A letter to Governor Dodge, Part 1

David Jensen P.O. Box xxxxx Sasamat Vancouver, B.C. V6R 4P2 December 21, 2007 David A. Dodge, Governor Bank of Canada 234 Wellington Street Ottawa, Ontario K1A 0G9 Dear Governor Dodge, Thank you for taking the time from your busy schedule to speak to the Vancouver Board of Trade. It was most enjoyable to once again make your acquaintance. I enjoyed the discussions that we had at UBC in the late 1990s and have followed with interest your progress at the Bank of Canada. I have pondered how to approach the following topic; one to which I have now dedicated more than 6,000 hours outside of my employ over the past 5 years. I have concluded that the best way to approach this matter is straight-up as it suits your temperament and mine as well. In your speech, you referred to the recent market turbulence as a re-pricing of risk after markets had become complacent after a period of excess. The implication is that the market is correcting itself as it should and that after a period of adjustment it will progress forward on a more stable footing. I believe that there is something profound underway with the subprime market turmoil representing an initial tremor in an approaching and severe correction in the world's capital markets. The market distortions inducing the current imbalance are difficult to perceive as two critical measures that provide critical reference points for economists and investors (and central banks) have themselves been distorted through intervention: The distortion of the measure of inflation calculated as the CPI as calculated not just in the US, but in Canada, Australia, and the Euro zone as well; and The price of gold. Let me first deal with the distortion of the CPI. John Williams is an economist who was retained by Boeing in the late 1980s to resolve problems with their key economic models that had functioned well for decades up to that point. Boeing requires accurate economic models to forecast accelerations and deferrals of its commercial aircraft to maintain a functioning production line. The Boeing 747, for example, has over 2 million part numbers with some lead-times over 2 years. If the supply chain is whipsawed by inaccurate forecasts, supply disruptions, as occurred at that time, quickly manifest themselves. What John Williams found was that the economic models worked fine. However inputs of inflation, which impact economic growth calculations, had been altered through adjustments in calculating the index by the Bureau of Labor Statistics (BLS) resulting in inflation being understated. Methods such as substitution effect, hedonics, owner-imputed rents for shelter costs, geometric vs. linear weighting, etc. had the effect of systematically understating inflation. When CPI inflation was calculated using the prior method used by the BLS, these economic models (and the resultant calculation of true economic growth and thus commercial aircraft demand) recovered their former high functionality. John Williams maintains a website www.shadowstats.com where he provides a calculation of inflation using a constant method initially utilized by the BLS before modifying it with the above noted methods. The SGS (shadow government statistics) calculation of CPI differs by 8% from the current CPI-U. We can see that the divergence from the BLS's original CPI calculation started mildly in 1982 and then strongly diverged in 1994/1995 just as Chairman Greenspan started announcing that inflation would decline due to internet related productivity improvements. As you can see in the following artic...

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