The Trouble With Shadowstats

Often, when I talk about inflation being low, people who disagree tend to cite John Williams’ Shadowstats as evidence that price inflation is not low at all.

Now, I don’t disagree with the idea that some people have experienced a higher level of price inflation than the CPI. Everyone experiences a different rate of inflation based on their purchasing habits, so by definition everyone’s individual rate will diverge from the official rate to some degree; some will be higher, and some will be lower. And I don’t disagree that rising food and fuel prices have been a problem for welfare recipients and seniors on a fixed income, etc, who spend a higher proportion of their income on food and fuel than, say, young professionals with a lot of disposable income.

What I do disagree with is bad statistical methodology. Shadowstats is built on the belief that the Bureau of Labor Statistics changed their methodology in the 1980s and 1990s, and that if we were using their original methodology the level of inflation would be much higher. Shadowstats presents what they claim to be the original methodology. But Shadowstats is not calculating inflation any differently.They are not using the 1980s or 1990s methodology that they believe would be higher.  All Shadowstats is doing is taking the CPI data and adding on an arbitrary constant to make it look like inflation is higher!

This should be obvious from their data, which has the exact same curve as the CPI data at a higher level:

alt-cpi-home2 (1)

In fact, according to James Hamilton of Econbrowser, John Williams admitted in 2008 that his numbers are just inflated CPI data:

Last month I called attention to an analysis by BLS researchers John Greenlees and Robert McClelland of some of the claims by John Williams of Shadowstats about the consequences for reported inflation of assorted technical decisions made by the BLS. Williams asked me to update with a link to his response to the BLS study. I am happy to do so, along with offering some further observations of my own.

You can follow the link to Shadowstats’ response to Greenlees and McClelland and judge for yourself, but my impression is that the response is more philosophical than quantitative. In a separate phone conversation, Williams further clarified the Shadowstats methodology. Here’s what John said to me: “I’m not going back and recalculating the CPI. All I’m doing is going back to the government’s estimates of what the effect would be and using that as an ad factor to the reported statistics.”

Price changes and inflation are important topics, and constructing alternate measures of inflation is a worthwhile activity. Researchers at MIT have tried to do this with their Billion Prices Project, which measures price trends across a much, much larger range of products and locations than CPI:


What the Billion Prices Project implies for Shadowstats is that the CPI is roughly correct, and there is no vast divergence between real-world price trends and the CPI number. Of course, maybe the 1980s and 1990s methodology would be different from the current numbers. It would be very interesting to compare the current CPI methodology with the older CPI methodologies and with the BPP data! But assessing this empirically would require someone to mine through the raw CPI data since the 1980s and recalculate the outputs with the real earlier methodology — a far longer, more difficult and sophisticated process than taking the CPI outputs and adding an arbitrary constant!


The Real 2013 Cliff

There’s a much bigger cliff than the so-called fiscal cliff. The absolute worst result of the fiscal cliff would be a moderate uniform tax increase at a bad time, resulting in a moderate contraction. It is an obvious — but ultimately rather cosmetic — stumbling block on the so-called “road to recovery”.

The much bigger cliff stems from the fact that the so-called recovery itself is built on nothing but sand. This is a result of underlying systemic fragilities that have never been allowed to break. I have spent the last year and a half writing about this graph — the total debt in the economy as a proportion of the economy’s output:

This is the bubble that won’t go away. This is the zombified mess that the Federal Reserve won’t let dissolve (as happened regularly in the 19th century and early 20th century each time there was an unsustainable debt bubble). This is the shifting sand — preserved by the massive monetary stimulus programs — that the so-called recovery is built upon. During the 1980s and 1990s and 2000s cheap money pumped up the debt level in America. In 2008, the bubble burst, and the hyper-connective fragile financial system was set to burn. Then central banks around the world stepped in to “stabilise” (or as Nassim Taleb puts it, overstabilise) the financial system. The unsustainable reality of debt vastly exceeding income was put on life support.

A high pre-existing residual debt level makes growth challenging, as consumers and producers remain focussed on paying down the pre-existing debt load, they are drained by pre-existing debt service costs, and they are wary about taking on debt or investing in a weak and depressed environment. It’s a classic Catch-22. The only true panacea for the depression is growth, but the economy cannot grow because it is depressed and zombified. That’s where a crash comes in — the junk is liquidated, clearing the field for new growth. That is what Schumpeter meant when he talked of “the work of depressions”, something that many mainstream economists still fail to grasp. (In fairness, a similar effect can probably be achieved without a depression through a very large scale debt relief program.)

Japan has been stuck in a deleveraging trap for twenty years, to no avail, all that has really occurred is that the private debt load has been transferred onto the central bank balance sheet — there has been very little net deleveraging) and while the Japanese central bank has completed round after round of quantitative easing — sustaining and preserving the past malinvestment and high debt load — the Japanese economy is still depressed.


That is the road America and most of the West are now on. And just as Japan’s bank stocks did multiple times even after the Japanese housing bubble burst, American banking stocks — even in spite of a year of fraud, abuse, mismanagement and uber-fragility — have been shooting up, up, up and away:


The zombie financial sector is the real cliff — as interconnective as ever, as corrupt as ever, and most importantly, nearly as leveraged as ever:

Margin Debt November 2012

This is a reinflated bubble built on foundations of sand. I don’t know which straw will break the illusion (middle eastern war? Hostility between China and Japan? Chinese real estate and subprime meltdown? Student debt? Eurozone? Natural disasters? Who knows…) but this bubble poses a far greater threat in 2013 than the fiscal shenanigans and the Boehner-Obama “Boner-Droner” snoozefest.