Impending Destruction of the US Economy

[Steve Gardner]

Source: Global Research

by Dr. Paul Craig Roberts

Global Research, December 1, 2007
informationclearinghouse.info

Hubris and arrogance are too ensconced in Washington for policymakers to be aware of the economic policy trap in which they have placed the US economy. If the subprime mortgage meltdown is half as bad as predicted, low US interest rates will be required in order to contain the crisis. But if the dollar’s plight is half as bad as predicted, high US interest rates will be required if foreigners are to continue to hold dollars and to finance US budget and trade deficits.

Which will Washington sacrifice, the domestic financial system and over-extended homeowners or its ability to finance deficits?

The answer seems obvious. Everything will be sacrificed in order to protect Washington’s ability to borrow abroad. Without the ability to borrow abroad, Washington cannot conduct its wars of aggression, and Americans cannot continue to consume $800 billion dollars more each year than the economy produces.

A few years ago the euro was worth 85 cents. Today it is worth $1.48. This is an enormous decline in the exchange value of the US dollar. Foreigners who finance the US budget and trade deficits have experienced a huge drop in the value of their dollar holdings. The interest rate on US Treasury bonds does not come close to compensating foreigners for the decline in the value of the dollar against other traded currencies. Investment returns from real estate and equities do not offset the losses from the decline in the dollar’s value.

China holds over one trillion dollars, and Japan almost one trillion, in dollar-denominated assets. Other countries have lesser but still substantial amounts. As the US dollar is the reserve currency, the entire world’s investment portfolio is over-weighted in dollars.

No country wants to hold a depreciating asset, and no country wants to acquire more depreciating assets. In order to reassure itself, Wall Street claims that foreign countries are locked into accumulating dollars in order to protect the value of their existing dollar holdings. But this is utter nonsense. The US dollar has lost 60% of its value during the current administration. Obviously, countries are not locked into accumulating dollars.

The reason the dollar has not completely collapsed is that there is no clear alternative as reserve currency. The euro is a currency without a country. It is the monetary unit of the European Union, but the countries of Europe have not surrendered their sovereignty to the EU. Moreover, the UK, a member of the EU, retains the British pound. The fact that a currency as politically exposed as the euro can rise in value so rapidly against the US dollar is powerful evidence of the weakness of the US dollar.

Japan and China have willingly accumulated dollars as the counterpart of their penetration and capture of US domestic markets. Japan and China have viewed the productive capacity and wealth created in their domestic economies by the success of their exports as compensation for the decline in the value of their dollar holdings. However, both countries have seen the writing on the wall, ignored by Washington and American economists: By offshoring production for US markets, the US has no prospect of closing its trade deficit. The offshored production of US firms counts as imports when it returns to the US to be marketed. The more US production moves abroad, the less there is to export and the higher imports rise.

Japan and China, indeed, the entire world, realize that they cannot continue forever to give Americans real goods and services in exchange for depreciating paper dollars. China is endeavoring to turn its development inward and to rely on its potentially huge domestic market. Japan is pinning hopes on participating in Asia’s economic development.

The dollar’s decline has resulted from foreigners accumulating new dollars at a lower rate. They still accumulate dollars, but fewer. As new dollars are still being produced at high rates, their value has dropped.

If foreigners were to stop accumulating new dollars, the dollar’s value would plummet. If foreigners were to reduce their existing holdings of dollars, superpower America would instantly disappear.

Foreigners have continued to accumulate dollars in the expectation that sooner or later Washington would address its trade and budget deficits. However, now these deficits seem to have passed the point of no return.

The sharp decline in the dollar has not closed the trade deficit by increasing exports and decreasing imports. Offshoring prevents the possibility of exports reducing the trade deficit, and Americans are now dependent on imports (including offshored production) for which there are no longer any domestically produced alternatives. The US trade deficit will close when foreigners cease to finance it.

The budget deficit cannot be closed by taxation without driving up unemployment and poverty. American median family incomes have experienced no real increase during the 21st century. Moreover, if the huge bonuses paid to CEOs for offshoring their corporations’ production and to Wall Street for marketing subprime derivatives are removed from the income figures, Americans have experienced a decline in real income. Some studies, such as the Economic Mobility Project, find long-term declines in the real median incomes of some US population groups and a decline in upward mobility.

The situation may be even more dire. Recent work by Susan Houseman concludes that US statistical data systems, which were set in place prior to the development of offshoring, are counting some foreign production as part of US productivity and GDP growth, thus overstating the actual performance of the US economy.

The falling dollar has pushed oil to $100 a barrel, which in turn will drive up other prices. The falling dollar means that the imports and offshored production on which Americans are dependent will rise in price. This is not a formula to produce a rise in US real incomes.

In the 21st century, the US economy has been driven by consumers going deeper in debt. Consumption fueled by increases in indebtedness received its greatest boost from Fed chairman Alan Greenspan’s low interest rate policy. Greenspan covered up the adverse effects of offshoring on the US economy by engineering a housing boom. The boom created employment in construction and financial firms and pushed up home prices, thus creating equity for consumers to spend to keep consumer demand growing.

This source of US economic growth is exhausted and imploding. The full consequences of the housing bust remain to be realized. American consumers lack discretionary income and can pay higher taxes only by reducing their consumption. The service industries, which have provided the only source of new jobs in the 21st century, are already experiencing falling demand. A tax increase would cause widespread distress.

As John Maynard Keynes and his followers made clear, a tax increase on a recessionary economy is a recipe for falling tax revenues as well as economic hardship.

Superpower America is a ship of fools in denial of their plight. While offshoring kills American economic prospects, “free market economists” sing its praises. While war imposes enormous costs on a bankrupt country, neoconservatives call for more war, and Republicans and Democrats appropriate war funds which can only be obtained by borrowing abroad.

By focusing America on war in the Middle East, the purpose of which is to guarantee Israel’s territorial expansion, the executive and legislative branches, along with the media, have let slip the last opportunities the US had to put its financial house in order. We have arrived at the point where it is no longer bold to say that nothing now can be done. Unless the rest of the world decides to underwrite our economic rescue, the chips will fall where they may.

Dr. Roberts was Assistant Secretary of the US Treasury for Economic Policy in the Reagan administration. He is credited with curing stagflation and eliminating “Phillips curve” trade-offs between employment and inflation, an achievement now on the verge of being lost by the worst economic mismanagement in US history.

© Copyright Paul Craig Roberts, informationclearinghouse.info, 2007

[Steve Gardner]

A bit of a heavy read but fascinating nonetheless.

One bit that really caught my eye was this:

Banks have multiple ties with the mortgage markets. They are a direct investor in the mortgage market. These appear in their balance sheets as level 3 assets, valued according to their own models. They have ties with them through their special investment vehicles (SIV) entities they control indirectly as a part of the shadow financial system of money market funds, hedge funds and investment banks. The SIVs obviate the need for banks to have a regulatory capital charge for the liabilities in terms of the Basel convention requirements for their capital adequacy ratios. Structured securities often provided ‘independent’, and often fictitious, funds and kept out of the bank regulators’ range of vision. With losses that the SIVs have incurred on mortgage-related assets, banks have had to absorb them into their balance sheets, to pre-empt SIV investors from withdrawing their investments. The red ink will go deeper and farther since there are no complete disclosures on this score.

This 'shadow financial system' set up to essentially circumvent the Basel requirement is, whilst not surprising, quite alarming. We - the taxpayer - are pumping billions of £, $, or whatever into shoring up the banks right now. It's kinda disheartening, don't you think?

And, as a parting thought, the fact that the sub-prime market has collapsed at the very same time that China, Iran et al are diversifying away from US debt is no coincidence.

So, where do you think the War on Terror might be heading?

Source: The Telegraph (India)

There is a disconnect between the real and financial sectors in the American economy today. In the real economy, it was business as usual — almost, until recently. The fundamentals remain reasonably strong, with the subprime crisis yet to cast a shadow really and, to many people as of now, is but a speed bump.

The picture is changing, albeit slowly. The International Monetary Fund has cut its 2008 growth forecast for the United States of America to 0.8 per cent, consumer confidence has fallen drastically and factory output has failed to increase, indicating that damage from the housing-market contraction is pushing the economy toward a recession. From all signs, the economy has already moved into recession in December 2007. Now the only point to debate is, if it will land soft or hard, and if it will be short and shallow, lasting a couple of quarters, or be deep and protracted.

In the financial sector, a sea of red ink has already been splashed with large write-offs taking place regularly in the balance sheet of banks, security houses, insurance companies and other players in Wall Street. It will be months before anyone knows the full impact of the catastrophe that has had the entire world of finance — across geographies — caught in a vicious gridlock of huge losses with a tangled web of various sectors of the market pulling each other down, as crabs do.

The crisis, no longer restricted to the subprime sector, having spread into other sectors of the economy, is the first genuine global crisis in an era of globalization. The process of globalization saw an unprecedented concentration of capital in the US.

Cross border instant, free and fast IT-enabled capital flows, rapidly increasing since 1996, now stand at $7 trillion. Overseas currency reserves of countries like China and Japan have largely invested in the US, now amounting to around $6 trillion. Of the $1 trillion petrodollar revenue that is being generated annually, some $300 billion are looking for a parking space. Meanwhile, US firms’ accumulations in their home currency are growing, in the absence of fresh investment opportunities. Since 2001, banks’ credits have gone up 83 per cent to $14.9 trillion and the total mortgage debt is up 106 per cent over the last six-and-a-half years.

It was riding on this excess liquidity, following the collapse of the dotcom bubble, that Greenspan’s Fed moved into the $20 trillion housing market. From the beginning of 2001 to November 2002, bringing the Federal interest rate in 11 installments from 5 to 0.75 per cent per annum, they put the mortgage market into high gear, with the mortgage market now standing at around $11 trillion to become by far the biggest market in Wall Street, exceeding even the Treasury debt market of $9 trillion. In the process, they transformed the housing sector from its vital but demarcated role of providing decent, affordable housing, into a distorted giant that was made to become the prime prop for both the physical and financial sides of the US economy.

Securitization of the mortgage market had already begun by the time the Fed-directed money had started to enter them. There grew a shadow banking system, the securitization machine, based on the principle of diversification and corresponding slicing of risk. The system was led by a desire to move risks off-balance-sheet on the part of banks, and an overwhelming reliance on ratings by both ‘new’, non-traditional investors, Middle and Far Eastern banks, as well as traditional investors, banks and monolines, whose capital requirements were dictated by ratings.

Insurers, known as monolines insurers, also got sucked in while insuring the bonds to cover their risk. They were tempted to enter because a new instrument named credit default swap (CDS), that offered credit default protection to poorly rated debts, had been meanwhile developed specific to the market. As in all derivatives, the CDSs depend on counter-parties to honour the contracts. If one goes down, the instrument is useless. This has happened in the CDS market.

Anyway, the insurance companies had found a loophole in the law that allowed them to deal with these derivatives. They set up shell companies called ‘transformers’ that they used as off-balance-sheet operations where they sold CDSs in which one party assumes the risk of a bond or loan going bad for a fee. The transformers are now in trouble. The CDS outstanding today is notionally valued at $47 trillion and monolines, although with an asset base of around $2 trillion, have a thin capital base. The largest one in this sector faces a reported a risk of default and has had to cut dividends to retain its triple A rating. The second largest has almost had a similar experience. Several hundreds of billions will be needed to help these ailing insurance companies regain triple A ratings. Other investors will also lose on the write-downs on the value of securities guaranteed by the insurance companies if they are unable to regain their previous status.

The auction rate securities market, a $300 billion slice of the municipal bond market, has more or less collapsed recently. The venerable Port Authority of New York had to pay an unbelievable 20 per cent raising funds in this market. The commercial paper (CP) market of $1.87 trillion is contaminated to a large extent, as a large part of their housing-based assets has become unmarketable. The stock values of many important home lenders are now quoting huge discounts.

Banks own around $800 billion mortgage-related securities guaranteed by bond insurers. Bailing out these insurers will cost the banks around $150 billion. There are about 3,000 hedge funds with an asset value of about $2 trillion. They take a hit as actual investors in the mortgage markets and stand to lose both in the mortgage and the CDS markets because of the disappearance of counter-parties. The CP, money market funds (MMFs) and the consumer debt (credit card) sectors have also become tainted because of their holdings, often unauthorized, of the mortgage market securities.

The disturbance in the subprimes caused a major disturbance in the banking system. Anything that was ‘structured’ is now being shunned by the markets leading to the back-stop providers, typically banks, ballooning their balance sheets. As a result, banks have become wary of extending new credit at the margin. With major inventory of leveraged loans being marooned on bank balance sheets, residual exposures of collateralized debt obligations (CDOs) — an instrument first developed by an obscure firm called Norma Inc. — have caused the banks to take huge writedowns. Exposures that were guaranteed by the monoline insurers were determined to be largely worthless.

Banks have multiple ties with the mortgage markets. They are a direct investor in the mortgage market. These appear in their balance sheets as level 3 assets, valued according to their own models. They have ties with them through their special investment vehicles (SIV) entities they control indirectly as a part of the shadow financial system of money market funds, hedge funds and investment banks. The SIVs obviate the need for banks to have a regulatory capital charge for the liabilities in terms of the Basel convention requirements for their capital adequacy ratios. Structured securities often provided ‘independent’, and often fictitious, funds and kept out of the bank regulators’ range of vision. With losses that the SIVs have incurred on mortgage-related assets, banks have had to absorb them into their balance sheets, to pre-empt SIV investors from withdrawing their investments. The red ink will go deeper and farther since there are no complete disclosures on this score.

The global write-downs of mortgage-related assets of banks have already been significant. The United Kingdom’s Northern Rock has had to be nationalized. Globally, a swathe of banks — British, Swiss, German, French, Japanese, Middle Eastern and even Chinese — have been seriously affected. Their disclosure on the mortgage market exposure will come slowly, over a long time.

The capital of one of the largest US banks is $128 billion, its level 3 assets $135 billion. All Wall Street US investment banks, specially the larger ones, have a significantly high level of level 3 assets in relation to their capital. Any erosion of these assets would have a serious effect on their capital; in some cases, their very existence. For the commercial banks, write-offs have to be matched by replenished capital for the banks to remain within the Basel agreement. For investment banks, the erosion of level 3 assets will lead to a lowering of their credit quality and will have the effect of widening spreads on their borrowing. If level 1 and 2 assets become level 3 in a falling securities market, it will make matters worse.

The US’s current account requirements are around $3 billion a day, which it meets by paying in its own currency. With the weakening of the dollar following a steady exit of funds to other currencies, the US dollar is on the way to losing its seigniorage as the sole reserve currency and the economic hegemony it implies.

The following is an estimate of loss, tentative and ballpark since the scenerio is evolving. Among the important sectors are housing — $1.6 trillion at 8 per cent decline of the housing prices according to the Case-Shiller/S&P index. This market is in the worst recession since the Great Depression. According to Roubini of RGE Monitor, prices will eventually fall, relative to 2006, by 20 to 30 per cent; the mortgage market, reported $3.2 trillion, conservatively, $0.3 trillion; insurance, $0.2 trillion; banks, 0.3 to 0.5 trillion; a total, conservatively, around $2.6 trillion, representing an alarming loss of about 20 per cent of the $14 trillion 2007 US gross domestic product.

When tangible losses in the sectors chained together emerge, a significant part of the GDP will have been swallowed up, impacting on the already saving-less and debt-burdened consumers, who will suffer the effects of the seized-up credit estimated currently at $2 trillion. With the credit crunch, banks are crippled: largely unwilling and unable to extend credit as before. The credit crunch will eventually cause a large number of defaults and failures among corporations and the broker-dealers. Meanwhile, the shadow banking system has pretty much shut down. Contraction of consumption, 70 per cent of the GDP, will occur, leading to deeper recession. The resulting recession will lead to US and global stock market declines.

A global spread of the crisis is inevitable, both through trade and importantly through the complex web of financial links among nations. Much will depend on China, if it can remain de-coupled when the crisis has spread.

The policy response of the Bush administration to the crisis has been two-pronged. First, fiscal relief of one per cent of the GDP translating into $140 billion. Second, extension of mortgage payments by a month. On the face of it, they remain hugely insufficient for a crisis of this order.

The Federal Reserve money support to banks , jointly with a few other central banks, has so far totalled around $300 billion. This apart, the Fed has brought down interest rates from 5.25 to 3 per cent per annum (225 basis points) from September 2007 to date. Further cuts have been promised.

The benefit of a cheaper rate will be restricted only to banks who have the use of the discount window. Even then, though the short-term rate has declined, long-term rates have gone up expecting inflation. It will help debt-service, and may not create fresh debts, as banks remain strapped for liquidity. It is also more than likely, a cheap Fed rate will not help loosen the current knots in the bond and derivative markets. On the other hand, there is a real risk that, at the inflation rate ahead of the bank rate, hyper-inflation will follow. Finally, there is the threat of a liquidity trap which Japan has experienced over the last 17 years or so after the bursting of its own real estate bubble, where, at almost zero rates, growth has not materialized.

If excess liquidity has fathered this crisis, a fair share of blame must be apportioned to the sharpening of globalization since 1990, with attendant free movement of capital across the globe. Unless globalization is halted and the world returns to a Bretton Woods type of order putting up partitions around various nations’ trade and capital movements and putting the US in an isolation ward preventing contagion, the situation can only worsen. This will no doubt go against the grain of TINA, there is no alternative to globalization. But now that we are about to face perhaps the greatest and longest financial crisis of all time — its roots in excess liquidity, thanks largely to globalization — the suggestion to reverse globalization, needs urgently to be considered.

[Steve Gardner]

Basically, this article argues that the economic data we see has been manipulated out of sight in order to make sure we - the general public - have no clue how bad things really are.

Here's a summary of some of the key deceptions the article highlights.

Under John Kennedy, out-of-work Americans who had stopped looking for jobs — even if this was because none could be found — were labeled "discouraged workers" and then excluded from the ranks of the unemployed.

Lyndon Johnson orchestrated a "unified budget" that combined Social Security with the rest of the federal outlays. This innovation allowed the surplus receipts in Social Security to mask the emerging federal deficit.

Richard Nixon created a division between "core" inflation and headline inflation. If the Consumer Price Index was calculated by tracking a bundle of prices, so-called core inflation would simply exclude, because of "volatility," categories that happened to be troublesome (and thus in the "headlines"). At that time, it was food and energy (as it is now).

Under Ronald Reagan, the Bureau of Labor Statistics decided that housing was overstating the Consumer Price Index and substituted an entirely different "Owner Equivalent Rent" measurement, based on what a homeowner might get for renting his house. This methodology, controversial at the time but still used, sidestepped what was happening in the real world of homeowner costs. Some say that led to the mortgage crisis today.

Under the first President Bush, officials moved to reorient U.S. economic statistical measure away from old industrial-era methodologies toward the emerging services economy and the expanding retail and financial sectors. Skeptics said the underlying goal was to reduce the inflation rate in order to reduce federal payments — from interest on the national debt to cost-of-living outlays for government employees, retirees and Social Security recipients.

Under President Clinton, the convoluted CPI changes proposed under Bush were implemented. And the Clintonites tinkered with the unemployment number, in part, by changing its housing economic sampling, disproportionately eliminating inner city households. That is believed to have reduced black unemployment estimates and eased worsening poverty figures.

Source: tampabay.com

Ever since the 1960s, Washington has gulled its citizens and creditors by debasing official statistics, the vital instruments with which the vigor and muscle of the American economy are measured.

The effect has been to create a false sense of economic achievement and rectitude, allowing us to maintain artificially low interest rates, massive government borrowing, and a dangerous reliance on mortgage and financial debt even as real economic growth has been slower than claimed.

The corruption has tainted the very measures that most shape public perception of the economy:

• The monthly Consumer Price Index (CPI), which serves as the chief bellwether of inflation;

• The quarterly Gross Domestic Product (GDP), which tracks the U.S. economy's overall growth;

• The monthly unemployment figure, which for the general public is perhaps the most vivid indicator of economic health or infirmity.

Not only do governments, businesses and individuals use these yardsticks in their decisionmaking, but minor revisions in the data can mean major changes in household circumstances — inflation measurements help determine interest rates, federal interest payments on the national debt, and cost-of-living increases for wages, pensions and Social Security benefits.

And, of course, our statistics have political consequences too. An administration is helped when it can mouth banalities about price levels being "anchored" as food and energy costs begin to soar.

The truth, though it would not exactly set Americans free, would at least open a window to wider economic and political understanding. Readers should ask themselves how much angrier the electorate might be if the media, over the past five years, had been citing 8 percent unemployment (instead of 5 percent), 5 percent inflation (instead of 2 percent), and average annual growth in the 1 percent range (instead of the 3-4 percent range).

Let me stipulate: The deception arose gradually, at no stage stemming from any concerted or cynical scheme. There was no grand conspiracy, just accumulating opportunisms.

The political blame for the slow, piecemeal distortion is bipartisan — both Democratic and Republican administrations had a hand in the abetting of political dishonesty, reckless debt and a casino-like financial sector. To see how, we must revisit 40 years of economic and statistical dissembling.

Pollyanna Creep

"Pollyanna Creep" is an apt phrase that originated with John Williams, a California-based economic analyst and statistician who "shadows," as he puts it, the official Washington numbers. In a 2006 interview, Williams noted that although few Americans ever see the fine print, the government "always footnotes the changes and provides all the fine detail. Nonetheless, some of the changes are nothing short of remarkable, and the pattern over time is what I call Pollyanna Creep."

Williams is one of the small group of economists and analysts who have paid any attention to the phenomenon. A few have pointed out the understatement of the Consumer Price Index — the billionaire bond manager Bill Gross has described it as an "haute con job." In 2003, a University of Chicago economist named Austan Goolsbee (now a senior economic adviser to Barack Obama's presidential campaign) published an op-ed in the New York Times pointing out how the government had minimized the depth of the 2001-2002 U.S. recession, having "cooked the books" to misstate and minimize the unemployment numbers.

Unfortunately, the critics have tended to train their axes on a single abuse, missing the broad forest of statistical misinformation that has grown up over the past four decades.

The story starts after the inauguration of John F. Kennedy in 1961, when high jobless numbers marred the image of Camelot-on-the-Potomac and the new administration appointed a committee to weigh changes. The result, implemented a few years later, 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, where many, if not most, of them had been previously classified.

By the 1969 fiscal year, Lyndon Johnson orchestrated a "unified budget" that combined Social Security with the rest of the federal outlays. This innovation allowed the surplus receipts in the former to mask the emerging deficit in the latter.

Richard Nixon, besides continuing the unified budget, developed his own taste for statistical improvement. He asked his second Federal Reserve chairman, Arthur Burns, to develop what became an ultimately famous division between "core" inflation and headline inflation. If the Consumer Price Index was calculated by tracking a bundle of prices, so-called core inflation would simply exclude, because of "volatility," categories that happened to be troublesome: at that time, food and energy.

Core inflation could be spotlighted when the headline number was embarrassing, as it was in 1973 and 1974. (The economic commentator Barry Ritholtz has joked that core inflation is better called "inflation ex-inflation" — i.e., inflation after the inflation has been excluded.)

In 1983, under the Reagan administration, inflation was further finagled when the Bureau of Labor Statistics (BLS) decided that housing, too, was overstating the Consumer Price Index; the BLS substituted an entirely different "Owner Equivalent Rent" measurement, based on what a homeowner might get for renting his or her house. This methodology, controversial at the time but still in place today, simply sidestepped what was happening in the real world of homeowner costs.

Because low inflation encourages low interest rates, which in turn make it much easier to borrow money, the BLS's decision no doubt encouraged, during the late 1980s, the large and often speculative expansion in private debt — much of which involved real estate, and some of which went spectacularly bad between 1989 and 1992 in the savings-and-loan, real estate and junk-bond scandals.

The distortional inclinations of the next president, George H.W. Bush, came into focus in 1990, when Michael Boskin, the chairman of his Council of Economic Advisers, proposed to reorient U.S. economic statistics principally to reduce the measured rate of inflation. His stated grand ambition was to move the calculus away from old industrial-era methodologies toward the emerging services economy and the expanding retail and financial sectors. Skeptics, however, countered that the underlying goal, driven by worry over federal budget deficits, was to reduce the inflation rate in order to reduce federal payments — from interest on the national debt to cost-of-living outlays for government employees, retirees, and Social Security recipients.

Hidden unemployed

It was left to the Clinton administration to implement these convoluted CPI measurements, which were reiterated in 1996 through a commission headed by Boskin and promoted by Federal Reserve Chairman Alan Greenspan.

The Clintonites also extended the Pollyanna Creep of the nation's employment figures. In 1994, the Bureau of Labor Statistics redefined the work force to include only that small percentage of "discouraged workers" who had been seeking work for less than a year. The longer-term discouraged — some 4-million U.S. adults — fell out of the main monthly tally. Some now call them the "hidden unemployed."

For its last four years, the Clinton administration also thinned the monthly household economic sampling by one sixth, from 60,000 to 50,000, and a disproportionate number of the dropped households were in the inner cities; the reduced sample (and a new adjustment formula) is believed to have reduced black unemployment estimates and eased worsening poverty figures.

Despite the present Bush administration's overall penchant for manipulating data (e.g., Iraq, climate change), it has yet to match its predecessor in economic revisions. In 2002, the administration did introduce an "experimental" new CPI calculation (the C-CPI-U), which shaved another 0.3 percent off the official CPI; and since 2006 it has stopped publishing the M-3 money supply numbers, which captured rising inflationary impetus from bank credit activity.

After 40 years of manipulation, more than a few measurements of the U.S. economy have been distorted beyond recognition.

Untruth in labeling

Last year, the word "opacity," hitherto reserved for Scrabble games, became a mainstay of the financial press. A credit market panic had been triggered by something called collateralized debt obligations (CDOs), which in some cases were too complicated to be fathomed even by experts. The packagers and marketers of CDOs were forced to acknowledge that their hypertechnical securities were fraught with "opacity" — a convenient and legally judgment-free word for lack of honest labeling.

Exotic derivative instruments with alphabet-soup initials command notional values in the hundreds of trillions of dollars, but nobody knows what they are really worth. Some days, half of the trades on major stock exchanges come from so-called black boxes programmed with everything from binomial trees to algorithms; most federal securities regulators couldn't explain them, much less monitor them.

Transparency is the hallmark of democracy, but we now find ourselves with economic statistics every bit as opaque — and as vulnerable to double-dealing — as a subprime CDO.

Of the "big three" statistics, let us start with unemployment. Most of the people tired of looking for work, as mentioned above, are no longer counted in the work force, though they do still show up in one of the auxiliary unemployment numbers.

The BLS has six different regular jobless measurements — U-1, U-2, U-3 (the one routinely cited), U-4, U-5, and U-6. In January 2008, the U-4 to U-6 series produced unemployment numbers ranging from 5.2 percent to 9.0 percent, all above the "official" number.

The series nearest to real-world conditions is, not surprisingly, the highest: U-6, which includes part-timers looking for full-time employment as well as other members of the "marginally attached," a new catchall meaning those not looking for a job but who say they want one. Yet this does not even include the Americans who (as Austan Goolsbee put it) have been "bought off the unemployment rolls" by government programs such as Social Security disability.

Second is the Gross Domestic Product, which in itself represents something of a fudge: Federal economists used the Gross National Product until 1991, when rising U.S. international debt costs made the narrower GDP assessment more palatable. The GDP has been subject to many further fiddles, the most manipulatable of which are the adjustments made for the presumed starting up and ending of businesses (the "birth/death of businesses" equation) and the amounts that the Bureau of Economic Analysis "imputes" to nationwide personal income data (known as phantom income boosters, or imputations; for example, the imputed income from living in one's own home, or the benefit one receives from a free checking account, or the value of employer-paid health- and life-insurance premiums).

During 2007, imputed income accounted for some 15 percent of GDP. John Williams, the economic statistician, is briskly contemptuous of GDP numbers over the past quarter century. "Upward growth biases built into GDP modeling since the early 1980s have rendered this important series nearly worthless," he wrote in 2004. "(T)he recessions of 1990/1991 and 2001 were much longer and deeper than currently reported (and) lesser downturns in 1986 and 1995 were missed completely."

Nothing, however, can match the tortured evolution of the third key number, the somewhat misnamed Consumer Price Index. Government economists themselves admit that the revisions during the Clinton years worked to reduce the current inflation figures by more than a percentage point, but the overall distortion has been considerably more severe. Just the 1983 manipulation, which substituted "owner equivalent rent" for home-ownership costs, served to understate or reduce inflation during the recent housing boom by 3 to 4 percentage points.

Moreover, since the 1990s, the CPI has been subjected to three other adjustments, all downward and all dubious: product substitution (if flank steak gets too expensive, people are assumed to shift to hamburger, but nobody is assumed to move up to filet mignon), geometric weighting (goods and services in which costs are rising most rapidly get a lower weighting for a presumed reduction in consumption), and, most bizarrely, hedonic adjustment, an unusual computation by which additional quality is attributed to a product or service.

The hedonic adjustment, in particular, is as hard to estimate as it is to take seriously. No small part of the condemnation must lie in the timing.

If quality improvements are to be counted, that count should have begun in the 1950s and 1960s, when such products and services as air-conditioning, air travel, and automatic transmissions — and these are just the A's! — improved consumer satisfaction to a comparable or greater degree than have more recent innovations. That the change was made only in the late '90s shrieks of politics and opportunism, not integrity of measurement.

Most of the time, hedonic adjustment is used to reduce the effective cost of goods, which in turn reduces the stated rate of inflation. "All in all," Williams points out, "if you were to peel back changes that were made in the CPI going back to the Carter years, you'd see that the CPI would now be 3.5 percent to 4 percent higher" — meaning that, because of lost CPI increases, Social Security checks would be 70 percent greater than they currently are.

Furthermore, when discussing price pressure, government officials invariably bring up "core" inflation, which excludes precisely the two categories — food and energy — now verging on another 1970s-style price surge.

Numbers that crunch

The real numbers, to most economically minded Americans, would be a face full of cold water. Based on the criteria in place a quarter century ago, today's U.S. unemployment rate is somewhere between 9 percent and 12 percent; the inflation rate is as high as 7 or even 10 percent; economic growth since the recession of 2001 has been mediocre, despite a huge surge in the wealth and incomes of the superrich, and we are falling back into recession.

If what we have been sold in recent years has been delusional "Pollyanna Creep," what we really need today is a picture of our economy ex-distortion. For what it would reveal is a nation in deep difficulty not just domestically but globally.

Undermeasurement of inflation, in particular, hangs over our heads like a guillotine. To acknowledge it would send interest rates climbing, and thereby would endanger the viability of the massive buildup of public and private debt (from less than $11-trillion in 1987 to $49-trillion last year) that props up the American economy. Moreover, the rising cost of pensions, benefits, borrowing, and interest payments — all indexed or related to inflation — could join with the cost of financial bailouts to overwhelm the federal budget.

Arguably, the unraveling has already begun. As Robert Hardaway, a University of Denver professor, pointed out last fall, the subprime lending crisis "can be directly traced back to the (1983) BLS decision to exclude the price of housing from the CPI. … With the illusion of low inflation inducing lenders to offer 6 percent loans, not only has speculation run rampant on the expectations of ever-rising home prices, but home buyers by the millions have been tricked into buying homes even though they only qualified for the teaser rates."

Were mainstream interest rates to jump into the 7 to 9 percent range — which could happen if inflation were to spur new concern — both Washington and Wall Street would be walking in quicksand. The make-believe economy of the past two decades, with its asset bubbles, massive borrowing, and rampant data distortion, would be in serious jeopardy.

The credit markets are fearful, and the financial markets are nervous. If gloom continues, our humbugged nation may truly regret losing sight of history, risk and common sense.