The Federal Reserve Board announced Thursday that from March 23, 2006 the Fed will cease publishing M3 money supply statistics. One thus wonders whether the U.S. political class has finally decided to hide economic failure by means of fraudulent accounting. Each new statistic would report stellar growth, with moderate inflation, increasing living standards and a stable financial system while in reality the majority of the population became poorer and economic decay morphed into collapse.

M3 money supply is crucial to the measurement of monetary policy. It was the explosion of M3 in 1971-73, and not any movement in price data, that demonstrated that President Richard Nixon’s price controls weren’t working and that inflation was getting out of control. It was by controlling M2 and M3 in 1979-82 that Fed Chairman Paul Volcker managed to bring that inflation back down to a level that the U.S. economy could live with. It was the abandonment of explicit money supply targets in 1993 which allowed M3 to begin increasing at more than 8 percent per annum, and led to successive bubbles in stocks and housing.

Commentators have hailed the appointment of incoming Fed Chairman Ben Bernanke as “ushering in an era of transparency” to quote Tracy Byrnes of TheStreet.com Friday. Bernanke believes in explicit inflation targeting, goes the argument, so the public will be able to see quickly whether his goals are being achieved or not. Even taking this idea at face value, it seems extraordinary that the first action of an “era of transparency” (for one assumes this change, which will happen on Bernanke’s watch, has at least been approved by him) is to abolish the statistic by which much of the economic community, including Nobel prizewinner Milton Friedman, believes that monetary policy can best be measured. Since when has it been transparent to cease revealing key data?

It is now clear that over a period of a decade, since the introduction of “hedonic” price indices, the political class has discovered the potential for economic statistics to be manipulated to suit its own ends. This is a bipartisan phenomenon, similar to the abuse of the decennial electoral redistricting process or of campaign finance legislation; the temptation is there and so the political class succumbs to it. In a way, it is surprising that it did not happen before.

The United States managed its economic policy quite well during the first 150 years of its existence without comprehensive economic statistics, and indeed without a central bank until the establishment of the Federal Reserve in 1913. The Fed collected some data on money supply from its inception, the Consumer Price Index was introduced during World War I for use in wage indexation, and national accounts were instituted as a tool of economic planning in the late 1940s.

However it was only in the 1980s and early 1990s that politicians came to focus on the links between reported economic statistics, Fed monetary policy, and the political calculus of elections, campaign finance and pork-barrel spending. Milton Friedman and Anna Schwarz demonstrated in 1963 that a largely accidental excessive contraction of the money supply by the Fed after the December 1930 bankruptcy of the Bank of the United States had been a major contributor to the Great Depression. Reported inflation soared in the 1970s, forcing up interest rates and damaging the real economy. Then Paul Volcker used tight monetary policy in 1982 to bring inflation under control, in turn producing considerable unpleasant political repercussions.

By 1992 it had become obvious to both political parties that reported economic statistics and interest rate trends played a major ongoing role in politics. President George H.W. Bush blamed his failed re-election bid in 1992 on excessively tight monetary policy, while President Bill Clinton’s campaign manager James Carville expressed in 1993 the wish to be reincarnated as the bond market because “you can intimidate everybody.”

With Wall Street obsessively analyzing economic statistics and Fed statements, and both bond and stock markets notoriously working off expectations rather than hard facts, it had become obvious even to politicians that if they could manage those expectations, they could produce for themselves a more comfortable political environment. In such an environment, interest rates would stay low, voters wouldn’t blame the political class for their troubles, and money for campaigns and pork-barrel spending would remain plentiful.

In the long run, reality would doubtless return to savage the American people, but in the long run, all politicians expect to become a Presidential museum, a hugely-paid lobbyist or a Nobel-winning philanthropist, leaving such problems to be sorted out by their successors. Meanwhile Wall Street, most of whose livelihoods depend on an ever rising, ebullient stock market, would assist politicians in keeping interest rates low and market conditions buoyant. Even the media, normally and rightly cynics where politicians are concerned, would get most of its data from politically controlled economic releases and from permanently bullish Wall Street analysts, and hence would itself assist in maintaining low interest rates and strong markets.

The problem thus became one of how to manage expectations so that the bond markets would remain tranquil, and money loose. The first step towards achieving this was to massage price indices. House price inflation, a problem during the 1970s, had already been taken out of price indices directly in 1980 and replaced with a “rental equivalent” factor that could be guaranteed to remain quiescent provided home rental rates remained under control. Low interest rates (making home buying attractive and reducing the supply of renters) and an ebullient housing market would assist greatly in achieving this.

A second suppressor of price indices was the 1996 change to “hedonic pricing” in which increases in chip capacity and processor speed in the tech sector could be deemed to reflect directly on the “hedonic” satisfaction received by consumers and thereby netted out from price inflation, regardless of the fact that only a small percentage of increases in chip capacity flow through to the performance of the gadgets themselves. This reduced reported price inflation by about 1 percent per annum, maybe 0.8 percent of which was spurious. It had the corollary benefit of increasing “real” GDP and productivity figures by the same percentage, thus enabling Alan Greenspan in July 1997 and thereafter to proclaim an era of more rapid productivity growth, justifying permanently higher stock multiples and lower real interest rates.

It is no coincidence that the U.S. Treasury’s introduction of Treasury Inflation Protected Securities in 1997 closely followed the introduction of hedonic pricing. Apart from directly reducing the borrowing cost on TIPS bonds, hedonic pricing also allowed commentators to use market TIPS yields to proclaim tighter “real” interest rates than was actually the case.

The third step was to focus public attention not on official inflation figures, even after hedonic pricing and the removal of housing, but on “core” inflation, stripping out oil, natural gas and commodity prices in which a free market operates, making them especially sensitive to gathering inflation pressures. Core inflation could expect to react sluggishly to excessively loose money. It would be further suppressed by hedonic pricing, which has a greater effect on core inflation than on reported inflation, because the tech sector is a larger percentage of the core than of the economy as a whole. While hedonic pricing suppresses reported inflation spuriously by about 0.8 percent, it can be expected to suppress core inflation by 1.2-1.4 percent.

Of course, the long run has a nasty habit of arriving in the end. The lengthy “productivity miracle” of the late 1990s had produced a stock market bubble that inevitably burst, and the flood of cheap money that removed the nastiest effects from the bursting stock market bubble inevitably produced a housing bubble. As the economy recovered and inflation began once more to appear money was kept loose by raising interest rates slowly, so that real interest rates remained negative, while the public focus on “core” inflation could disguise this fact, thus reassuring the bond market even when in September 2005 reported inflation for the preceding year reached 4.7 percent.

At this point, the political class introduced a new Fed Chairman, Ben Bernanke, who was intellectually inclined to worry far more about deflation than inflation. They made sure he was thoroughly attuned to the demands of politics by giving him a period as Chairman of the Council of Economic Advisors, and persuaded him that his belief in inflation targeting is best fulfilled by setting a not too aggressive target of 2 percent per annum on core inflation rather than reported inflation (otherwise, with reported inflation of 4.7 percent, short term interest rates would have to be jerked up to 7 percent immediately from their current 4 percent.)

There are still a few monetarists around, however, who examine money supply figures to determine whether monetary policy is loose or tight. M1 and M2 have been suppressed by careful definition management, so that new instruments such as money market funds are not included in them, thus allowing their growth to remain quiescent. M3, the broadest commonly used definition of money, includes money market funds, and has been rising by over 8 percent per annum in the last decade. More significantly, in spite of rising nominal rising short term interest rates, M3’s rise has been accelerating, to an annual rate of 11.5 percent in the 3 months to October 2005 – nominal rates may have risen, but real rates, compared to reported inflation, have been declining and monetary policy has remained very loose.

As was evidenced Friday, there’s a simple solution to this too – stop reporting the M3 money supply whose growth gives such embarrassing indications. Conspiracy theory, anyone?

We’ve seen this pattern of apparently attractive reported data concealing deep seated problems before. Last time, the culprit was Enron, which hived off unprofitable activities into special purpose subsidiaries, thereby reporting ever growing profits and becoming the seventh largest company in America. As cash flow became more scarce, the tricks became more egregious, and the distortions larger. Eventually, Enron ran out of cash and was forced to declare bankruptcy in November 2001.

The same must surely be true of a government that practices such chicanery with price and money supply data. While the combined forces of the U.S. government and Wall Street should be able to keep the balloon in the air for a considerable time, the funny-money bubble has already been inflating for a decade, and we may now be approaching the point at which the statistics can no longer be managed enough to keep it inflated.

On the Enron timetable, it may not yet be November 2001 for the U.S. economy. It may not yet even be August 2001, when Enron CEO Jeff Skilling mysteriously resigned and the stock began to drop precipitously. But Enron stock peaked at $90 per share, for a market capitalization of $270 billion, in July 2000.

Even using spurious data, the U.S. economy’s long growth trend since 1982 is surely past its peak. Is the United States therefore within 16 months of economic collapse?

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

This article originally appeared on United Press International.