Although it is standard procedure for governments to soothe their citizenry with placebo politics in order to avoid panic and uprising, there is a line after which such a campaign is counterproductive. In fact, misleading statements about financial security are potentially dangerous to the country’s long-term economic wellbeing, and potentially toxic to investors.

Economic and financial statistics are the battleground over which the war of perception is fought. But as the saying goes: “Figures lie, and liars figure.”Politicians are masters of the selected use of statistics to lend credibility to their statements. In reality, the numbers often mask the truth.

A year ago, financial markets hovered near nominal highs, retail sales appeared to be growing and real estate prices were near historic highs. Wall Street and Washington made the most of these “over-the-top” numbers to foster a sense of economic invincibility. With the national gaze lifted towards sunny skies, few noticed the danger of the mortgage crisis, which lay below like a tiger trap.

But like watching a poorly dubbed martial arts film, the average American is beginning to notice that the dialogue does not match the on-screen action. As a result, many people are developing a deep suspicion of statistics, which over time will greatly diminish the government’s credibility. In the coming economic crisis, this loss of credibility may have severe consequences.

One vital statistic in the perception battle is gross domestic product (GDP), which is the total of all spending on goods and services within our economy, and is used as the key measure of national wealth generation and economic growth. It may be surprising to some, but GDP includes money spent on clearing up natural disasters such as hurricane relief and pollution control. How such expenditures – that really only replace what has been lost – increase national wealth, is beyond me.

Unemployment figures are another worry. Government adjustments for seasonal and population changes are acceptable. But excluding from the unemployment rolls those who are neither actively seeking jobs nor the “long-term” unemployed is not.

Perhaps, the greatest area of concern about statistical manipulation is the measurement of inflation, or Consumer Price Index (CPI). By manipulating this single statistic the government can miraculously transform rising prices into economic growth.

The Department of Labor has set so-called “core” inflation, excluding food and energy, at 2.2%. Even “headline” inflation, including food and energy, is published officially at only some 4%. The problem is that these figures bear very little relation to the reality of price increases experienced on Main Street, which some estimate to be in excess of 10%.

Statisticians assign different weights to the elements comprising the CPI that are often not reflective of the spending habits of ordinary citizens. For example, housing maintenance (including heating oil), a major expenditure, is given only a small part in the Index’s makeup. In addition, the re-pricing of items such as automobiles to allow for added “hedonistic” features such as enhanced “value for money” is wide open to varying judgments. How these statistical decisions are made is really anyone’s guess. But it is absurd to assume that the government’s overwhelming interest in reporting low inflation does not influence the final numbers.

The financial consequences for investors can be severe. For example, the Dow Jones Industrial Average Index, against which many investment returns are measured, closed at a nominal high of 14,093 on Oct. 12, 2007. The media reported it as a sign of good things to come. On May 23, 2008, the Dow closed at 12,480 – off a bit, but apparently not too bad. But if that day’s close is adjusted for the official CPI, then it’s not worth 12,480, but only 9,856 when compared with its previous market cycle high, of 11,723, in the year 2000.

Worse still, if adjusted for the more likely but still conservative inflation rate of 8%, the recent close of 12,480 becomes the equivalent of only 6,742 in the year 2000. What looks like a nominal gain of some 757 points or 6.4% is, in fact, a real loss of 4,981 points or some 42% over those eight years!

One set of statistics that is impossible to distort are currency exchange rates, which have provided a somber report card on America’s economic fortunes. Not able to manipulate these numbers, the authorities instead distort their meaning, and have attempted to convince Americans that a weak dollar is in the national interest.

Those wise enough to ignore the spin, and see the falling dollar for what it is, namely a loss of wealth, have invested in good companies listed on the stock exchanges of producer nations, such as Australia, Canada and Switzerland – all countries with appreciating currencies. Such moves have greatly enhanced wealth and protected those investors against further dollar erosion.
[Editor’s Note: John Browne is the senior market advisor for Euro Pacific Capital Inc. For a more-detailed analysis of the nation’s financial problems, and the inherent dangers that these problems pose for both the U.S. economy and for dollar-denominated investments, click here to download Euro Pacific’s new financial-research report, “The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities.” The report is free of charge. Peter D. Schiff, Euro Pacific’s president and chief global strategist, is a regular contributor to Money Morning, and most recently wrote about the oil crisis and China’s growing consumer class in his most recent Money Morning column.]

Source: The Statistical Battleground

Buenos Aires, Argentina May 30, 2008

*** Four months ago China was brought to its knees in the face of the most ferocious meteor of the last 50 years, succumbing to its vulnerability to the uncontrollable and unmanageable force of nature. Today those knees have been literally broken after another dramatic and uncontrollable event for China: a devastating earthquake in Sichuan province, in the South West that killed and buried more than 56,000 people (and that number is rising every day…), injured 300,000 and 30,000 are still missing.

China normally enjoys a position of worldwide domination and control when it comes to internal policies that silence their opponents, and the development of an economy that exports deflation, and in protecting its industry and monetary competitiveness. However, in the face of these natural disasters, China find it can do little more than kneel and beg for aid from the very world it attempts to dominate whenever possible.

Chinese agriculture has once again been adversely affected in Sichuan as well as in other zones of disaster in the last few months. 34,000 hectares of farmland and irrigation systems have been destroyed in some areas: ““up to 100,000 hectares of rice paddies might have to be used to grow alternative crops”, the China Daily reported. Additionally, farming machinery and facilities have been damaged and 12.5 million head of poultry and livestock has been killed….

As the country’s leading agricultural province, Sichuan provides 6% of the nation’s total grain output which includes 5% of the national total summer grain production, 8% of the total vegetable oil crops and 5% percent of the total vegetable production, said Wei Chao’an, Vice Agriculture Minister, speaking to the China Daily.

China food inflation surged to 22% in April. Through enacting price controls in areas hit by these disasters, the government is trying to cap inflation, that came in at 8.5% for April.

It is important to note that China has also been imposing agricultural export restrictions, increasing tariffs and imposing export quotas after inflation skyrocketed to its highest level in 12 years during February while at the same time 40% of the country’s inflation comes from the international price increases, according to Chinese economists.

It is like trying to extinguish a fire using a bucket of gasoline.

Also, China continues to import products that keep rising in price, from food to energy. We must remain aware that oil and corn are part of our everyday life in the form of plastics to toothpaste.

On the other hand, China is net exporter of agricultural products, which means that higher export restrictions will actually create the opposite effect to what they are trying to avoid in the process – that being it will bring about inflation. In restricting the international food supply they are generating a greater increase in international prices.

China has also increased subsidies to farmers in hopes they will raise more pork and cultivate more grains. Ultimately these measures do little more than to create relative price distortions while at the same time they discourage farmers from producing more of the same.

As quoted in the China Daily, Qi Jingmei, a senior economist at the State Information Center, noted that “The Chinese market is linked to the global market by thousands of threads. You can’t cut them off completely”.

As the country is imposing restrictions to food exports, it is opening its state food reserves of wheat, rice and pork in a move to contain inflation. Huang Jikun, of the Chinese Agricultural Policy Center noted that: “The potential for prices to go up may well rise in future, because you can’t always tap the grain reserves.”

These reserves could in turn run out in a few months, especially if the farmers decide to turn to the production of more profitable commodities in the face of depressed domestic prices. And if you combine this scenario with a policy of export restrictions an explosive cocktail could be generated when the world finds out that China is returning to participate actively in the world-wide grain purchase.