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Lies, Damn Lies, and Government Statistics
When the US dollar was totally based upon gold, and before the Federal Reserve existed, inflation basically was tied to the supply of gold. When new gold was found and came into play, inflation occurred; when gold reserves were down, deflation occurred. You can find some interesting articles in older, economic magazines about gold and inflation.
However, this relationship started to change partially when the Federal Reserve System* was born in 1913 (by the way, the federal income tax was also born in 1913) and then massively when Nixon took us off the gold standard in 1971. These actions provided the ability to create inflation at will.
When the government needs money it goes to the treasury and says, “We want $10 million dollars.” This was in the old days when $10 million amounted to something. The treasury would say, “You’ve spent all the tax revenues, so we can’t give you any more.” The government would then go to another door—that of the Federal Reserve and ask for the money. The Fed would say, “Sure.” It can write a check for money that didn’t exist previously. The government would then deposit the check in a bank (probably one that owns the Federal Reserve) and the bank then had the ability to loan out $100 million to their customers. And where did that money come from? The Federal Reserve just printed it. This, of course, would be very illegal if you and I did it. However, the big banks, through the Federal Reserve, could print money out of thin air. Not only that, but they could charge interest on it. That’s right, banks could charge interest on money that didn’t exist before and was printed out of thin air by an agency that they owned. This process essentially levied a tax on everyone else. It was a silent tax called inflation.
My mom was born in 1904 and told me that when she first went to the movies, it cost 5 cents. I can remember going to the movies in the 1950s and I got to see two movies, plus a cartoon in the middle, for 50 cents. Today, the price to see one movie is about $15.
In the late 1950s, I paid 15 cents for a hamburger. When I visited the UN building, I was horrified to discover that hamburgers cost $1. Today, my 15 cent hamburger can range from $2.50 to $15, depending upon where it is purchased. Do you see a trend here? It is all thanks to the tax created by the Federal Reserve called inflation.
Now, this opened up a great business for the government. Politicians could promise people anything they wanted in order to get elected. To pay for their promises, they just had to go to the Federal Reserve, who would write a check to the government and create the money out of thin air. Then, the banks that owned the Fed could loan about ten times the money that was deposited, and charge you interest on the money that was created out of thin air.
Because money was still backed by gold for the first half century of the Fed’s existence, there seemed to be some constraint over the money creation process. Around 1970, however, countries were redeeming more and more Federal Reserve Notes for gold and the US gold supply was shrinking. Thus, Nixon ended the gold standard for the US dollar in 1971.
Then we pulled something really amazing out of the hat. We got the rest of the world to treat our paper money, which the Federal Reserve could print at will, as the world’s reserve currency. It basically meant that we could spend at will and other countries would fund that spending. However, social security also funds the spending at will because the social security administration uses your social security taxes to buy up the debt created from thin air. When the Fed writes a check for money that didn’t exist, it creates a debt and the government uses your social security money (among many sources) to buy it.
I can remember when the U.S. debt first hit a trillion dollars in the 1980’s. The curve on a graph of the debt looked asymptotic and I thought then, “It has to end.” But that’s a little like Yellowstone National Park. Yellowstone is a huge volcano. It erupts about every 600,000 years and when it does, it destroys everything in North American. When was the last time it erupted? About 640,000 years ago. That makes it 40,000 years overdue to explode and wipe us out, but who knows? It might not happen for another 50,000 years or it might happen tomorrow.
Well that’s the same story with our debt. Officially, it is now about $16.4 trillion and if you include unfunded future liabilities such as social security and Medicaid, then it is about $100 trillion (depending on whose estimates you look at). Just like Yellowstone will one day destroy North America, the US Debt will one day destroy the United States. And I can guarantee that it will happen within the next 23 years -- not the next 50,000. Right now the official debt is 105% of the US GDP, according to the US Debt clock (www.usdebtclock.org).
Now, until all of this explodes, the US has to do several things to keep the game going because it has made promises to protect you from the inflation it has caused. For example, funding for entitlement programs such as social security (which is bankrupt and another promise with no good faith backing) are tied to inflation. The government measures inflation and then has to increase SS payments by its own measurement.
Therefore, wouldn’t it make sense for a government that is hopelessly in debt to figure out some way to lie to you about inflation? Yes it would and yes it does. Enter the Consumer Price Index.
The government uses a cost of living benchmark called the Consumer Price Index (CPI). The Bureau of Labor Statistics (BLS) produces the statistic and says simply that the CPI “is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
Aspects of the CPI began in the mid-1880s when the Bureau of Labor was asked to estimate the impact of new tariffs on prices. In those days the government got its money from tariffs, not income taxes. The government officially started tracking inflation in 1919 and has regularly published it since 1921. However, it wasn’t used that much until after World War II.
So let’s look at what’s happened to the CPI over time. The following graph shows the CPI from 1913 through 2006. Incidentally, it started in 1919, but the Federal Reserve system started in 1913 so that’s probably why they go back that far.
Notice how smooth and predictable it has been since 1980 which very little fluctuation in the annual amount of change. Also notice how the CPI just took off in the mid-1970s after Nixon ended the gold standard. And at the same time, he thought that the climbing CPI reflected poorly on his presidency. As a result, he turned to the Federal Reserve (interesting the role that the Fed has in all of this mess) and asked chairman Arthur Burns to find a lower measure of inflation.
And suddenly “Core Inflation” was born. Basically, the old CPI calculation was stripped of two of the biggest burdens on Americans—food and energy. But when you see your groceries and gas prices go up, you are typically not that fooled by the low core inflation rate. How long did it take for gasoline to go from $1 per gallon to $4? And that didn’t show up in the CPI at all.
During Ronald Reagan’s presidency, housing prices were going up rapidly. As a result, the BLS in 1983 decided how much rent would be on a house (if it were rented) and used that as a measure of housing prices. So when real estate prices surged in the 1980s and the 1990s, they were vastly underestimated in the CPI.
Shortly after the Clinton administration took over, the government was allowed to start using a variable basket of goods. For example, if steak got too expensive, it could substitute hamburger. In addition, straight arithmetic weighting of the CPI components was shifted to geometric weighting. And everyone thinks, “How wonderful the Clinton administration was in controlling the economy” . . . but that’s another story.
Many of you know that I frequently cite for you John Williams’ Shadowstat statistics for the CPI and his measure of GNP growth (which subtracts the CPI) to determine whether or not we are in a recession or not. Williams calculates the CPI based upon the way it was before Clinton (though not before Reagan and Nixon). And according to Williams the US has been in a recession since 2000 with the exception of one quarter in 2003—and that’s just by using pre-Clinton measures of the CPI which are higher by about 7%.
The CPI makes a big difference for a lot of people. 50 million social security recipients and many millions more of military and federal pensioners depend upon the CPI for increases to their monthly retirement checks to cover the more expensive cost of living. Numerous agreements in the private sector are all tied to the CPI changes. So the government lies about the CPI and the lies are becoming bigger and bigger.
Now, there is more to come. In the fiscal cliff negotiations, both parties were negotiating a new way to calculate CPI call the Chained CPI. The Chained CPI is a much more exaggerated form of goods substitution for when things go up too much.
Switching to the new Chained CPI would result in a savings to the government of about $150 billion by reducing costs of living estimates between 2014 and 2022. And since things like standard deductions and limits on retirement accounts that are linked to the CPI, these changes would also raise income tax revenues by about $62 billion.
I think it’s important that you are aware of the games being played. It is only a matter of time before the “Yellowstone” of government debt explodes and totally destroys the US economy. In my opinion, it’s only about $15 trillion overdue.
But remember that this crisis presents opportunity which every good trader will exploit. You cannot trade your vision of the future, you can only trade what is happening right now – and these markets don’t allow for buy and hold anymore. Isn’t it time that you become savvy enough to be able to trade these market conditions?
Perhaps a good New Year’s resolution is to prepare yourself to trade. We can help you. We suggest that you begin with The Peak Performance Home Study Course and the Peak 101 Workshop. Understand the powerful effects your personal psychology has on your trading. These effects can be magnified by a crisis, however, the proper training can transform your psychology into an important edge in the markets.
* For a very well documented history of the Federal Reserve, read The Creature from Jekyll Island by G. Edward Griffin.
About the Author: Trading coach and author Van K. Tharp, Ph.D. is widely recognized for his best-selling books and outstanding Peak Performance Home Study Program—a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.vantharp.com. His new book, Trading Beyond The Matrix, is expected for publication February 2013.
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Skill and Luck in Trading
My high school basketball team was a “middle of the district” team—out of eight schools in our league, we were clearly better than three, clearly worse than three and about even with one of the other schools.
Late in my senior year, we played a Christiansburg High team whom we should have beaten, but it was on their court and we didn’t play our best. With seconds to go, it was a tie game. Christiansburg’s best player took a shot that bounced off the rim and traveled fairly far from the basket, out to where the guards (smaller players like me) are usually positioned. I jumped, grabbed the rebound and was slammed by a Christiansburg player who was going after the rebound as well. The ref called the foul and I would shoot a “one and one”, meaning that if I made the first throw, I would get a chance to sink the second.
As I stepped to the line, I still remember an unusual clarity about what was going on around me—an added acuteness of the senses, if you will. Like every basketball player on the planet, I had life-long dreams of one day stepping to the free throw line to take the game winning shot. I had physically practiced this very scenario thousands of times and played it out in my head since I was a little boy tens of thousands of times more.
I went through my normal pre-shot routine and released the ball. As the ball went through the hoop hitting nothing but net, it made the familiar “swish” which was followed by a roar from the fans. With the game won and the pressure off now, the second shot was another swish though to be honest, I remember it less well.
So I had lived out my “little boy” dream of hitting the game winning shot! I believe that a game winning shot and a well-played trade in the markets hold some interesting similarities but some notable differences between the roles of luck and skill.
Luck vs. Skill
An interesting book published in the last few months has gotten some press lately for a couple of reasons. Number one, it is well written and gives some great insights into the nature of success. But more importantly, viewers saw the book in a Warren Buffet office tour he recently granted to CNNMoney. To watch the brief clip, you can watch it here: http://money.cnn.com/video/news/2012/12/26/n-warren-buffett-office-tour.cnnmoney/ (Actually, no one mentions the book in the interview but you can barely glimpse the cover under a remote control as the camera pans across Buffett’s desk. Such is the cache of Warren Buffet…!)
The name of the book? The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing by Michael J. Mauboussin. In it, the author writes about the fascinating roles of luck and skill in various activities. I was particularly intrigued by the distinctions that Mauboussin makes about the mix of those two factors in different fields of endeavor.
In certain areas, luck plays a small role while in others, it plays a large role. Where luck has a minor role (like in shooting free throws), cause and effect are closely related. Conversely, there is a looser causal relationship in areas where luck has a bigger part to play (weather forecasting, and yes, trading). In these latter areas (more affected by luck or outside chance occurrences), you can only distinguish skill over time or with a sufficiently large sample size.
Mauboussin also identifies a third category of activity: endeavors that are purely luck. This group would include activities like roulette or the lottery. He describes an easy test to distinguish this last group – skill is required if you can lose on purpose. I can clearly miss a free throw on purpose by shooting the ball 10 feet too short or aiming 90 degrees away from the bucket. But I can’t lose a coin flip on purpose not matter how hard I try (I’ll lose 50% of the time with a fair coin, just like everyone else).
For today, the main point that we can take away is that Van’s decades-long insistence on the importance of psychology in trading is clearly evident in Mauboussin’s work. Why? A horseshoe tossing champ doesn’t have to deal with many forms of uncertainty – his activity is very cause and effect oriented. But because traders and investors deal with uncertainty in every trade, our decision-making biases and processes can either make us or break us as traders!
From a trading and investing perspective, I find some of Mauboussin’s insights invaluable. We’ll dig in more next week and I look forward to sharing more of Mauboussin’s work with you in future articles.
Until then, I welcome your comments and feedback. Send them to drbarton “at” vantharp.com
Every day, Ken approaches the market as a craftsman, prepared to hone his craft and do the work of trading. Occasionally, he’s pleasantly surprised to earn a high R multiple but on most days, he makes a few modest trades. In this short video, Ken details his thoughts on the recent market action in preparation for Tuesday, January 8. The initial move out of the open was down so Ken went short using the leveraged VIX ETF – UVXY. Ken exited that short position after the market found support in the late morning, and then went long a little later using the leveraged Russell ETF – TNA. Each trade earned about one R for a “journeyman’s” day.
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