Yesterday the Bureau of Economic Analysis (BEA) revised its 2Q08 GDP growth to an annualized rate of 3.3%, up from 2.7%. It’s a shame this data had to be revealed on August 28, a date not associated with humorous pranks; had it come out on April 1st investors would have a much better clue that the BEA is joking.

There are several problems with the BEA’s data. But the most glaring of them pertains to its inflationary measures. According to the BEA, the GPD price index—its primary measure of inflation—was 1.2% for 2Q08.

I’ve thought long and hard about what demographic possibly experiences inflation of 1.2%. The closest group I could come up with was the Amish—who don’t use electricity or drive cars and therefore are immune to energy prices—though their status as “food consumers” hurt even this hypothesis—food is second only to energy in terms of price hikes.

Alas, no one in the US is experiencing inflation of 1.2%. And its frightening to think that the “official” inflation data from the US government is even less accurate than the phony Consumer Price Index (CPI) numbers used by the Federal Reserve—CPI is around 5%.

As we’ve mentioned on these pages several times before, the Bureau of Labor Statistics has altered its measure of inflation several times in the last 30 years. The first major change was put forth by Michael Boskin, Chief Economist during the first Bush Administration, and Alan Greenspan, former Chairman of the Federal Reserve.

John Williams of www.Shadowstats.com, describes this beautifully:

Up until the Boskin/Greenspan agendum surfaced, the CPI was measured using the costs of a fixed basket of goods… The identical basket of goods would be priced at prevailing market costs for each period, and the period-to-period change in the cost of that market basket represented the rate of inflation in terms of maintaining a constant standard of living.

…Shortly after Clinton took control of the White House, however, attitudes changed. The BLS… [changed] the weighting of goods in the CPI fixed basket. Over a period of several years, straight arithmetic weighting of the CPI components was shifted to a geometric weighting. The Boskin/Greenspan benefit of a geometric weighting was that it automatically gave a lower weighting to CPI components that were rising in price, and a higher weighting to those items dropping in price.

The second significant change involved “hedonic” adjustments or adjustments made based on the assumption that new items were more efficient and therefore worth “more.” Williams uses an example in which one could claim that a washing machine doesn’t cost 20% more because the user gets 20% more pleasure out of the fact that it is more efficient or powerful than an old washing machine.

With all of these changes implemented, the Federal Reserve’s measure of CPI was able to greatly understate the rate of inflation in the US. Keep all of this in mind when you consider that the BEA’s current measure of inflation is even lower than the Fed’s highly manipulated CPI!

So what does all of this have to do with GDP growth?

Barry Ritholtz of The Big Picture explains:

…the measure of Inflation is crucial to getting an accurate read on GDP (or Durable Goods). Say you live in a country that produced $100X worth of widgets in Year 1. In Year 2, it produced $110X worth of widgets. What was your GDP gains? 10% ? 0% ? Or something in between? If your inflation data is ~2%, then you can conclude that the bulk if those widget sales was growth.

So, when you consider that the BLS claims that the US GDP grew at an annualized rate of 3.3% in 2Q08 because inflation was only 1.2%, you begin to realize how manipulated this data is. If the BLS used “real” rates of inflation—roughly 10%—it would be clear the US GDP shrank in 2Q08.

There appears to be no end to the tactics employed to massage official US economic data. However, it doesn’t matter what kind of lipstick you put on a pig… it’s still a pig. And the US economy is clearly in a recession. It started with the housing market, spread to the credit markets, and will soon be spreading to consumer spending.

I expect 3Q08 and 4Q08 results for retailers will be abysmal. Sales for automobiles and other large expenditures have already plummeted. Retail and smaller consumer discretionary items are next. Might be worth establishing a few shorts in the sector.

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