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The GDP of the USA is as close to fiction as one can get. Using the methodology to define the CPI pre-1990, the current and for most of the last 20 years CPI in the US is understated by a factor of two. This is a big deal since it means that the GDP growth in the range of 3% was more like zero and periods of no-growth were actual contractions. The CPI is only one component of the GDP deflator but there is indication that producer price increases have been quite high too.

The mass migration of US factory jobs to China and all the “right-sizing” and “down-sizing” was not for free and it looks like the US GDP has been stagnating for the last 20 years. I originally bought into the line that there were productivity gains, but there were also major wage reductions (all those lost manufacturing jobs were replaced with low pay service sector jobs.) All the talk about the new IT-based economy was a crock too since those jobs went to China and India as well. The only source of growth that I can see is population increase in the US which is significant at around 2%.

So I would say the US GDP is closer to 10 trillion and not the 15 trillion that is being trumpeted in the media.

But it is important to understand that GDP (via CPI) overstatement is only a part of what is called the USA “number racket”. Employment statistics is equally fake. Money supply is another good example of “number racket”. All the USA economics statistics now is manipulated by “power that be”. Not to the extent war casualties are manipulated but still…
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[May 17, 2008] Data To Die For

May 9, 2008 How can we realistically trust the data that come out of the various US departments anymore? Even given the benefit of the doubt, i.e. assuming model massage was originally established to provide a clearer picture of the US economy, the ultimate result now looks more like an elaborate GIGO * contraption designed by Rube Goldberg.

Case in point: the Net Birth/Death model of the Bureau of Labor Statistics. During the most severe downturn in the real estate and homebuilding sector since the Great Depression, the model keeps creating phantom construction jobs (see chart below, click to enlarge).

Not only did the model spew out a total of 98,000 net additional construction jobs in the 12 months to April 2008, it produced more such jobs in April 2008 than the same month last year (45,000 vs. 37,000, or +21%). In other words, new construction businesses that were established in that period supposedly created many more jobs than those lost from businesses shutting down.

The first casualty of war is the truth - Aeschylus. Problem is, who's the enemy?

*Garbage in, garbage out

Want To Fix The Fed? Get Rid Of It

Inquiring minds have been pondering Volcker's latest statements regarding stagflation, the CPI, regulation of banks, and even the need for an administrator to watch over the Fed.

Let's see where Volcker is right and wrong with his analysis of the current economic situation and what to do about it.

The US economy is not now in the kind of stagflation crisis it had been in, in the late 1970s, former Federal Reserve Board Chairman Paul Volcker told Congress today, but it's not impossible.

'I think there is some resemblance now to inflation in the early 1970s,' he warned the Joint Economic Committee. The economy obviously does not have the full-blown, double-digit inflation crisis that finally appeared, but he said, 'there is an underlying tendency to inflation.'

Volcker also told the committee that the Consumer Price Index may understate the actual rate of inflation. For example, during the real estate boom, the housing component of the CPI rose only slightly. And to consumers, 'when food and energy are running high, not for a couple of months and dropping, but running high for years, it doesn't sound quite right, it doesn't feel quite right.'

My Comment: As for not believing the CPI, virtually no one does. Inquiring minds may wish to consider CPI Numbers For April: Spotlight On Energy fora look at the latest numbers. Furthermore, as Volcker points out, housing was dramatically understated for years. Housing is overstated now. However, Volcker fails to go far enough with this line of thinking.

Other Problems Inherent With The CPI

The CPI cannot measure stock prices or prices falling because of rising productivity. Peak oil is a factor. So is worldwide demand. It's debatable that prices can even be accurately measured or that there is any such thing as a representative basket of goods and services to measure. Most importantly: the CPI is useless in measuring the magnitude of credit bubbles that manifest themselves in other ways besides prices. Finally, the CPI is a lagging indicator.

The final analysis shows that anyone who believes the CPI is (or is even supposed to be) a measure of inflation is making a huge mistake. The solution is to start with a sound definition of inflation and deflation: Inflation is a net increase in money supply and credit. Deflation is the opposite.

Inquiring minds that have not yet done so may wish to read Inflation: What the heck is it? for further discussion.

Volcker did not forecast a recession, rather he talked about a necessary rebalancing of an economy that depended too much on consumption financed with borrowing. 'Somehow that has to change,' he said. 'It's a kind of a rough ride but we have to have it happen to avoid more severe consequences.' And in fact, consumption is declining and exports rising, 'laying the basis for a sustained recovery.'
My Comment: There is clearly a need for rebalancing. However, there is no basis whatsoever for believing a sustained recovery is possible any time soon. The recession is barely a few months old, and some do not even think it has started yet.

More to the point: The jobs picture is miserable, banks are horrendously undercapitalized, and foreclosures are mounting. A Flood of Foreclosures Prove Loan Modification Isn't Working. Bank failures are coming.

In his analysis of the credit crisis, Volcker said the mathematical modelling and financial engineering behind the structured investment products involved are inherently incapable of accounting for the human element of market behaviour.
My Comment: That's easy to agree with. Some of the housing and structured credit models are completely absurd, especially at the rating agencies.
And, having necessitated Fed intervention to rescue the markets and economy as a result, the investment banks which used the financial innovations now need to face the same kind of regulation as commercial banks.

'I believe there is no escape from the conclusion that, faced with the kind of recurrent strains and pressures typical of free financial markets, the new system has failed the test of maintaining reasonable stability and fluidity,' Volcker said.

My Comment: The problem is not lack of regulation. The problem is the Fed itself is distorting the free market. Eliminate the Fed, eliminate fractional reserve lending, and eliminate borrowing money into existence and none of this would have happened, at least to any significant degree.
Asked about the Fed's arranged merger of Bear Stearns by JP Morgan Chase, he said 'I can understand' why the Fed felt it had to act as it did. The more important question, though, is whether better regulation and supervision could have prevented the collapse in the first place.
My Comment: The important question is when do we get rid of the Fed? But first we need people to see that the Fed (and fractional reserve lending) are indeed the big problems.
Faced with the threat of a cascading breakdown of financial markets, the Federal Reserve felt compelled to extend its safety net with long-dormant emergency powers.

'The natural corollary,' to that Volcker said, is that systemically important investment banking institutions should be regulated and supervised along at least the basic lines appropriate for commercial banks they resemble in key respects.'

My Comment: Speaking of corollaries, please consider the Fed Uncertainty Principle corollary #3:

The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab.

Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

By its intervention in the mortgage and other credit markets, the Fed may imply official support for a particular sector of the economy. 'The creators of the Federal Reserve could be rolling over in their graves knowing the Fed is buying mortgages,' he said.

The intervention, in turn raises potential questions about the political independence of the Fed.

My Comment: Volcker is back on track with those statements. The solution to me is easy: Abolish the Fed. Unfortunately, he comes up with a different answer as follows:
Volcker said the Fed should have the lead role in financial regulation, but to take that on, it needs a reorganization with a senior administrator and a stronger staff if it's to fulfill that roll.
Let's see: Now we need a senior administrator to watch over the Fed to watch over the banks and brokers? The Fed itself needs a stronger staff. Who is going to watch over the senior administrator? Congress? How can any of this possibly solve questions about the political independence of the Fed.

Instead of fixing the problem, Volcker proposes still more government partnerships. He never addresses the root problems: 1) Fractional reserve lending fosters credit bubbles and 2) the Fed compounds the problem by micromanaging interest rates.

In my opinion, it's time to stop the madness and abolish the Fed and along with it fractional reserve lending. Sadly, we are moving the opposite direction towards more government intervention, nationalization of banks, nationalization of housing, and more regulation on top of regulation, with increasing power to the organization most responsible for creating the mess we are in.

Mike "Mish" Shedlock
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LIBOR Credibility In Doubt

Bloomberg is reporting Libor Poised for Shake-Up as Credibility Is Doubted.

The benchmark interest rate for $62 trillion of credit derivatives and mortgages for 6 million U.S. homeowners faces its biggest shakeup in a decade as lawmakers question if banks are understating borrowing costs.

For the first time since 1998, the British Bankers' Association is considering changing the way it sets the London interbank offered rate, according to Chief Executive Officer Angela Knight, who appeared before a parliamentary committee in London today. ``We've put Libor under review,'' Knight said in an interview yesterday. The BBA will announce changes May 30, she said.

The BBA, an unregulated London-based trade group, sets Libor by polling 16 banks each day on the rates they pay for loans in dollars, British pounds, euros and eight other currencies. The association is under pressure to show the rates are reliable following complaints by investors that financial institutions weren't telling the truth after the collapse of subprime mortgages nine months ago contaminated credit markets and drove up borrowing costs.

While the BBA set the one-month dollar Libor rate at 2.72 percent on April 7, the Federal Reserve said banks paid 2.82 percent for secured loans later that day. Secured loans typically yield less than unsecured debt.

"The Libor numbers that banks reported to the BBA were a lie," said Tim Bond, head of global asset allocation at Barclays Capital in London. "They had been all the way along."

The cost of borrowing in dollars for three months should be as much as 30 basis points, or 0.30 percentage point, higher than the current rate, Citigroup Inc. said in a report last month. Banks are understating borrowing costs on concern they will be perceived as "weakened" by the credit turmoil that forced banks to record $323 billion of losses and credit-markets writedowns, said Peter Hahn, a fellow at the London-based Cass Business School.

"Since the credit crunch, it's something that appears to have been manipulated," said Hahn, a former managing director at Citigroup. "We are in an extraordinarily delicate confidence time where a small event can shatter things quite easily."

The Bank for International Settlements said in a March report some lenders were manipulating the rates to prevent their borrowing costs from escalating.

Libor is used to guide banks in setting rates on most adjustable-rate mortgages. The prices they quote for credit default swaps are also linked to Libor.

"Libor is a proxy for the effective rates of the economy," said Rav Singh, an interest-rate strategist at Morgan Stanley in London. "Libor eventually feeds into the economy. There's so much on the back of the Libor problem. There are structured products, all the swaps and then there are the hedging positions."

LIBOR As Of 2008.05.13

Curve watchers anonymous has been watching LIBOR.

The above table from Bloomberg.
Reasonable spreads can be seen in the red box on the right.

A year ago the spread between the Fed Funds Rate and LIBOR 7 basis points, today it is 52 basis points. Bear in mind these are snapshots. LIBOR was acting poorly many times over the past year, especially last August-September and November-December, where the spreads were even greater than they are today.

I checked LIBOR the day after the last Fed rate cut. It was 2.72 so it has been drifting lower in recent weeks. This has been the pattern. The Fed cuts rates and it takes weeks for LIBOR to come in. Historically that is not the case, nor should it be the case.

One Month LIBOR Table

click on chart for sharper image
The above chart thanks to MoneyCafe

Money Cafe reports one Month LIBOR on or after the first of the month for a one month deposit in U.S. Dollars on the last business day of the previous month. Thus the above table reflects a credit crunch in August and November.

At the end of April the spread between LIBOR and the Fed Funds rate was 80 basis points. It is now down to 51 basis points, assuming of course one can believe that is what banks are really charging each other for overnight loans.

Mike "Mish" Shedlock
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