The US Economic Collapse Of 2019
Gold-Eagle’s Editor Note:
International market analyst Daan Joubert has ‘leaped’ into the future to 2020 with an aim to analyse the causes of the US Economic Collapse Of 2019. His objective is to help the reader prepare for the eventual economic collapse.
Another Chapter For Tuchman’s “The March Of Folly”
For some observers it came as no surprise in 2019 when the US economy suffered a collapse that was much, much worse than what had happened after 9/11; even worse than the Great Financial Crisis (GFC) that began in 2007/8. This is an attempt to pre-empt the conclusions of the President’s Commission on why the collapse could not be foreseen by the fraternity of economists. It is anticipated their conclusion, similar to that of the Commission that met after the GFC, will be that by available statistics, it appeared that the economy was inherently healthy. Then, much out of the blue, a few trends in the economy that initially seemed to be of little consequence combined with global changes and foreign developments to precipitate this new Great Collapse (GC) of 2019, doing so with little or no advance warning.
It must be stated up front that the Commission is unlikely to go back far enough into history to gain full perspective on the causes of the GC. It seems likely that they will look only at the shock of the GFC just more than 10 years ago and its after effects as reasons for the slide into the current economic abyss. And, of course, placing most of the blame for the collapse on the situation in Europe, actions by foreign countries and global factors. As before, this will be the cover for selective blindness by mainstream economists and short sightedness and outright expediency on the part of politicians and their experts who formulate government policy. Government incompetence and intransigence are recurrent over many centuries, as described in Tuchman’s excellent book, “The March of Folly”, to which the history of the GC could be a new chapter.
While this review begins earlier than the GFC, it is restricted in its scope; there is no discussion of the social, demographic and political reasons why the financial system and the economy were allowed – some may prefer to use the term ‘assisted’ – over a number of decades to drift in the direction that eventually made the GC inevitable. Undoubtedly, someone willing to tackle that task will require a keen and inquisitive mind, well able to delve behind the political and other smokescreens obscuring the mismanagement and misgovernment of primarily the post-Kennedy era.
There are many such complex reasons, going back at least to the 1970s, even earlier, that contributed to the climate that firstly made the GFC possible and inevitable and then, subsequently, set the stage for the Great Collapse of 2019. This review of causes of the GC deals predominantly with only one of them, a policy innovation that dates to the first Clinton administration, when much effort went into engineering a strong economy designed to ensure the re–election of Clinton in 1996.
One element in that re-election strategy is without doubt the single most important factor in creating the situation where a major economic collapse became hard wired into the future – with Clinton’s repeal of the Glass Steagall Act having provided the final push towards the 2007/8 financial crisis and then still contributed to the GC.
This preliminary review covers the initial effects of this factor through to the 2013–2014 period, by which time an economic collapse had already become inevitable. A more detailed review to follow will consider the complex developments of the past 6 years, when geopolitical factors intruded more and more to complicate the domestic situation and in effect combined with a worsening internal situation to make the GC that much more severe.
The hedonic CPI
Herb Stein was an economist in the Administration of pres. Reagan. He stated that if something could not continue indefinitely, it will stop. It has since become known as Stein’s law. Some people might think this fact is so self–evident that it is an affront to common sense to call it a Law. However, the evidence from real life shows that most of the brightest minds in the US just did not believe in this Law at all. For a long time they did not believe the housing market bull could become a bear; even longer it was believed credit could continue to fund household wealth indefinitely; they preferred Keynes and Krugman rather than Stein, holding the belief that governments can run up deficits without end. In a sense, it was these firmly held beliefs that were the main drivers for the Collapse of 2019.
Hedonics is the economic principle that if the price of an item – product or service – increases, but the quality of the item in the hands of the buyer is estimated to have improved to the same degree, then the price has suffered no inflation. It is inflation neutral. If, on the other hand, the improved quality is deemed of greater value to the user than the increase in price, then the adjusted price is disinflationary and the item for the purpose of the CPI becomes cheaper than it used to be, sometimes even if in actual price. Despite early evidence that the consequences of an hedonic official CPI had been impoverishing worker households, this fact apparently had failed to shake a widely held belief in the ‘morality’ of the practice. A low official CPI was desirable as that meant interest rates could be lowered to assist economic growth; the real GDP also received an artificial boost that counted in favour of the Administration.
Excessive household credit is one cause of the road to ruin for the economy, but the progressive erosion of purchasing power with the introduction of the hedonic CPI made it increasingly more difficult for households to cope with their debt. A search through available old internet archives for specific early warnings of future troubles in the economy rather than merely general opinion, showed that prior to 2004 there were very few explicit warnings that a combination of too much household debt and reduced household purchasing power was a growing risk.
One of the earliest is an 1999 article on market bubbles that contained a warning on trends in household credit. A long term analysis based on the YoY increases in total US consumer debt relative to increases in total disposable income showed the ratio even then was becoming hyperbolic. In the opinion of the author the trend was not sustainable and if not curbed, would result in a major problem for the US economy. Stein’s Law was not mentioned, but it was clear the trend towards such unbridled use of credit relative to income had to stop at some point in time.
A later series by the same author compared Japan after the collapse of 1990 with the USA in 2006. While explaining the circumstances for the Japanese slump after 1990, it also was a surprisingly good preview of the GFC that had started two years after the series was published – and thereby puts a lie to the conclusion of the Congressional Commission that later found the GFC could not have been anticipated.
While in 2019 debt was again a major contributing factor, as it was in 2007, the root cause of the recent Collapse lies in changes to the CPI that became the vogue during the 1990s. The main, but definitely not only culprits, were hedonically tuned prices of consumer goods and services and, also, an acceptance of the principle of substitution as one justification for this practice.
We leave the subject of substitution out of this discussion, except to mention that it is also subject to Stein’s Law; when its effects are projected well into the future, even for only a few decades, substitution becomes unsustainable. One proponent of hedonics apparently declared that it is acceptable that when people can no longer afford steak they should buy hamburger, known as ‘minced meat’ in other parts of the world. In other words, it was known that the hedonic CPI was bound to have a negative effect on household standard of living. It is not known whether the person who made that comment at any time indicated what kind of protein people could buy when they no longer could afford hamburger – scaling down through all alternatives to fresh meat until only pet food remains affordable. With some elderly people on Social Security already doing so, tainted pet food imported from China sparked a subdued panic.
An excellent example of hedonics comes from the computer industry. Using purely imaginary numbers from the early years of computerisation, assume a departmental secretary used a desktop computer that had cost $2500, had 1 Mb of RAM, disk space of 10 Mb and the CPU executed at the rate of 50 MHz. Then, after having used it for a year or two, it was replaced by another desktop that had 10 Mb of RAM, a hard disk of 250 Mb and the CPU executed at a rate of 250 MHz. On applying these factors to its retail price of $1300, the hedonic price of this far more capable computer was only $389 – of course with the desired deflationary effect on the new CPI.
The fact that the calculation of the perceived benefit of this advanced computer to the secretary disregarded the fact that it had little measurable effect on her typing speed nor how long she worked on a document was not really considered – at least until the very rapid advances in technology made these kinds of adjustments so ludicrous that some changes were forced. This hedonic principle also applied to other sectors of consumer goods so that consumer inflation was kept low despite the near consistent increase in the nominal prices of nearly everything, including energy and food.
The table below, sourced from an internet archive which credits the Bureau of Labor Statistics, is representative of that era. It lists the negative contribution to the CPI-U of various consumer goods sectors for the period 2012 to 2013. It is not clear whether these were the only sectors making such a disinflationary contribution to the overall inflation number, as expressed in the official CPI at that time.
However, do keep in mind these are annual figures that could be representative of the whole period since the mid-1990s. If so, compounding even approximate rates for various sectors of consumer goods for most of the years since the introduction of CPI hedonics, implies a major difference between the official CPI index and cumulative increases in the actual prices of consumer essentials by 2013 - 2014, which is selected as the base line for this review. Observe the effect of technological improvements on durable consumer goods, which was probably typical of the full period since the mid-1990s, as well as the contribution made by food and other household essentials.
Table 1: Disinflation in product sectors 2012–2013
It is clear that over the period under discussion, from the major implementation of hedonics in the mid-1990s to about 2014, the following must have held true:
- A majority, if not all sectors of consumer goods and perhaps services sectors too, underwent consumer friendly improvements over time that hedonically must have had the effect of reducing the contribution of any price increases to the CPI. Given the high rate of annual hedonic for some sectors, it is possible adjustments for some technology products brought the new adjusted price to below the previously recorded price; if so, the new adjusted price would have been deflationary in actual fact, despite a higher tag price
- Over time and as competitive pressures and improved technology consistently brought about improvements to products and services, the difference between the hedonic CPI and increases in the actual cost of living, as reflected in prices consumers did pay for goods and services, widened substantially
The net effect of these stratagems to keep the CPI low in order to justify low interest rates – which was politically desirable to boost the economy, first during the Clinton administration following the recession of the early 1990s, then again after the shock of 9/11 and even more so after the 2007/8 GFC – is shown in charts produced at that time by John Williams at a website, http://www.shadowstats.com , now long defunct.
Williams calculated a CPI using the methodology employed before 1980, thus before the first tentative changes to the CPI methodology to result in a lower value for the inflation gauge. Later, during the Clinton era, more fancy footwork within the CPI calculation became routine. The initial purpose of the CPI before 1980, to serve as a Cost of Living index, meant that Williams’ SGS CPI corresponded better than the CPI to changes in the true cost of living for US households during the period from 1994 to 2013, and after, when hedonics as illustrated in Table 1 had become the norm.
The disastrous effect of this disparity on households and the economy follows from the well-known but apparently disregarded fact that employers had always used the CoL index as a guide to salary and wage increases. Doing the same with the new CPI that by a wide margin understated the increase in the true cost of living, meant that in time working households had become impoverished to an increasing degree.
In many cases parents either refuse or are actually unable to see any flaws or signs of misbehaviour in their children. When they do, they often find excuses in extraneous factors or genetics to absolve themselves of any feelings of guilt. Experts in academic and other intellectual endeavours have similar problems; they are effectively blind to flaws in their pet theories and accomplishments; more so if they themselves played a notable role in formulating a new theory or other significant achievement.
Practitioners of two disciplines, economics and engineering, suffer from the risk that when a pet theory or new concept is put into practice, time might show up the flaws in their ideas in a truly disastrous fashion. Engineers have a saving grace in that their mistakes as a rule are of limited extent when viewed on a national scale.
Economists, on the other hand, when they happen to be successful in promoting their theories to the extent where these receive widespread political support, may find that they have contributed to disasters on a national scale, with severe effects on perhaps all of the population. When that happens, it must be extremely difficult to perform a mea culpa and admit that they were wrong before the disaster had run its full course – hoping perhaps the time of miracles has not passed, or that some other development that can carry the blame for the coming crisis might arise ! It seems in fact economists can be more steadfast and persistent than parents in loyalty to their theories against any and all criticism of their intellectual progeny, disregarding any and all hard facts to the contrary in order to maintain their bias.
Like communism, the concept of hedonic adjustments for perceived improvements in consumer quality sounds beautiful in principle. However, as recent events now have shown, its eventual impact on the economy and on the lives of people does not differ much from what many people in the USSR and in China had experienced after some decades of their new political order.
Proponents of hedonics might be blinded with respect to its consequences. However, the outside observer only has to consider 3 charts, widely available well before 2013, and do so from the perspective of Stein’s Law, to recognise disastrous flaws arising from the hedonic policy and how these became a direct cause of the Great Collapse.
Against a claim that realisation of the extent to which the charts signal the coming of a great collapse can be attributed to hindsight, the first defence is the series of articles from 2006 previously mentioned, in which the negative consequences of the hedonic CPI were already mentioned. Given that the author was not a recognised economist, by 2013 the evidence of the unintended consequences of the official CPI, as evidenced in the charts to follow, surely had to have been clear to any diligent observer. By 2014 the problem of income inequality had become headline material; surely, any serious exploration of possible reasons for this development should have easily recognised the role of the hedonic CPI. However, it still amazes that many economists of stature seemingly remained oblivious of what was happening until far too late.
All three the charts originate from the John Williams’ http://www.shadowstats.com website, but these examples were sourced off archives of the public domain during the period under discussion. At the time, they were therefore generally available for anyone who cared to consider the long term effects of these trends. It needs but little knowledge of how an economy functions to have been able to anticipate the extreme dysfunction that would result if the trends in these charts were to have continued.
Chart 1: Three versions of the CPI index – 1977–2004
The first chart demonstrates that as early as 2004 implicit evidence was available of important trends that, given adequate consideration and analysis, clearly had to be unsustainable. Competent economists surely must have known that wage increases tended to follow the official CPI, and they should have realised the trends shown in the above chart were a recipe for disaster.
The green curve is the official CPI. The red curve is a recalculation of the official CPI by Stewart and Reed, done as if all the adjustments in use by 2004 had been in effect from 1977, which would have made their inflation curve lower than the official CPI. The blue curve is the SGS CPI as calculated by Williams, employing the methodology of before 1980, i.e. without the effects of hedonic adjustments and other stratagems that had the effect of resulting in a lower figure for the CPI. Originally, the CPI had served as a Cost of Living index (CoL) and the SGS CPI therefore is an approximate rendition of the change in the cost of living of households between 1980 and 2004.
By as early as 2004, the SGS CPI index was already about 65% higher than the official CPI index. It is a well-known fact that wage and salary increases generally keep pace with the official measure of the rate of inflation. Prior to 1980, this practice meant that the income of households adjusted over time so as to sustain their standard of living . The widening gap between the official CPI, as an approximate measure of increases in wages and salaries, and the SGS as a measure of the increase in the cost of living, means that households were losing purchasing power, becoming impoverished and thus increasingly unable to maintain a constant standard of living.
By hindsight, by 2004 the warning bells should already have been ringing loudly for anyone with an open and questioning mind and willing to listen. Obviously this did not include the majority of economists and their political allies in Congress. Yet, by then it really was already too late to rescue the economy; in terms of the above chart, even as early as 2004, a solution that could rectify the damage that had been done to household finances must have ++become politically and economically impossible.
While the worsening situation of households must have been evident to an objective student of economics, those people who were committed to the new CPI could point to growth in the economy as evidence that all was well with the economy. A positive trend was of course assisted by using a much lower CPI to discount nominal growth, but also by the fact that households were compensating for reduced real income. The number of single income households dropped sharply as increasingly both partners had to seek employment. Alternatively, the working partner had to take on a second job, else they could not make ends meet.
Thus, throughout the period under discussion there was no easily apparent reason to question the CPI methodology in the academic world or in the media. In fact it was the opposite that happened; academia embraced hedonic principles as a new gospel of inflation. Among politicians, president Clinton appreciated that the low inflation made a low interest rate possible during the run-up to his re-election. Later, during concerns for the date change in 2000 and subsequently, after 9/11 and the aftermath of the GFC that erupted in 2007, it was not politic at all to question anything that may disturb the low interest regime, even if the household dilemma had been recognised.
In the years after 2004 and through the period of the GFC, the hedonic calculation of the CPI remained essentially unchanged. Chart 2, below, shows the official CPI as a red curve and the SGS version in blue, from 1980 to 2013. The constant high degree of divergence between the two CPI curves since the late 1990s leaves no doubt that the difference between the actual cost of living and the picture of inflation presented by official CPI, already evident by 2004 as shown in Chart 1, had remained very wide for most of the next decade.
Chart 2: Consumer inflation – Official vs ShadowStats
Initially, the adjustment to the CPI had relatively little effect. However, after 1991 the curves started to diverge more and then the gap widened even more during the first Clinton administration. By the late 1990s the difference had reached approximately 6-8% p.a., which then remained quite constant until the end of the chart in 1913.
Assuming, as was implied earlier, that employers during this period continued to grant wage and salary increases that were generally in line with and probably a little higher than the official rate of inflation, there can be no doubt that as income lagged the cost of living by quite a margin, employees were losing purchasing power.
Historically, the CPI in its role as cost of living index was of vital importance during the high inflation of the 1970s, as a guide to what level of wage increases would keep employees able to maintain their standard of living. Given that since 1998 inflation officially only rarely exceeded 3%, general wage and salary increases of 2% above the official CPI may have seemed generous. On this assumption, the average difference between wage increases and the increase in the cost of living during this period of 15 years would have amounted to about 4–6% p.a. Such a rate, compounded for more than 15 years, means that by about 2013 the average employee had lost perhaps half of his purchasing power.
The decline in purchasing power since 1980, from Chart 1 already evident by 2004, accelerated after the mid-1990s. Initially, households could adjust to this trend when the income of the primary wage earner was augmented by the partner also seeking employment, either part time or full time. However, the accelerated erosion of their purchasing power as compounding took effect, soon had many people working at two jobs, generally with one of the jobs being part time, or the household had to seek for relief by applying to the SNAP food stamp program.
It is therefore no wonder that participants in this program increased from 6 million in 2000 to almost 50 million by 2014 out of the population of just more than 300 million. This increase should be viewed as an indictment of government policies and surely must also have waved red flags for economists and politicians alike. If the red flags were in fact noticed, there is no evidence from that time that the real reason for such a major dislocation in the economy, one that compelled one out of seven Americans to seek food assistance, was correctly identified. Over time, instead, the problem was addressed by the introduction of even more subsidies and grants to keep households financially afloat – another trend that was later found to be unsustainable.
While not every household devolved into a state where food stamps and other forms of government subsidies or charities became necessary for survival, there can be no doubt that working households suffered severe budgetary pressures. Chart 3 shows the direct effect on the purchasing power of working America in terms of real wages earned by production and non–supervisory workers.
Chart 3: Real average weekly earnings – discounted by official and SGS CPI
Chart 3 shows the real average weekly earnings of production and non–supervisory employees from 1964 to 2014, discounted by using the official CPI and the SGS CPI, the latter serving as an equivalent of changes in a Cost of Living index. It is clear that by 2014 the purchasing power of average working households had declined almost 50% relative to what it had been prior to 1980. It can be safely assumed that this also applied to supervisors and at least lower level management, even if perhaps not to the same degree.
The chart also shows that real wages peaked in 1973 and then declined. This means that even during the period of high inflation in the later 1970s increases in wages had failed to keep pace with the increase in the cost of living. What later developed after 1994 was therefore not new. However, the deliberate change in CPI policy was much more severe in its effect on working households, as can be seen from the divergence between the red and blue lines in Chart 3 after 1966.
The evidence presented in the three charts makes it clear that by 2013 and perhaps as early as 2004, well before the GFC, the situation had deteriorated to where a collapse had become near certain. By 2013 the impoverishment of most consumer households made a collapse inevitable. The counter measures needed for a timely prevention of a collapse would have had to be a combination of a substantial increase in real wages and salaries for working households and some form of price controls to reduce prices of essential goods, or at the very least to keep them constant – both of these measures would have been essentially impossible on political and economic grounds.
By 2013 it would not have been possible to return to a more correct calculation of the CPI – the increase in interest rates in response to much higher true inflation by itself would have killed the economy to precipitate a recession, or depression. Hindsight teaches that if the collapse could have happened earlier – better still, if there had been no rescue of the financial system after the GFC had started in 2007 – the turmoil and misery that would then have followed would have been vastly less than what we had to experience last year and the terrible aftermath, which is still raging.
The complexities of what happened after 2013, when global factors cross pollinated with a struggling economy, until the final Great Collapse happened in 2019, will be reviewed and discussed in a second report. During these last 6 years it was attempts by the government to treat the domestic consequences of a manipulated CPI by any means available, while trying to protect US hegemony and interests internationally, that sucked the financial health out of the country and depleted the ability of the US to cope with a worsening global situation, right up to the point of final collapse.
The reaction of officialdom seemed to have followed in the footsteps of governments of the past after they had committed to a foolish policy. As so eloquently described by Tuchman in her book, “The March of Folly”, at the hand of historical examples, it seems the typical reaction of rulers and governments is that they do nothing more to avoid the consequences of their mistake than use blinkers to avoid seeing what lies ahead – and when they do try something new it just worsens the existing situation.
Approaching and into 2018, a disgruntled and often desperate populace engaged in often widespread disorder and turmoil, with frequent incidents of civil disobedience and inner city rioting, adding to the problems faced by government. The measures that were taken to retain the semblance of control on occasion tended to the extreme and are continuing as the state tries to cope with the aftermath. No doubt there will be discontent and hardship for most people for perhaps a number of decades.
A discussion of what happened during 2019 and the ongoing situation will have to wait until everything has become more settled, nationally and globally. By then the colloquium of top economists, brought together by the president this past month to review why they gave no timely warning of an imminent Great Collapse, may have made known their conclusions. It is near certain however that – as had previously happened after the 2007/8 Great Financial Crisis – the Commission will conclude it was not possible to foresee the collapse until after it was happening.
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The reader of this piece of fiction, in effect looking at the past from a position where the Collapse already had become fact, needs to consider three questions:
- Are the trends described here an adequate representation of key features of the situation as it was by 2013-2014?
- Are these trends, should they be maintained for the near to medium term, as indications seem to be, of sufficient magnitude in their total effect – including the impoverishment of US worker households, the need for the government to increase household subsidies in various forms, subsidised job creation, a long term effect on the budget deficit, etc. – to induce a major economic collapse?
- Is there a rational explanation why these trends as a reason for concern seem to receive such little attention? Inequality of income has become a buzzword, but it is as if it is a fact without cause that has to be addressed in some manner in order to alleviate the problem, but not to identify and rectify its cause. That is, other than blaming it all on the 1% and thus as an insoluble problem?
Can it be that the concept of a hedonic CPI sounds so moral and with such strong logic – like Communism and Democracy and Capitalism – that it blinds adherents to any negative effects until it is far too late? That is the one explanation that does make sense to me.
My interest in market behaviour began in the early 1980s when I developed a course in technical analysis in support of technical software I had developed. For what I had termed ‘Market Psychology’ I developed a model that described how the players in a market reacted to changes in the price as it went through a complete bull-bear cycle.
The model was widely tested and proved quite accurate at anticipating major trend reversals after significant bear or bull trends. Other aspects of technical analysis had assumed more priority and this model was not pursued to any degree.
Over time, as I became interested in aspects of the economy, initially the process of bubble markets – this was after all during the raging 1990s – was fascinating. But it seemed there were trends in the US economy in particular that carried the seeds of recession or worse unless the trends changed. The articles referred to in the above tale, namely the developing hyperbolic trend between increases in household debt and income as well as the comparative study of Japan (1990) and the US (2006) are expressions of this interest.
© 2015 Daan Joubert