JOHN WILLIAMS’ SHADOW GOVERNMENT STATISTICS

 COMMENTARY NUMBER 281
General Update, GDP, Durable Goods

February 26, 2010

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69% of 4th-Quarter’s 5.9% "Boom" Due to Nonfarm Inventories

Economic and Financial Crises Are Not Over

Fed Still Panicking Despite Happy Talk

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PLEASE NOTE: The planned brief economic general update for Tuesday is incorporated in today’s text. With near-term writing disrupted somewhat by a heavy-hitting new seasonal malady, a full update on the markets is planned tentatively for early next week, with one on the economy for the week following (post-February jobs report).  The next regular Commentary is scheduled for Friday, March 5th, following the release of that February employment/unemployment report. The report on the U.S. Treasury’s 2009 GAAP-based financial statements for the U.S. government is scheduled for release around "four-ish" this afternoon (Eastern Time), after the markets in New York close for the week and the month. Assuming it is so released, a special Commentary will follow over the weekend.

– Best wishes to all, John Williams 

It Is Not Over. Underlying economic and financial fundamentals signal and suggest ongoing economic contraction and continued financial system instability. Despite the relatively happy talk out of the Fed in the last several weeks as to systemic stability, Mr. Bernanke continues to behave as though he has a serious problem. Consider the latest surge in the monetary base.

Chart of Monetary Base

Shown is the St. Louis Fed’s Adjusted Monetary Base, seasonally-adjusted, where the base surged by $90 billion dollars (an annualized 198% pace of increase) in the two weeks ended February 24th, to a record $2.184 trillion. The prior record high had been in the prior two-week period. 

The monetary base — currency in circulation plus bank reserves — is the Fed’s primary tool for adjusting broad systemic liquidity, as measured by the money supply. Yet, the SGS Ongoing M3 Estimate — M3 once was the Fed’s broadest money measure — still is on track for a deepening annual contraction in February 2010. Since November 2009, annual real M3 (net of CPI-U inflation) has been in a deepening contraction, signaling an intensifying economic downturn in the months ahead (see Commentary No. 277).

As a result, economic reporting increasingly will surprise the markets to the downside. Recent surprises in weaker home sales, new jobless claims and consumer confidence have not been of substance, but negative market reactions to those numbers likely foreshadow significant negative market reaction as the general outlook shifts, from one of ongoing economic growth and recovery, to one of renewed recession.

As discussed in recent Commentaries, the best picture from the better quality series is one of ongoing bottom-bouncing. Consumers account for more than 70% of GDP, yet growth in personal consumption cannot be sustained without growth in inflation-adjusted income. Short-term gain can be had, however, through debt expansion, but consumer credit is contracting, and actual, disposable consumer income is not keeping up with inflation.  This is a long-term structural problem, and, until it is addressed, there can be no economic recovery. 

Short-Lived Boom Times. Six-percent growth is considered an outright economic boom, but few believe the current economy is booming, despite the revised report of official 5.9% annualized growth in the fourth-quarter GDP. As discussed later, most of the reported growth was due to relatively stronger nonfarm inventories, yet the inventory improvement is not supported by strong orders. When consumption fails to support production and inventories build-up, manufacturers tend to cut back production, and GDP falls. While I do not find the reported current quarterly gain credible, it is in place, and it sets up renewed quarterly contractions beginning as early the current quarter. Such would be viewed popularly as a double-dip recession.

Consensus economists, Wall Street and political Washington nonetheless continue touting the end of the recession. Yet, the longest and deepest economic downturn since the first downleg of the Great Depression still has some time to run. Although a continuing (renewed) downturn quickly may gain popular recognition as a double-dip recession, not popularly recognized is my contention that that the "brief" 2000 recession, from March to November 2001, which has been revised away in GDP reporting, was much longer and deeper than officially claimed, and that the current downturn already is the second-dip of a multiple-dip depression than began in late-2000. 

More-protracted-than-official-recession timing is evidenced by the ongoing recessionary behavior of industrial production and payrolls — coincident indicators of broad economic activity — from late-2000 until well into 2004. Those same indicators were showing recessionary activity again by early-2007, where the official timing of the current recession started with December 2007. This area will be explored further in the upcoming full economic update planned for the week of March 8th.

GDP-Related Definitions. For purposes of clarity and the use of simplified language in the following text, here are definitions of key terms used related to GDP reporting:

"Gross Domestic Product (GDP)" is the headline number and the most widely followed broad measure of U.S. economic activity. It is published quarterly by the Bureau of Economic Analysis (BEA), with two successive monthly revisions and with an annual revision the following July.

"Gross Domestic Income (GDI)" is the theoretical equivalent to the GDP, but it is not followed by the popular press. Where GDP reflects the consumption side of the economy and GDI reflects the offsetting income side. When the series estimates do not equal each other, which almost always is the case, the difference is added to or subtracted from the GDI as a "statistical discrepancy." Although the BEA touts the GDP as the more accurate measure, the GDI is relatively free of the monthly political targeting the GDP goes through.

"Gross National Product (GNP)" is the broadest measure of the U.S. economy published by the BEA. Once the headline number, now it rarely is followed by the popular media. GDP is the GNP net of trade in factor income (interest and dividend payments). GNP growth usually is weaker than GDP growth for net-debtor nations. Games played with money flows between the United States and the rest of the world tend to mute that impact on the reporting of U.S. GDP growth.

"Real" means growth has been adjusted for inflation.

"Nominal" means growth or level has not been adjusted for inflation. This is the way a business normally records revenues or an individual views day-to-day income and expenses.

" GDP Implicit Price Deflator (IPD)" is the inflation measure used to convert GDP data from nominal to real. The adjusted numbers are based on "Chained 2005 Dollars," at present, where the 2005 is the base year for inflation, and "chained" refers to the methodology which gimmicks the reported numbers so much that the total of the deflated GDP sub-series misses the total of the deflated total GDP series by nearly $40 billion in "residual" as of second-quarter 2010.

"Quarterly growth," unless otherwise stated, is in terms of seasonally-adjusted, annualized quarter-to-quarter growth, i.e., the growth rate of one quarter over the prior quarter, raised to the fourth power, a compounded annual rate of growth. While some might annualize a quarterly growth rate by multiplying it by four, the BEA uses the compounding method, raising the quarterly growth rate to the fourth power. So a one percent quarterly growth rate annualizes to 1.01 x 1.01 x 1.01 x 1.01 = 1.0406 or 4.1%, instead of 4 x 1% = 4%.

"Annual growth" refers to the year-to-year change of the referenced period versus the same period the year before. 

Inventories Generated "Boom" Growth. Relatively stronger nonfarm inventories accounted for 4.09 percentage points, or 69.0%, of the revised 5.93% annualized growth rate reported for fourth-quarter GDP. That was up from 3.61 percentage points (63.0%) of the 5.73% growth rate reported initially. As discussed in the opening comments, without demand to support production, inventories eventually would be wound down, sapping growth from future GDP reporting.

GDP.  The "second" estimate (first revision) of fourth-quarter 2009 Gross Domestic Product (GDP) released this morning (February 26th) by the Bureau of Economic Analysis (BEA) showed an annualized real growth rate of 5.93% (initial estimate of 5.73%) +/- 3% (95% confidence interval). Such followed a 2.24% gain reported for third-quarter GDP. The year-to-year change in real fourth-quarter GDP revised to a gain of 0.15% (previously up by 0.10%), following a 2.64% contraction in the third-quarter. The numbers are of such poor quality at this point that the BEA still is not publishing initial estimates of Gross National Product (GNP) or Gross Domestic Income (GDI) for the quarter or for the year.

The aggregate revision was little more than statistical noise, with the upside revision reflected fully in a downside revision to GDP inflation (the implicit price deflator). The annualized fourth-quarter GDP deflator revised to 0.36% from 0.60% in the initial estimate. Just-revised seasonally-adjusted CPI-U data showed reduced annualized CPI inflation in the fourth-quarter at 2.62%, versus 3.69% in original reporting (inflation was thrown back into the second quarter; see Commentary No. 280), but any related impact on GDP reporting should not show up until the July 2010 annual GDP revisions, since the adjustments affect multiple quarters. The annualized third-quarter GDP implicit price deflator effectively was zero (-0.02%), while the annualized third-quarter CPI revised to 3.69% from 3.60%. Generally, the weaker the inflation rate used in deflating the GDP, the stronger is the resulting "real" GDP growth.

The GDP series remains largely worthless in its early reporting and heavily gimmicked in both short- and long-term reporting. Consider the net export account mentioned in recent commentaries. Last month’s "advance" estimate lacked December trade data to complete the fourth-quarter estimate of net exports, where a wider deficit is a net negative for GDP reporting. Despite the October and November data — seasonally- and inflation-adjusted by the BEA — suggesting a deteriorating fourth-quarter deficit in goods trade, the "advance" estimate of GDP reflected an annualized $12.2 billion improvement in the goods deficit in "net exports." When the December trade data were reported, the quarterly goods data indeed showed an annualized deterioration, one of $20.0 billion, but such translated not into a decline, but only to a smaller $5.5 billion improvement in the goods portion of the net exports account. Had the net exports deteriorated by the otherwise reported $20.0 billion, the 5.93% GDP growth rate would have been 5.11%. Only the goods data can be assessed here, because the services side of the trade data basically is a guess.

In any event, the small overall quarterly revision had minimal impact on the annual GDP numbers. For 2009, real GDP fell by a revised 2.42% (previously 2.43%), following a 0.44% gain 2008. The 2009 real decline remained the deepest since the war-end production shutdown in 1946, which showed a 10.94% annual contraction. In nominal terms — the way companies usually track their sales and people count their income — 2009’s 1.27% (unrevised) annual decline was the worst since a 6.31% decline in 1938, during the second dip of the Great Depression. Nominal GDP rose by 2.58% for the year in 2008.

The SGS Alternate-GDP estimate for fourth-quarter 2009 remains an annual contraction of 4.6% versus the official estimate of a 0.1% gain, less-negative than the annual 5.7% (2.2% official) estimated contraction in the third-quarter. While annualized real quarterly growth is not formally estimated on an alternative basis, a flat quarter-to-quarter circumstance, plus or minus, likely would have been realistic, reflecting the bottom-bouncing at low levels of activity seen for much of the last year in key underlying economic series. Given the fourth-quarter inventory problems discussed earlier, renewed quarter-to-quarter contraction in the GDP as of first-quarter 2010 remains a strong bet.

GNP and GDI. The initial estimated of Gross National Product and Gross Domestic Income for the fourth quarter should be published at the end of March, along with the third-estimate of fourth-quarter GDP. Since this reporting closes out the year, and since the early estimates are without substance, the BEA tends to hold off as long as possible with these numbers, even though they are tied to the GDP estimates.

Despite Some Gains, New Orders for Durable Goods Still Bottom Bouncing. The Census Bureau reported yesterday (February 25th) that the regularly volatile, seasonally-adjusted new orders for durable goods jumped by 3.0% in January, versus December, following an upwardly revised monthly gain of 1.9% (initially a 0.3% gain) in December. Unadjusted, year-to-year change in January new orders was a gain of 9.9% following a revised 2.0% decline (previously down by 3.1%).

The widely followed nondefense capital goods orders rose by 4.7% for the month, following a revised 2.5% gain (previously a 0.2% decline) in December. Year-to-year orders were up by 17.7%, following a revised 0.6% (previously 2.5%) annual decline.

All of the January gain in total new orders and part of the December revisions were due to increased aircraft sales, which usually are erratic and get stretched out in years, in terms of delivery. Net of the aircraft sales, January orders fell by 0.6%. The volatility in aircraft orders is one reason for viewing the series smoothed over a six-month moving average.

Motor vehicle production has been a major contributor to recent positive economic reporting, yet January new orders here fell by 2.2% for the month, and were only 1.0% ahead of where they were a year ago. The gain in December motor vehicle orders, however, revised higher to 5.5% from an initial 3.6% increase.

Chart of New Orders for Durable Goods

 

The general pattern of the series — before adjustment for inflation — remains one of bottom-bouncing. Against an average monthly level of $165.6 billion since last December, the January 2010 level of $175.7 billion remains within the realm of normal month-to-month volatility, if considered in the context of the long-term aircraft sales.

Week Ahead. Given the underlying reality of a weaker economy (and likely re-intensifying downturn in the coming months) and more serious inflation problems than generally are expected by the financial markets, risks to reporting will tend towards higher-than-expected inflation and weaker-than-expected economic reporting in the months ahead. Such is true especially for economic reporting net of prior-period revisions.

GAAP-Based Financial Statements of the U.S. Government (Fiscal-Year 2009). The Treasury’s GAAP financial statements are scheduled for release this afternoon, February 26th, around 4 p.m. New York time. The statements were delayed, without explanation, from the regularly scheduled release date of December 15, 2009 to mid-February, and then again due to weather disruptions. A Reporting Focus Commentary will follow after I have had a chance to assess the report. A table of what I expect in the summary reporting is available in the Hyperinflation Special Report.

Employment/Unemployment (February 2010). The February employment and unemployment estimates are scheduled for release on Friday, March 5th. Briefing.com reports consensus estimates of the unemployment rate rising to 9.8% in February from 9.7% in January, with payroll employment expected to lose 20,000 jobs for a second month. I would expect both a higher unemployment rate and deeper payroll decline than the consensus forecasts, given among other issues catch-up in bad seasonal factors and renewed slowing in the general economy. An updated outlook on the employment/unemployment report will be published next week as detail from related series becomes available.

 

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