Dow-Jones Industrial Average, dropped from a 2000 peak of 11,700 to a level 500-700 points lower. Moreover, allowing for eight years worth of inflation, by official data, the decline was nearer 25%, making the real return much worse than "naught." This is what people have to watch in a stagflationary economy, which the new Consumer Price Index numbers (June's one-month increase of 1.1 percent) have finally started to admit.

The possibility that inflation could even reach double digits should start to resolve today's central debate: whether this decade's unhappy U.S. economy is more like that of the depression 1930s or that of the stagflationary 1970s. Alas, there are elements of both.

To begin with, even the national media agree that home prices are in their biggest nationwide decline since the 1930s. Also, last month's slump in the Dow-Jones Industrial Average was the biggest June slide since the early depression year of 1930. And depending on who you talk to, the financial crisis is either the biggest since World War Two or the biggest since the 1930s.

Yet there is also escalating resemblance to the 1970s, when a global food and energy price surge followed the loose fiscal policy and boom of the Vietnam war era. No such trend existed in the 1930s. However, especially since 9/11 and then the invasion of Iraq, our decade has also seen has that kind of easy money and loose fiscal policy. As a result, global food and energy prices have been soaring.

The just-released inflation numbers suggest a gruesome possibility. Our own decade, like the years from 1966 to 1982, could see another severe economic downturn and stock market slump, but one partially camouflaged by fast-rising prices. Here is the precedent: between a Dow-Jones (intra-day) peak of 1000 in early 1966 and an August 1982 bottom of some 780, the Dow declined a nominal 22%. However, a truer calculation, adjusting for soaring inflation, put the real decline close to 70 percent -- a disguised disaster.

Could it happen again? Maybe. It is possible to imagine somewhat similar economic terrain. In 2010 or 2012, the Dow-Jones could easily be at 10,500 or 11,500, for a seemingly small ten-year or twelve year decline. But if simultaneous inflation has totaled some 30 percent, then the real decline would be 30-40% -- major league erosion, in other words.

And there is a worse possibility -- that the changed Consumer Price Index measurements in place since the 1990s have significantly underestimated inflation, and the true damage has already been much deeper. Why would Washington allow this, you might ask. The answer: that because a large chunk of the federal budget rises with inflation, the savings from understating it are enormous, however unfair to retirees and workers.

We are not talking small numbers. With global inflation heating up, the investment firm of Morgan Stanley recently noted that "The percentage of the world's population living under double-digit inflation is 42 percent. Six out of the ten most populous countries have inflation running at more than 10 percent."

Bill Gross of California-based PIMCO, the world's biggest bond manager, tells investors that interest rates on U.S. Treasury notes are inadequate. Inflation around the globe has averaged nearly 7 percent over the past decade, but the official U.S. inflation rate has averaged 2.6 percent. "Does it make any sense," says Gross, "that we have a 3 percent to 4 percent lower rate of inflation than the rest of the world?" And if Washington understates inflation by one percent, he adds, then gross domestic product has been overstated by that same amount. ("U.S. Inflation understated, Pimco's Gross says," MarketWatch, May 22, 2008)

Nor is Gross alone. In May, former Federal Reserve Chairman Paul Volcker told the Congressional Joint Economic Committee that "I think there's a lot more inflation than in those [CPI] figures." He said that the sharp run-up in housing before the recent implosion wasn't reflected in CPI data, adding that food and energy prices should not be excluded in gauging long-term trends. And when prices do go up, he said, government calculators are "much more inclined to say that there are improvements in quality" rather than an increase in inflation.

At Charles Schwab & Company, one of the nation's biggest money managers, chief economist Liz Ann Sonders wrote in June that "Over the past 30 years, major changes have been made to the calculation of the CPI due to "re-selection and reclassification of areas, items and outlets, [and] to the development of new systems for data collection and processing," according to the Bureau of Labor Statistics. If you eliminate those adjustments and calculate CPI as it would have been calculated in 1980, it would be nearly 12 percent today...No wonder clients constantly tell me they distrust government inflation data." ("Back to the 1970s?" Charles Schwab Investing Insights, June 19, 2008)

Cynics will point out that rigged data and sneaky book-keeping are par for the course in American finance. However, the accusations implicit in the Volcker, Gross and Sanders comments suggest a government scandal of the first magnitude. Maybe our presidential candidates should take a break from discussing how many troops to move from Iraq to Afghanistan or vice versa and start publicly discussing the extent to which a fundamental mismanagement of the U.S. economy rests on a framework of what can bluntly be described as lies, damn lies and statistics.

Author and commentator Kevin Phillips' most recent book is Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism, published by Viking in April.