There is no shortage of villains being accused of igniting the financial brushfire raging across Wall Street: the housing bubble, misguided interest rate policy, poor regulation, numbskull credit ratings agencies, vicious short-sellers and out-of-control personal greed are a few suspects.

Maybe they're all to blame. But what if the underlying problem goes far beyond the financial sector? What if the US economy has just been a lot worse than was thought for a long time and now the chickens are coming home to roost?

That's the dark thinking beyond what is known as Pollyanna creep, a phrase coined by an economist named John Williams. He runs a website called Shadowstats.com that trades in the idea that some key US government statistics have become so optimistically misleading as to become useless. Now, this might sound a bit like a plotline from one of those Matrix movies - we're all living in an illusion to inure us from dire reality. But given what's gone on with Freddie and Fannie, Lehman, Merrill, AIG, Washington Mutual and more, it doesn't sound so fringe.

Indeed, over the past few years, some of Mr Williams's views on economic indicators - the consumer price index, in particular - have been echoed by better-known and leading investment community figures, such as the bond investor Bill Gross, the strategist Stephen Roach and James Grant.

“The numbers are misleading, and Wall Street uses the numbers to help sell their products,” says Mr Williams, whose chief bugaboos, in addition to the CPI, are GDP and unemployment rates. “Recently, I'd contend that what we've been getting is absolutely junk on the GDP,” he says, despite recent official figures that US GDP grew 3.3 per cent in the second quarter. “There's no question that we're in a recession and probably have been in one since the last quarter of 2006. It didn't start with the housing mortgage crisis.”

According to Mr Williams, all the big measures have had their methodologies revised over the past few decades to paint the US economy in the best possible light. However, he says, changes in methodology were always spelt out at the time - with rationales for doing so - thus it's not as though this has gone on in the dark of night.

In his recently published and rather depressing book, Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism, one-time Nixon White House advisor Kevin Phillips discusses Pollyanna creep as part of an era of “bullnomics: the pied-piping of America toward a misleading financial ideology [the efficiency and reliability of markets], buttressed by a spectrum of dubious thinkers, doctrines and enablers”. In popular culture, he notes, this coincided with a surge in self-help and get-rich media, perhaps best exemplified by the 2007 bestselling book, The Secret, which effectively argued that you can make money by imagining it.

More practically, he writes that some of the biggest changes to CPI calculation happened between 1997 and 1999 “while the public and the politicians were preoccupied by bull market euphoria and the actions in Congress to impeach Bill Clinton”. In their effort to reduce social security outlays - and buttressed by a belief that CPI in fact overstated inflation - Alan Greenspan and others implemented some controversial modifications that factored in such issues as “hedonics”: an abstruse way of measuring increased satisfaction from goods. (Example: as described in a 2005 Wall Street Journal story, a specialist in the Bureau of Labor Statistics (BLS), which compiles the CPI, adjusted the price of a $329.99 TV down to $194.99 after concluding that an improvement in the quality of its screen over a previous model of the same size was worth at least $135. The TV still cost $329.99 retail, but the CPI recorded it as being worth nearly 30 per cent less.)

Pollyanna creep did not arise from any single decision, nor was it the product of a conspiracy. It's not unlike the advent of “earnings before one-time items” reporting in the private sector - an accountancy practice virtually unheard of 20 years ago but which has become commonplace and presents a rosier view of a company's performance. These practices are accepted because they suit the purposes of all involved. But that doesn't make them the right thing to do.

Four years ago, the bond investor Bill Gross, of Pimco, made waves when he published a newsletter calling the CPI an “haute con job”. He recently penned an update, arguing that it was hard to reconcile America's reported CPI rates with the much higher rates from a basket of 24 other countries. Noting that he does not write for a “conspiracy blog,” Gross went on: “Just as many in the global economy are refusing to mimic the American-style fixation with superficialities in favour of hard work and legitimate disclosure, investors might suddenly awake to the notion that US inflation should be, and in fact is, closer to worldwide levels than previously thought.”

On its website - in a section about “misconceptions” about the CPI - the BLS debunks the debunkers. “The improvements chosen by the BLS that some critics construe to be a response to short-term political pressure were, in fact, the result of analysis and recommendations over decades, and those changes are consistent with international standards for statistics,” the bureau says.

The Pollyanna creep crowd, naturally, is not buying it and this week they may have some currency. And amid all the talk of financial markets clean-up, the debate over whether the biggest economic indicators are as useful as they should be may be a can of worms worth reopening.

— Richard Siklos is an editor-at-large at Fortune magazine

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