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Tharp's Thoughts Weekly Newsletter

January 23, 2008 — Issue #356
  
Workshops

Van Is Teaching Workshops in Singapore and Australia

Article

Lies, Damned Lies, and Government Statistics by Van K. Tharp Ph.D.

Education

Something for Everyone in March

Trading Tip

Uncertainty - The Ugliest Word in Trading and Investing – Part IV by D.R. Barton, Jr.

Melita's Corner

A Quote from Einstein by Melita Hunt

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Feature

Lies, Damned Lies, and Government Statistics

by Van K. Tharp Ph.D.

 

I think the actual quote goes something like “Lies, Damned Lies, and Statistics”; however, my personal feeling is that government statistics are absolutely the worst.  Today, I want to talk about some of the government’s economic statistics they use to tell us how the country is doing.  

Back in the late 1980s inflation was in double digit figures.  Interest rates rose as high as 14%.  Basically at this point, our government said, “We never want to see interest rates that high again.”  We won’t do anything fiscally responsible or anything like that.  We certainly won’t curtail government spending.  We certainly won’t get rid of the debt.  And we certainly will not stop the printing presses.  However, we can assure that the government will never again have double digit inflation rates because we’ll simply change how we define and determine inflation.  

In the 1980s, the government published the CPI (the Consumer Price Index) to determine the level of inflation.  For example, according to government statistics (i.e., the worse kind of lies), our CPI in 1982 was 100.  (Incidentally, the first lie is that they keep changing the year in which the base is calculated.  It used to be 1967 = 100).  Anyway, despite that lie, today (as of November 2007) the CPI is about 210.  Now do you really believe that the price of things has only doubled since 1982?  Wasn’t gasoline only a dollar a few years ago?  And doesn’t the price of energy affect almost everything connected to our economy?

The following data shows the available CPI data since 1913 from the web site, http://inflationdata.com.

Month

CPI Index

12 Year Change

January 1913

9.8

January 1924

17.3

76.5%  (11 years)

January 1936

13.8  (real deflation)

(20.2%)

January 1948

23.7

71.7%

January 1960

29.3

23.6%

January 1972

41.1

28.7%

January 1982

101.9

149.3%

January 1996

154.4

51.1%

January 2007

202.7   (Nov 07 = 210)

26.4%

The way to make sure we don’t have double digit inflation again is to change how we calculate inflation.  Elements of the CPI were first introduced in the 1880s, but it wasn’t formally calculated until 1921.  And, of course, the above table shows data back to 1913.  You’d probably be shocked to compare 1921 with now, so there is no comparison.  In fact, the CPI wasn’t really formally used by the government until after World War II when it was used to adjust auto union contracts for inflation.  Later, it was used to adjust social security payments and that was its downfall because the government could not afford to make payments that high so it started to “adjust them.”

Originally, the CPI was measured using the costs of a fixed basket of goods, a fairly simple and straightforward concept. The identical basket of goods would be priced at prevailing market costs for each period.  When the next period was calculated, usually at the end of the next month, then the new cost of that basket of goods was assumed to be the change in inflation.

But let’s look at how we can adjust the basket.  Notice how much the basket went up from 1960 to 1972.  But at that point, the government said we cannot tolerate such rates of inflation.  What can we do?  Well, we can adjust how we calculate it.  And notice that the last 11 years is the third lowest shown.  But that’s just because of how its calculated.  So what changes could the government make?

First, they could decide that technological changes can be used to reduce the price of the basket.  For example, I’ve bought many computers over the years, and I’ve usually spent about $2,500 to $3,000.  My first, computer was a Kaypro.  It was a big metal portable computer.  It ran on the CPM operating system, and I believe its memory was 64K.  I think we also had big 8 inch floppy disks that were about 80K, so they could hold everything that was in the memory.  I wouldn’t have been able to start this business or write the Peak Performance Course without that computer.  But I replace my personal computer every three or four years, with each one costing about the same.  Today my $3000 will buy me a core-dual processor with a 500GB hard drive and about 4 GB of memory.  So we’ve moved from KB to MB to GB … and the local electronic store has 1 TB hard drives now.  

How does the CPI handle such technological advances?  Well, if your basket of goods has a $3000 computer in it, but it will now do 10 times as much as the one you bought 5 years ago, then you are really only paying $300 for that computer.  That’s right, technological advances have a deflationary effect on how the CPI is calculated.  You still pay the same for the computer, but the CPI goes down.  Such concepts were brilliantly added during the Reagan administration.

What else happens to the CPI?  Well, government officials in their wisdom said that if prices went up too much, people would buy cheaper things.  Thus, if steak increased from $1/lb to $10/lb, then people who could no longer buy steak would buy hamburger instead.  That is, because people could do that, the government could now make adjustments to how the CPI was calculated.  If something became too expensive because its price went up too much, we’d just put something cheaper in the basket.  When this idea was first thought of, it was unconscionable.

However, when Bill Clinton took office, it suddenly became the way to do things.  But they really didn’t substitute hamburger for steak, instead, they just changed the weighting of each item.  For example, if steak was 2% of the basket, the government would simply change the weighting if it got too expensive and make it 1% of the basket.  This was the Boskin/Greenspan concept.  Wasn’t our former Federal Reserve Chairman brilliant?  He went from being a strong supporter of a gold standard in his early years to figuring out ways to adjust the CPI so that a gold standard is not necessary.  This kind of geometric weighting reduces the CPI by 2.7% each year.  So if inflation is reported at 2%, it is really 4.7%, but you don’t really know that, right?

The Bush administration has introduced a new measurement called the CPI-U.  This makes a further adjustment of around 0.4% to the CPI.  Why?  Well, it’s simply another adjustment to make the figures lower.

According to John Williams, who publishes a shadow statistics web site, traditional inflation rates can be estimated by adding 7.0% to the CPI-U annual growth rate (3.8% +7.0% = 10.8% as of August 2006) or by adding 7.4% to the C-CPI-U rate (3.4% + 7.4% = 10.8% as of August 2006). Graphs of alternate CPI measures can be found as follows. The CPI adjusted solely for the impact of the shift to geometric weighting is shown in the graph on the home page of www.shadowstats.com.

Incidentally, if the government adds a new tax, like an increase of 10 cents to the price of a gallon of gasoline, then this new tax, is subtracted from the CPI.  After all, the tax was put there by the government, so even though you have to pay it, they figure that they do not have to account for it in their CPI statistics.

Now if you don’t like all of this government manipulation, you could probably figure out the inflation rate indirectly through M3, which directly measures all the new money being pumped into the system.  However, several years ago, the government stopped publishing M3.  They said it wasn’t a very useful statistic and no one really paid attention to it.

So what is the impact of all of this?

  • We are in an inflationary secular bear market.  But you are not supposed to know that. 

  • Over the last 10 months the official CPI went from 202.7 to 210 for a 3.6% inflation rate.

  • But adjusting back the government statistics, according to John Williams, it is now running over 10%.  And that probably seems more like your personal experience of inflation.

  • And based upon the M3 data, our money growth (real inflation) is running at about 15%.

Now all of this has some real impact on another set of government statistics, the GDP.  The GDP is the way the government measures growth.  When we have two negative quarters of less than zero growth, we are considered to be in a recession.

However, GDP growth is the growth of the economy above the inflation rate.  If the government says the GDP is increasing by 2%, while inflation is 3%.  It really means that growth was 5%, with a 3% adjustment for inflation.  However, what happens when real inflation is running above 10% (or 15% if you want to measure M3)?  It really means that the government manipulation of inflation is really masking a massive recession.  In fact, according to John Williams, except for one quarter of 2003, we’ve been in a recession since the secular bear market started in 2000.

I’ve been using other measurements of inflation in my monthly update because I didn’t trust the CPI.  However, in the future, I plan to report John William’s statistics for the CPI, M3, as well as the CRB index and the price of gold.

 

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling book Trade Your Way to Financial Freedom and his 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.iitm.com.

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Trading Tip

Uncertainty - The Ugliest Word in Trading and Investing – Part IV

by D.R. Barton, Jr.

“Enough is too little. More is better.  Too much is just right. ”--Shade tree mechanic saying

I still remember that day 27 years ago as if it were yesterday. (How’s that for a trite opening?)

It was a very odd thing to remember, actually.

I was helping a friend work on his older model Toyota Celica.  (I could hold wrenches and remember where he laid parts when he took them off).

He found that the valve cover gasket was the reason that he was getting an oil leak.  Not wanting to run to the auto supply store, he decided to use a product that is essentially a liquid gasket (Form-A-Gasket, I think it’s called).

As he put on the first layer (without reading the instructions, of course), I remember thinking that this was a pretty cool product.  But the pungent odor was something to behold!  After the first layer, he then proceeded to add a second even thicker layer.  And not satisfied with that, he then put on still more.

Being merely an interested observer, I asked why he squeezed so much goo out of the tube onto valve case.  His response (quoted above) will forever be burned into my brain:

“Enough is too little.  More is better.  Too much is just right.”

And while that approach may work for applying liquid gasket, I think that it truly hinders many traders.  Let me explain.

In weeks past we have been discussing uncertainty and how it effects our trading even if we don’t really know that it’s the root cause to various problems. One could even take an extreme view and say that all aspects of trading are just various tools we use to cope with market uncertainty. We have discussed how some people cope with uncertainty by just ignoring it. But clearly that’s just one tool that’s used.

Another coping mechanism that traders and investors use for dealing with uncertainty is the collection of massive amounts of information.

These folks are the shade tree mechanics of the trading world.  They have before them a limitless supply of liquid gasket, so they set out to use every last drop.  No news story goes unread.  No technical indicator goes uninvestigated.  No piece of fundamental analysis skipped.

More data is better. Too much is just right!

And while getting sufficient input for a decision is prudent, there are problems with gathering too much data.

Endless Feedback Loops

One of the main problems that occurs when one looks at too much data is that pieces of data contradict themselves.  One technical indicator says to buy, while another says to sell.  One analyst says, “It’s a screaming value” while another says that "it’s a lead balloon." 

So what is the natural tendency to overcome this contradiction?  More data, of course.  Let’s see if I can take a poll of three more analysts to see what they think about this stock.  Or, what does the super-big-mac-rsi-momentum-quick-stoichastic-eieio-oscillator tell me about what’s happening here?  We look for something to break the tie.

But a funny thing happens on the way to data-driven consensus.  The decision making waters get muddier, not clearer.

In fact, if we get enough analysts agreeing on something, it’s usually much safer to bet the other way.  And while seeing how many momentum indicators we can get to line up on the side of overbought or oversold is a fun mathematical and intellectual exercise, it often just leads us to the point of finding out that the instrument we’re watching is about to stay overbought or sold for a long time.

This issue of dealing with data overload is a huge one, so we’ll continue to discuss it next week.  For now, the short answer is to find a moderate number of useful independent variables to help guide your decisions.  Too few, and you make decisions that are no better than a coin toss.  Too many, and your decisions begin to look like either over-optimization (curve fitting) or consensus building.

We will continue to delve into uncertainty and look at quantifying it, ignoring it, transferring it and living with it.  And I would love to hear your stories on dealing with uncertainty.  If you’ve had an experience dealing with uncertainty that provided a great learning, a vexing question, or just a good belly laugh, please forward it to me:  “drbarton” at “iitm.com.  Let me know if I can use the story (either anonymously or credited) in a future article.

Great Trading!

D. R.

About D.R. Barton:  A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena.  He is a regularly featured guest on both Report on Business TV,  and WTOP News Radio in Washington, D. C., and has been a guest on Bloomberg Radio.  His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  “drbarton” at “iitm.com”. 

 

Melita's Inspirational Corner

A Quote from Einstein

by Melita Hunt

I picked up my embroidered black jacket to wear the other day, and had forgotten the quote that appears on the inside lining. It is the simple saying from Einstein:

 We cannot solve problems with the same thinking we used when we created them. 

I’ve heard it and read it many times before but had never really taken the time to think through what it meant for me. I remember thinking to myself many years ago: What exactly does that saying mean? And how can I think differently? I am who I am and I think how I think. I don’t GET it.

Suffice to say, I now realize that it is a great statement about shifting beliefs and the importance of having paradigm shifts. Otherwise known as “aha” moments.

Here are a couple of very simple problems that people might experience in their lifetime. The first is about money and the second is about relationships.

Problem One: I never seem to have enough money. I have got to work harder to make more money, but I am already working as hard as I possibly can. I’d like to double or quadruple my income, but I don’t know how I could work much more than I already do.

Do you recognize any key beliefs in this particular problem? And when I say beliefs, I mean, what is the person thinking when they address the problem in this manner? One that stands out for me is that the person believes that “hard work” is the only way to increase their income.

Going back to Einstein’s quote, if this person continues to have the same “thinking,” then they are going to find themselves caught in the loop of this problem and never be able to escape it. It is going to be a lot of “hard work” for them to make more money. The answer lies in the person changing their thinking.

Let’s take a look at a relationship problem.

Problem Two: I can’t communicate with my spouse. We seem to get caught up arguing about the same things over and over again. She/he never gives me a break or recognizes the good things that I do, and always focuses on things that are going wrong.

Do you recognize any key beliefs in this particular problem? What is the person thinking?

The key lesson is to see that if they keep thinking that they “can’t communicate with their spouse” or “he/she NEVER gives me a break,” then of course the same patterns are going to keep repeating themselves. Neither of those statements are completely true, but they keep the problem alive.

It’s quite simple really.

But how do we change our thinking?

Well that’s the really cool part. Depending on how willing you are to do self work and really learn about yourself, there are many avenues that you can take. Some are simple and easy to do yourself, and others may include doing further training in this type of thing.

The famous steel magnate Andrew Carnegie used to lock himself away in a dark room for a couple of hours, with just a small table and a pen and paper. He would then clear his mind, forget what he “knew” about all and sundry, and just wait in the dark for answers and information to come to him. It is a form of meditation that I think many of us wouldn’t take the time to do. We are too intent at working things out with all of the knowledge that we have attained, fooling ourselves into thinking that we “should” know all of the answers.

Perhaps those answers haven’t been revealed to us yet because we’re not ready to “hear” them. And that is what I think Einstein was saying in his quote. Change your thinking, change your life.   

Identifying the so-called problems is the first step. So if any of you choose to send me your problems, then perhaps we can do some work next week on shifting the underlying beliefs and resolving the problem at a new level of thinking.

Is anyone game?

Send your “problem” to Mel@iitm.com

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita’s progress regarding her recently diagnosed lung cancer (she is a never-smoker). Please feel free to read her blog at www.myleftlung.com.

You can contact Melita at mel@iitm.com

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