The Gold Report: The last few years have been very volatile for investors, particularly resource equity investors. The mainstream media, citing government statistics of improved employment rates and housing starts, called an end to the recession and is forecasting a slow recovery in 2013. You are looking at the same indicators, but coming up with different numbers. Let's start with the unemployment rate. What are you seeing and why is it different than what we are hearing everywhere else?
John Williams: I contend that the economy effectively hit bottom in June 2009, followed by a period of somewhat volatile stagnation, and it is beginning to turn down anew. There never was a recovery and no economic data shows the type of recovery that the official gross domestic product (GDP) report is showing. The GDP shows levels of activity now that are above where the economy was before the recession. It's been above that level now for more than a year. No other major economic series has shown a full recovery, shy of perhaps inflation-adjusted retail sales, which is due to a problem with the inflation rate used to adjust the series. Generally, the illusion of recovery has resulted from the government's use of understated inflation.
TGR: Are you predicting a double-dip recession?
JW: It's more like the pattern a fellow would take going off a ski jump. A plunge and then moving forward, maybe up a little bit and then plunging anew. The economy officially will be recognized as a double-dip recession at some point, but in reality it's all part of the ongoing economic crisis that we've seen for the last five or six years.
TGR: One of the indicators people look at to determine the existence of a recession is the unemployment rate. Why you are seeing a different number for that than some of the officially announced numbers?
JW: Unemployment is a matter of how you define it. The government has six measures of unemployment. The headline number is the third level of unemployment (U3). That measures people actively seeking work in the last four weeks. That doesn't mean just reading newspaper want ads; it is people mailing resumes and doing interviews. That number was reported at 7.9% for January, but that's not the common experience. The broadest measure that the government has is U6. That includes the people defined as unemployed in U3 plus what they call "discouraged workers" and those who are working part-time for economic reasons, people who are underemployed. U6 was at 14.4% in January.
If you accounted fully for all discouraged workers, not those who have been discouraged for less than a year as counted by the Bureau of Labor Statistics for U6, you'd find that the unemployment rate is up around 23%. The recession has gone on for so long that people have given up looking for work, but those individuals still consider themselves to be unemployed. If there were jobs available, they would take them, but the government doesn't count them in the headline labor force statistic. That is why the official unemployment rate is shrinking while the number of people who want to work, but can't find a job, has actually increased.
TGR: Are some of these discouraged unemployed actually retired?
JW: Whether individuals are just coming out of school or finding that they have to come out of retirement in order to make ends meet, so long as they are looking actively for a job, again, the government counts them as unemployed. Formerly retired individuals, who want to work but end up as discouraged workers, still are counted as unemployed in the broader measures. They're just not able to find work and have given up looking for work because there are no jobs.
As to common experience, if you were to survey everyone in the country as to whether he or she was unemployed, you'd get a response suggesting something close to the 23% unemployment rate. The average person doesn't have to think too long to tell you whether or not he or she is unemployed. He or she may consider him or herself unemployed, but may not necessarily be counted in the headline government's numbers. Again, the "accurate" unemployment number remains a matter of definition. Common experience is close to 23%.
TGR: Another indicator of the health of the economy is housing starts. You called December housing starts "not statistically significant." The Department of Commerce reported a 12.1% increase and analysts are saying it's the biggest jump in four years. Are you counting different things?
JW: I'm looking at the official numbers. The problem is that the official numbers are just not too meaningful. The 12% headline gain has a 95% confidence interval around it of +/- 16%. Within the Census Bureau's usual reporting error, the monthly gain was statistically insignificant; it just as easily could have been a monthly contraction.
The current level of housing starts is still off about 70% from the peak of activity in 2006. We are certainly off the bottom in the housing market, but it's still at historically very low levels.
The month-to-month numbers are not meaningful because of the uncertainties of the surveying and problems with seasonal adjustments. Seasonal adjustments have become much more volatile and increased the uncertainty around the reported month-to-month changes since we've had this terrible downturn. Specifically for December, the housing series likely received some boost for the month from unseasonably mild weather and from rebuilding activity tied to Hurricane Sandy. Seasonal distortions are fleeting, and the rebuilding gains will be temporary.
Separately, the mechanism is not in place for sustained growth here. That also applies to retail sales. In both instances, you're looking at problems in the banking system and at structural problems with consumer liquidity.
TGR: Retail sales is another indicator people look at to determine the strength of the economy. You reported a contraction in the third quarter of 2012. The Census Bureau reported a 4.7% growth year over year based largely on increased car sales. Why are those numbers different and where do you see that going in the rest of this year?
JW: I look at those numbers adjusted for inflation, and, as an aside, that third-quarter contraction was quarter-to-quarter, not year-to-year, although the annual growth is close to new-recession territory. The government adjusts the GDP for inflation as a way, theoretically, to measure underlying economic activity as opposed to measuring activity that can be affected heavily simply by rising prices.
It is the same thing with retail sales. If you back out official CPI inflation, as is done by the St. Louis Fed, you'll find that a lot of the headline retail sales growth has been tied to inflation, but the official CPI inflation rate is understated. That results in too high an inflation-adjusted growth rate. Again, we also face the fundamental issue of bad quality month-to-month numbers because of a variety of seasonal adjustment problems. That should leave the average person without much confidence in what's actually being reported month-to-month.
You really need to look at the underlying fundamentals in order to make any sense of what is happening in the real world. Fundamentally, retail sales and housing growth are based on the condition of the consumer. The consumer increasingly is illiquid. Reports of median household income, adjusted for inflation, show that household income plummeted well into 2011 and has been stagnant at the lowest levels of the current cycle ever since. The average guy is not staying even with inflation. That is important, because income drives consumption, and consumption accounts for more than 70% of GDP. If, net of inflation, you don't have sustained growth in income, you're not going to have sustained growth in consumption.
You can, however, experience temporary growth by borrowing activity through debt expansion. Former Federal Reserve Chairman Alan Greenspan recognized the deteriorating fundamentals of household income, and encouraged massive debt expansion in order to fuel ongoing economic growth. That, however, led to the debt panic in 2008. Debt-fueled growth is not sustainable, and consumers, still lacking adequate income growth, now also lack the option of significant debt expansion in order to fuel consumption growth. Problems in the banking system continue to impair credit availability for consumers.
TGR: Now that loans are more difficult to get, are you predicting that retail and housing probably aren't going to bounce up in 2013?
JW: Exactly. The only type of loan growth to consumers has been in government lending of student loans. It has not been in the types of loans that drive auto or retail sales. With the shortfall in income, there's no way the consumer could support sustainable growth in consumption and without that you don't have sustainable growth in the GDP.
That is why we haven't had an actual recovery in inflation-adjusted GDP. Also, there is no recovery pending, and that has all sorts of terrible implications for the financial markets and the current fiscal circumstances in the United States.
TGR: What does all of this mean for the stock market? If people believe the government numbers and have a false vision of the economy, does that really hinder investors if the rest of the market believes those same positive numbers? Don't we always hear that stocks move based on perception rather than reality?
JW: For some time, I don't think stocks have been moving based on anything tied to reality; the market has had no appearance of being rational. There are other factors at work here with the result of some very unusual trading activity. What will happen, eventually, is that underlying economic reality will become undeniable, and even official reporting will be revised to a pattern of contraction, an official double-dip recession. That likely will not be good news for stocks.
TGR: If there is no real recovery, will the Dow drop or stagnate?
JW: A weaker economy is not good for corporate profits. The government will try to compensate, which will just worsen the liquidity crisis, and sovereign solvency issues will increase. At some point, the global markets are going to turn very heavily against the U.S. dollar. That will spike domestic inflation, which will lead to higher interest rates. Again, that is all generally bad news for the financial markets, but good for gold.
TGR: You and I have talked quite a bit about the pros and cons of adjusting inflation figures in the past. The idea of a chain-weighted urban CPI (CPI-U) gained mainstream media attention during the fiscal cliff debate as a way to control costs by slowing Social Security outlays. How would that work? And how would this be different from what is already happening?
JW: This is not new. The government went through a similar process back in the 1990s and did, in fact, change the way the CPI-U was reported. The goal then was to reduce the reported rate of inflation along with a resulting reduction in the cost of living adjustments for programs such as Social Security. This enabled the government to reduce the deficit without anyone in Congress having to do the impossible—voting to cut Social Security. What the government tried to do was change the CPI from a fixed-weight index where it effectively measured the cost of inflation—reflecting the ability to maintain a constant standard of living—to a cost of living measure based on the idea that people would substitute hamburger for steak, for example, if steak got too expensive.
This is a declining standard of living measurement. I can't imagine any use for such a measure other than government's playing games. But, even with these tricks, the CPI-U still is not fully substitution based. The experimental chain-weighted CPI, the C-CPI, however, would be just that, fully substitution based. Using the C-CPI would allow the government to knock another 0.6–1% off official inflation, further reducing the cost of living adjustments to Social Security.
It's unconscionable. It's effectively a fraud. Shame on the government for trying to do that. This impacts people's retirements. There was some protest when the idea was floated as one way to deal with the Fiscal Cliff, and the politicians pulled back. I fully expect they will try to push it forward again, in the negotiations in the months ahead. Politicians should just be straightforward with the American people and say, "We can't afford to pay the cost of living adjustments that we had contracted." At least people would know what is happening and could plan accordingly.
TGR: Let's talk about what is happening using some real numbers. I'm hearing a prediction of 2.3% inflation in 2013, up from 1.7% in 2012. You have your own alternative CPI-U that's a measure of the amount needed to maintain a constant standard of living. Does that shadow the government figures, following the same general trend, but at a higher number or do the two numbers move independently?
JW: The pattern generally is the same. I have gone back through the adjustments that the government has made and added them back in to the final inflation calculations. I'm either adding in somewhat over 3% or somewhat over 7% to what the government reports, depending on whether I am using 1990- or 1980-based methodologies.
TGR: If the trends are the same, aren't people using the government figures at least getting a true idea of the direction of inflation, whether things are getting better or worse, and a general idea of how much of a raise they will have to request in order to maintain their standard of living?
JW: They may be getting the relative trend year-to-year, but, at the moment, the official numbers are well shy of the actual magnitude. The magnitude of actual inflation outweighs the magnitude of the short variation, at present. For example, there was a period in recent years where the official CPI went negative year-to-year. My numbers slowed, with year-to-year change softening, but they did not go negative.
TGR: Let's talk about something that we can touch and hold and everyone understands—precious metals. You have said that despite the Sept. 5, 2011, $1,895/ounce ($1,895/oz) gold price and the April 2011 $48.70/oz silver price, precious metals have yet to re-hit their 1980 historic levels, adjusted for inflation. How does the price of gold move historically versus inflation?
JW: Gold is a basic inflation hedge, over time. Since the founding of the Federal Reserve (active in 1914), the U.S. dollar has lost 95.7% of its purchasing power, based on the government's headline CPI number. Based on the ShadowStats inflation estimate, reflecting 1980 methodologies, the dollar has lost 98.9% of its purchasing power. In that same 99-year period, the dollar also has lost 98.9% of its purchasing power against gold. Gold has fully offset the pummeling effects of domestic inflation on the purchasing power of the U.S. dollar, as measured over decades.
TGR: Another place where reality often shows through is energy prices: gas and electricity. What did you see for inflation in energy prices in 2012 and what is the outlook for the energy commodities and the stocks behind them in 2013?
JW: All this ties back to the fiscal crisis, the U.S. government's effective long-term insolvency. If the government cannot bring its annual budget deficit under control, eventually it will have to meet its obligations by printing money. That creates inflation, a hyperinflation.
This is why the global markets are so cautious at present. Very few people want to hold dollars long term. A massive flight from the dollar, which is likely this year, would be the beginning of a major inflationary period. The problems with the dollar would boost oil prices in dollar-denominated terms, with resulting higher gasoline prices and higher domestic inflation. This is despite not having a strong economy.
TGR: So you're predicting higher gas prices, but a weaker economy.
JW: Right. I'm looking for a weaker economy with higher inflation—driven by bad monetary policy reflected in a weak U.S. dollar—which will have a big impact on dollar-denominated commodities.
TGR: What is your overall prediction for 2013 inflation and would that change if quantitative easing ended?
JW: I can't give you a hard number but I expect inflation to increase rapidly. It will certainly be picking up by the end of the year. It is unlikely that the Fed will be able to back off its quantitative easing.
TGR: Based on this outlook, what can investors do to protect themselves? If we know the truth, how can that help investors prosper—or at least survive?
JW: First, concentrate on preserving the purchasing power of your wealth and assets. The best hedge is physical gold, silver and other hard assets outside the dollar. Look at stronger currencies. I still like the Swiss franc, the Canadian dollar and the Australian dollar as hedges.
You need to hold the hedge through the tough times. If gold is up at $100,000/oz, don't get excited and take profits, because the gain there just reflects maintenance of your purchasing power. It suggests the magnitude of the purchasing power you've lost in the dollars you did not put into hard assets. Remain liquid so you can get through the tough times. If you preserve your wealth and you are liquid, you will have some of the most interesting investment opportunities that anyone has ever seen, once the system recovers. I can't put any timing on that, but it's not likely going to be a couple of months. It's more likely going to be a period of years.
TGR: Thank you so much for the advice.
JW: Always happy to talk.
The New York Times and Investor's Business Daily. He received a bachelor's degree in economics, cum laude, from Dartmouth College in 1971, and was awarded a Master of Business Administration from Dartmouth's Amos Tuck School of Business Administration in 1972, where he was named an Edward Tuck Scholar.
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From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. John Williams was not paid by Streetwise Reports for participating in this interview. Interviews are edited for clarity.
