JOHN WILLIAMS' SHADOW GOVERNMENT STATISTICS


Issue Number 13A


November 21, 2005

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Severe Political Manipulation of Key Data Underway


Alternate Government Jobs Data Suggest Katrina-Impact Reporting Fraud


Fed Discontinues Vital Inflation/Monetization Measure


Inflation Jumps to Early-1980s Levels as Recession Signals Increase


To my knowledge, weighed against various political games played with economic reporting during the Johnson, Nixon, Bush I and Clinton administrations, the present state of affairs is without domestic precedent. There may be manipulation parallels in Communist China and the former Soviet Union, but not in the United States.

In the practiced propaganda of totalitarian states, the lack of alternative information makes it difficult to quantify the manipulations. While most everyone accepts that the data are rigged, even talking about data manipulation can be dangerous to one's well-being.

In contrast, what is happening with the U.S. statistics can be demonstrated with alternate data sources -- often from within the government -- yet the phony numbers appear to have broad public acceptance within the financial community, despite occasional questions raised in the free press. As usual, broad financial-community public acceptance of the data is more related to business self-interest than to an honest public assessment of economic conditions.

Indeed, it is the best of times and the worst of times, depending on which economic releases one reads. Unfortunately, underlying economic reality continues to support the latter outlook. While the latest GDP, employment and CPI reports showed stable to robust economic activity with contained "core" inflation, retail sales joined other key SGS indicators signaling or confirming recession.

Beyond distortions from Hurricane Katrina, the weakening economy also was evident in housing starts, consumer confidence, industrial production, new claims for unemployment insurance and the trade deficit. On the pricing front, official CPI inflation pushed to a 15-year high, while SGS Standard Inflation and gold prices are nearing highs last seen in 1982/1983, and PPI inflation is the highest since 1981.

Joint exorcisms were performed by the Bureaus of Economic Analysis and Labor Statistics (BEA and BLS) on the most popular September and October economic releases in an effort to purge recent statistics of the unwholesome influence of Hurricanes Katrina and her somewhat less-malevolent sisters, Rita and Wilma. These are manipulations well beyond the institutionalized gimmicked methodologies designed to overstate business activity and understate inflation, as discussed in the background articles available on the SGS home page. These are actions of a politically-desperate administration.

Further, the exorcisms have not been limited to cabinet-level statistical bureaus. The Board of Governors of the Federal Reserve System has performed an unnatural act, where the U.S. central bank announced it would cease publishing M3 -- its broadest measure of the money supply. It is as though the Wall Street Journal suddenly announced it was ceasing publication of the Dow Jones Industrial Average.

The Fed's explanation for the action, as obtained by Gillespie Research Associates, blamed the series' lack of relevance and its high maintenance cost. Such is nonsense. More likely, the Fed does not want the public to see what it is about to do to the money supply under presumptive Fed Chairman Bernanke. (See also "Bye-Bye, M3, but Why?")

All these issues, including the Fed's explanation of the move and M3's unique relationship to inflation and economic growth will be explored in depth in a special SGS supplement due for publication in the next several business days.

Although the administration declared its numbers to be clean and healthy, following the exorcisms, signs of statistical reporting fraud in the cleansed data have surfaced in other statistics. With President Bush's approval rating falling to uncharted depths, his political operatives must be incredibly desperate and inept to try to hide economic problems that can be blamed, at least partially, on a natural catastrophe. Yet the evidence is strong that they are doing exactly that.

The alternate employment measure of official nonfarm payrolls by state (see April 2005 SGS "Reporting Focus"), published by the BLS, shows that aggregate seasonally adjusted payrolls fell by 279,000 in September. The numbers included payroll declines in Louisiana, Mississippi and Alabama of 251,000, 60,000 and 5,000, respectively. That means that net of perhaps 316,000 jobs lost to Hurricane Katrina, the rest of the economy only created 37,000 new jobs in September, per this little-followed report.

What was reported in the officially cleansed versions? Despite market expectations of a 150,000 to 200,000 drop in seasonally-adjusted September 2005 payroll employment, the monthly jobs loss was reported initially at just 35,000, or 244,000 shy of the decline seen when the same numbers were totaled on a state-by-state basis.

Of course, the first official reporting was released on October 7th, but the state-by-state breakout was not published until October 21st. Hence, the more dire numbers reflected later and better information, perhaps? Not a chance! The October employment report, which followed on November 4th, showed that September payrolls declined by only 8,000, in revision! Neither the official September nor the October national payroll or household surveys gave any detail on Katrina impact. The official data are as though the storm never took place.

On a basis similar to the aggregated state nonfarm payroll data, the aggregated state household survey data showed a seasonally-adjusted September unemployment rate of 5.21% instead of the official 5.10%, but the reporting also shed some light on why unemployment was not higher. In addition to the 138,000 increase in unemployed people in Louisiana and Mississippi, there were another 198,000 who lost their jobs in September, but who were not counted as unemployed. Since they were assumed to be coping with effects of Katrina, instead of searching for jobs, these people were just removed from the labor force count. Had they been counted as unemployed, the September unemployment rate would have been 5.33%, nationally.

Then there is the first estimate of third-quarter GDP that showed annualized, inflation-adjusted growth jumping to 3.8% in the third quarter, from 3.3% in the second quarter. Rather than damage third-quarter GDP, as might be deduced from the August and September industrial production numbers, Katrina looks it helped growth in the July to September period. How such could be possible is for politicians, not economists, to explain.

Over the same quarter, Katrina and Rita were blamed by the Federal Reserve for largely knocking the growth out of August industrial production and forcing a 1.5% contraction in September production. As a result, annualized industrial production growth slipped from 1.7% in the second quarter to 0.9% in the third. Slowing industrial production rarely accompanies accelerating GDP growth.

One of the simpler issues with the bogus spurt in GDP strength is that the inflation rate used to deflate the GDP in the third quarter was just 3.1%, compared to 5.1% for the annualized third-quarter CPI. The difference is that a 5.1% deflator would have slowed reported GDP growth to 1.8%.

Finally, among the big three economic releases, the recent CPI has included a fair representation of rising energy prices. Yet, somehow, energy costs have not been able to make their way through to other goods in the CPI. Some comments from those participating in the October purchasing managers survey included thoughts such as "most price increase letters I have ever seen," and "concern over the price of oil and its effect on the future prices of commodities ... we are seeing some significant price increases..." There is little question that the so-called "core" inflation is rising as a result of the broad reach of oil prices within the economy. The question is when such will begin showing up in CPI reporting.

In the private sector, here's an update on what may have been an unsuccessful exorcism by the Conference Board of the Leading Economic Indicators (LEI), formerly published by the U.S. government. As discussed in the August SGS, the Conference Board revised its methodology with the effect of scuttling an existing recession signal and warning. They're back! What used to be a traditional recession signal was generated by the revamped indicators, when September showed a third consecutive monthly decline.

Consensus estimates are for the October LEI to rebound strongly in reporting due today, but there is a lesson here for manipulators. So long as the reported data have some anchoring in actual numbers, eventually they will tend to pick up underlying bad news in some detectable form.

Data and reporting distortions due to the hurricanes still are ongoing and can be severe, with the impact on the numbers not necessarily obvious. For example, the previously reported four-point plunge in August's help-wanted advertising to a level of 35 turns out to have been no more than an artifact of data gathering problems. The August level revised to 38, when September was reported up a point to 39. While similar massive revisions may await recent government reporting, the example of the different nonfarm payrolls shows that different data were available to the BLS and suggests a deliberate decision by someone in the administration to beef-up the publicly-followed post-Katrina numbers.


UPDATED RECAPITULATION OF THE CURRENT OUTLOOK

In general, the broad economic outlook has not changed. The 2005 to 2007 inflationary recession continues to deepen, and its near-term development was intensified a bit by Katrina. Recession, inflation and risks of dollar selling are upon us and continue to offer a nightmarish environment for the financial markets.

The Shadow Government Statistics' Early Warning System (EWS) was activated in May and signaled the onset of a formal recession early in July 2005. The EWS looks at historical growth patterns of key leading economic indicators in advance of major economic booms and busts and sets growth trigger points that generate warnings of major upturns or downturns when predetermined growth limits are breached. Since the beginning of 2005 a number of key indicators have been nearing or at their fail-safe points, with four indicators moving below those levels, signaling a recession. Once beyond their fail-safe points, these indicators have never sent out false alarms, either for an economic boom or bust.

Negative GDP growth will not surface in regular government reporting until 2006, now that it is clear that Katrina's impact is being neutralized in official reporting. The National Bureau of Economic Research (NBER) should time the downturn to mid-2005 and announce same sometime in early-to-mid 2006. The popular financial media will begin to debate whether there is a recession underway by late 2005. Those Wall Street economists who act as shills for the market will keep up their "strong growth is just around the corner" hype regardless of any and all evidence to the contrary.

From the standpoint of common experience, this downturn will be considered the second leg of a double-dip recession, not an independent contraction as will be claimed officially.

Most economic data already are softening, and the trend will accelerate sharply, with regular monthly contractions seen for both payroll employment and industrial production, net of the short-term hits from Katrina. Political manipulation, can keep the payroll data afloat for a while longer. Significant deterioration also will be seen in corporate profits and federal tax receipts. Lower tax receipts will combine with disaster recovery spending and the ongoing war in Iraq to accelerate deterioration in the federal deficit.

This outlook is predicated on economic activity that already has taken place and does not consider any risks from exogenous factors such as renewed terrorist activity in the United States, another major natural disaster or a financial panic as the markets.

Market perceptions of the downturn in business activity are mixed. When expectations begin to anticipate weak data, expectations also will be lowered for inflation, although stagflation seems to be gaining in some consensus thinking. Consensus forecasts generally still will tend to be surprised on the downside for economic reports, and on the upside for inflation reports, for some time to come.

The roots of the current difficulties are structural in nature. A consumer starved of income growth and overburdened with debt cannot sustain the real (inflation-adjusted) growth in consumption needed to keep GDP growth in positive territory. The income weakness is a direct result of the loss of a significant manufacturing base to offshore locations and the ensuing explosive, perpetual growth of the U.S. trade deficit.

Exacerbating economic and financial woes will be unusually high inflation during this contraction. Inflation, fueled by high oil prices, weakness in the U.S. dollar and accelerating Fed monetization of federal debt, will not be brought under control simply by weakness in economic demand. Instead, persistently high prices only will serve to intensify the 2005 to 2007 recession, making it unusually long and protracted. Ongoing inflation woes and dollar problems will maintain upside pressure on long-term interest rates, inhibiting the traditional flattening of the yield curve expected with a recession.

Risks of the current circumstance evolving eventually into a hyperinflationary depression are extraordinarily high.

The unfolding inflationary recession remains the worst of all worlds for the financial markets. Particularly hard hit will be the U.S. dollar, with downside implications for both equity and bond prices.

THE BIG THREE MARKET MOVERS

(Each of these series is explored in the background article "A Primer On Government Economic Reports," available on the home page.)

As discussed in this month's opening comments, while there is ongoing impact of three severe hurricanes on a number of economic series, the employment, GDP and CPI data apparently are being cleansed so as to remove as much bad news as possible.

The big three market movers are the focus of the manipulation/propaganda blitz. Accordingly, reported results will have less than usual relevance to actual underlying activity, and upcoming reporting likely will be more determined by political need than the economic factors that sometimes drive results.

Employment/Unemployment -- Net of Hurricane Katrina impact, payroll growth has been statistically indistinguishable from no growth or outright contraction in the last two months. Given the state-by-state payroll aggregations discussed in the opening comments, 37,000 jobs seems a reasonable estimate for nonfarm jobs creation in September, while October's report showed a 56,000 increase. Both those numbers are well within the +/- 108,000 90% confidence interval published by the BLS. Changes in the unemployment rate also continue to be statistically insignificant, while shifting assumptions on issues such as whether an unemployed hurricane victim is unemployed continue to skew the numbers.

The popularly followed unemployment rate U-3 for October eased to 4.95% from 5.10% in September, seasonally adjusted, within the published +/- 0.2% error margin. Unadjusted U-3 unemployment eased to 4.6% in October from 4.8% in September, while the broader U-6 unemployment measure declined from September's 8.5% to 8.1%. October's seasonally-adjusted U-6 rate also notched lower to 8.7% from September's 9.0%. Including the long-term "discouraged workers" defined away during the Clinton administration, total unemployment remains roughly 12%.

For October, the household survey showed a seasonally-adjusted 214,000 increase in household employment (the number of people with at least one job), following a 17,000 decline in September's number.

October payrolls showed a seasonally-adjusted gain of 56,000 (20,000 net of revisions) +/- 108,000 after September's official loss, including Katrina impact, of 8,000 (previously a loss of 35,000). Annual growth in payrolls continued easing in a recession-like pattern, declining from a near-term peak of 1.79% in August, to 1.67% in September, to 1.43% in October.

October's payroll gain of 56,000 included an upward bias of 37,000 jobs from the "net birth/death" adjustment to potential reporting entities, a level down from the prior year's 55,000 upside bias.

October's employment/unemployment data were against a background of uncertain September help-wanted advertising, mixed softness in employment as reported in the various October purchasing managers surveys, and a continued monthly deterioration in new claims for unemployment insurance (see the respective sections).

Next Release (December 2): November payrolls and unemployment reporting still are likely to be dominated by BLS manipulations. While underlying reality suggests continued deterioration in the jobs market, it is possible there will be an upside surprise in new jobs created, as part of an unfolding attempt at creating a statistical economic "miracle" for the Bush administration, coming into the mid-term election year.

Looming in the January 2006 employment report (due February 3rd) is the annual benchmark revision for March 2005. A downward adjustment of 191,000 will be made to unadjusted March 2005 payrolls, along with estimated monthly revisions spread out on both sides of the benchmark month.

Gross Domestic Product (GDP) -- The "advance" estimate of annualized inflation-adjusted growth for third-quarter GDP came in at 3.80%, up from 3.31% reported in the second quarter. Annual growth slowed slightly to 3.56% from 3.59% in the second quarter.

As noted in the opening comments, the inflation rate used in deflating the GDP was unusually low for the quarter, 3.1% for the full GDP against 5.1% for the CPI annualized for the third quarter over the second quarter. Other reporting issues aside, if the deflator were understated by 2.0%, then real growth would have been overstated by 2.0%. The resulting drop in third quarter real growth to 1.8% would have been more consistent with other data, though still far from reality.

Given the combination of long-term upside methodological biases built into the GDP and the deflation issues, an actual quarterly contraction of one percent in third-quarter GDP would have been credible.

Next Release (November 30): The "preliminary" estimate revision for third-quarter GDP should tend to weaken somewhat, given the larger than expected trade deficit in September. Nonetheless, with politics driving the reporting, little is likely to dampen the happy numbers of the initial estimate.

Consumer Price Index (CPI) -- The post-Katrina seasonally-adjusted September CPI-U increased by 1.2% (1.2% unadjusted), with October up by 0.2% (0.2% unadjusted), following August's 0.5% jump. September's annual inflation rate was 4.69%, the highest reading in 15 years, up from August's year-to-year inflation of 3.64%. October's annual inflation eased to 4.35%

The "experimental" Chained Consumer Price Index (C-CPI-U), the fully substitution based CPI that presumably is the eventual replacement for current CPI reporting, showed annual inflation at 3.52% in September and 3.32% in October, both up from 2.99% in August.

Adjusted to pre-Clinton methodology, annual CPI growth would be about 7.2% as of October. As shown in the table below, the SGS Standard CPI, net of all the methodology changes of the last 30 years designed to suppress inflation reporting, broke 8.4% in September.
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               COMPARATIVE ANNUAL INFLATION RATES -- SGS VERSUS BLS
              ------------------------------------------------------
                                          SGS       BLS       SGS
                                BLS     Standard    Core      Base
                              CPI-U[1]   CPI[2]   CPI-U[3]  CPI-U[4]
              ------------------------------------------------------
                  2005
                  ----
                October         4.3%      8.1%      2.1%      4.7%
                September       4.7%      8.4%      2.0%      5.1%
                August          3.6%      7.3%      3.1%      4.2%
              ------------------------------------------------------
               Sources: Shadow Government Statistics (SGS), Bureau
               of Labor Statistics (BLS). [1]Year-to-year change in
               unadjusted CPI-U. [2] Approximation of SGS Standard
               CPI, using CPI-U cleansed of BLS methodological "im-
               provements" of the last 30 years. [3] Year-to-year
               change in unadjusted CPI-U, ex food and energy, net
               of inflation in major necessities. [4] Year-to-year
               change in unadjusted CPI-U, ex computers, new autos
               and recreation, based on BLS data, cut down to of-
               ficial inflation in the necessities of life, which
               still woefully understates reality.
              ------------------------------------------------------
Contrasted with the 2.1% annual Core CPI-U inflation rate that excludes the necessities of food and energy, the SGS Base CPI-U that includes only the necessities was up 4.7%. The latter rate, however, still suffers the standard CPI-U understatement.

Next Release (December 15): Inflation reports generally should surprise consensus forecasts on the upside, with "core" inflation increasingly reflecting the pressures from oil prices. The November CPI likely will fall, though, as the recent sharp sell-off in gasoline gets over-counted in the current data. Despite occasional one-month swings, annual inflation will remain high and should begin to accelerate to the upside, again, by early 2006. With last year's seasonally-adjusted monthly inflation reported at 0.3% for November, monthly November 2005 inflation above or below that will move the reported annual inflation in tandem.


OTHER TROUBLED KEY SERIES

To varying degrees, the following series have significant reporting problems. All series (including the more trouble free) will be addressed in a monthly "Reporting Focus," with the this month's analyses split into two separate supplements, the first covering the Fed's abandonment of M3, the second being Part II of the introduction of the Shadow Government Statistics Standard CPI alternative to the CPI-U.

In addition to the big three, other series that have been detailed are "The Federal Deficit" (an original background article and an update in the "Alert" of July 7, 2005), "Consumer Confidence" (November 2004 SGS), "The Trade Balance" (December 2004 SGS), "Industrial Production" (January 2005 SGS), "Initial Claims for Unemployment Insurance" (February 2005 SGS), "Retail Sales" (March 2005 SGS), "Alternate Payroll Employment Measures" (April 2005 SGS), "Money Supply - Part I/SGS Early Warning System" (May 2005 SGS), "Money Supply - Part II" (June 2005 SGS), "Financial- and Trade-Weighted U.S. Dollar Indices" (July 2005 SGS), "Short-Term Credit Measures" (August 2005 SGS), "Income Variance/Dispersion" (September 2005 SGS), and "CPI" (an original background article, as well as October 2005).

Federal Deficit -- The official, accounting-gimmicked 2005 U.S. budget deficit (fiscal year-ended September 30th) was $318.6 billion, down from 2004's $412.8 billion. Better reflecting actual net cash outlays, the gross federal debt as of September 30, 2005 was $7.933 trillion, up $554 billion from September 2004, which, in turn, was up by $596 billion from September 2003.

As of October 2005, the first month in fiscal 2006, the twelve-month rolling deficit narrowed further to $308.4 billion, against $400.6 billion in October 2004. The gross federal debt as of October 31st totaled $8.027 trillion, up $597 billion from October 2004, which, in turn was up $557 billion from October 2003.

The official federal deficit will be inflated quickly by billions being allocated to disaster reconstruction and to the ongoing war in Iraq. FEMA already is out of funds for paying flood damage claims, and the Pension Benefits Guaranty Corporation has indicated a large operating deficit. Government finances also will suffer tax revenue losses from the Gulf Coast in addition to revenue shortfalls that will intensify as a direct result of the recession.

The GAAP-basis 2005 Financial Reports of the U.S. Government is scheduled for release on December 15th. The GAAP deficit likely will come in around $4 trillion, more than twelve-fold the size of the official 2005 fiscal shortfall. This will be next month's "Reporting Focus," planned as a special supplement to be published on December 19th.

Initial Claims for Unemployment Insurance -- Impact from an extraordinarily severe hurricane season is tapering off in initial claims. On a smoothed basis for the 17 weeks ended November 12th, annual change turned positive (an economic negative), up 1.8%, after a 0.5% annual decline in the 17 weeks ended October 1st. The hump in claims from the hurricanes has passed, and current weekly levels should continue running above year ago levels, going forward. Positive year-to-year growth in the initial claims series confirms signals of recession.

The volatility of the seasonally-adjusted weekly numbers is due partially to the seasonal-adjustment process. When the series is viewed in terms of the year-to-year change in the 17-week (three-month) moving average, however, such is a fair indicator of current economic activity.

Real Average Weekly Earnings -- September's post-Katrina seasonally-adjusted real average weekly earnings fell by 1.2% from August, after August's 0.5% monthly loss. October's earnings, though, rebounded by 0.4%, thanks to the lower monthly CPI increase, with September's monthly decline revising to 1.0%.

October's reported real earnings fell 1.6% from the year before, after September's 2.3% drop and August's 1.1% loss. Volatility in this series comes primarily from variations in reported CPI growth.

Allowing for the biases built into the CPI-W series used to deflate the weekly earnings, annual change in this series signals a deepening recession.

Retail Sales -- Retail sales also are signaling recession. Following August's pre-Katrina, seasonally-adjusted monthly retail sales plunge of 1.9% (originally 2.1%), September sales rose by 0.3%, and October fell by 0.1% +/- 0.7%. Unfortunately, these recent monthly growth rates all have been less than official CPI inflation. That means that retail sales growth net of inflation has been in contraction, and GDP normally tends to follow the same pattern.

Inflation-adjusted year-to-year growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession, and that level was broken in October. Starting with the peak annual inflation-adjusted growth of 7.28% in June, growth slowed to 7.13% in July, 4.53% in August, 1.95% in September and 1.45% in October. Impact from the hurricanes has been mixed and appears to have been negligible in aggregate.

Next Release (December 13): November retail sales should come in below expectations, mirroring impaired economic activity.

Industrial Production -- Seasonally-adjusted September industrial production tumbled 1.5%, blamed largely on the Gulf Coast catastrophes. October rebounded by 0.9% (0.7% net of revisions), all following August's 0.2% gain and annual benchmark revisions. The revisions were not significant. Year-to-year growth generally has slowed since the December 2004 near-term peak of 4.4%, with October annual growth at 1.9%.

Next Release (December 15): Industrial production increasingly will mirror the recession, entering a series of regular monthly contractions. Upcoming reports will tend to surprise market expectations on the downside.

New Orders for Durable Goods -- Seasonally-adjusted new orders for durable goods in September (post-Katrina) fell 2.1% (minus 1.8% net of revisions), following August's 3.8% increase (revised from 3.3%). Year-to-year growth in September was 6.4%, down from 10.0% in August. The widely followed nondefense capital goods orders plunged by 8.1% for the month, after gaining 2.2% in August.

As to Katrina impact, reconstruction will tend to boost new orders in the replacement of storm-damaged goods ranging from automobiles, washing machines and computers to factory production equipment.

Durable goods orders once was one of the better leading indicators of broad economic activity, when smoothed using a three-month moving average. After the semi-conductor industry stopped reporting new orders, however, the series' predictive ability suffered a serious setback.

Trade Balance -- The revised seasonally-adjusted July trade deficit in goods and services of $58.0 billion, widened to $59.3 billion in August and to a record $66.1 billion in September. It is not clear how much these numbers were affected by data-flow disruptions or trade disruptions related to the hurricanes. That will clear up with time. In the interim, the September deterioration was enough beyond market expectations to dampen third-quarter GDP growth in revision, if GDP reporting were normal.

Shy of short-term hurricane disruptions to paperwork flow, and a temporary reduction in September and possibly October export flows, the longer term outlook for the deficit remains one of continual deterioration and successive record monthly deficits.

Next Release (December 14): The October trade deficit could narrow if the September deficit surge was due partially to storm-related cuts in export flows. Nonetheless, new record monthly deficits will follow in the months ahead.

Consumer Confidence -- Consumer confidence continued falling in October, to levels generally seen in recessions. The Conference Board's consumer confidence index fell 2.9% in October, after September's 17.1% plunge, while the University of Michigan's consumer sentiment dropped another 3.5% in October, following September's 13.7% hit.

With respective annual rates of decline of 8.5% and 16.5% for the Conference Board and University of Michigan October 2005 readings, these lagging, not leading, indicators, are signaling that the economy already is in recession.

Short-Term Credit Measures -- Short-term credit measures for businesses continued to show strong annual growth, well over 10 percent, while annual growth in consumer credit has slowed to below four percent.

Seasonally-adjusted consumer credit showed no growth in September, with annual growth slipping to 3.7%, down from 4.3% in August and 4.4% in July. Without growth in income, growth in personal consumption can be supported short-term only by debt expansion or savings liquidation, and debt expansion is slowing.

Annual growth in commercial paper outstanding eased slightly from 19.5% in September to 17.4% in October. Annual growth in commercial and industrial loans, however, picked up to 12.8% in September and 13.6% in October, following August's 12.4%. Rising sales can fuel short-credit needs, but so too can slowing sales, slowing collections and rising inventories.

Producer Price Index (PPI) -- The post-Katrina seasonally-adjusted September finished goods PPI jumped by 1.9% (1.8% unadjusted) for the month, followed in October by another 0.7% (1.3% unadjusted), all on top of August's 0.6% increase. September and October annual inflation rates were 6.9% and 5.9%, respectively, after August's annual inflation rate of 5.1%. September's annual inflation was the highest since 1981.

Next Release (December 20): Despite a large component of random volatility in monthly price variations, PPI inflation reporting over the next several months should continue in tandem with the CPI to top market expectations. The CPI, however, is more subject to political manipulation.

Purchasing Managers Survey (Non-Manufacturing) -- Published by the Institute for Supply Management (ISM), there is nothing unusually wrong with this survey of the service industry, except it does not have much meaning. Unlike its older counterpart, the manufacturing survey, if service companies such as law firms, hospitals or fast-food restaurants have "increased orders," that does not necessarily mean that economic activity is increasing.

The overall October index rebounded 12.6% to a level of 60.0, following September's 18.0% plunge to 53.3. The index is a diffusion index, where a reading above 50.0 indicates a growing service economy, in theory. Both the employment and prices paid components, however, have some meaning.

The October employment component eased to 52.9 from 54.9, suggesting still-softening employment in the service sector.

The prices paid component diffusion index is a general indicator of inflationary pressures. The October index backed off 4.2% to 78.0, after September's 21.3% explosion to a record high of 81.4. The October reading, however, still is highly inflationary, and, on a three-month moving average basis, the annual change in October rose to 6.4% from September's 3.5%.


BETTER-QUALITY NUMBERS

The following numbers are generally good-quality leading indicators of economic activity and inflation that offer an alternative to the politically hyped numbers when the economy really is not so perfect. In some instances, using a three-month moving average improves the quality of the economic signal and is so noted in the text.


Economic Indicators

Purchasing Managers Survey (Manufacturing) - New Orders -- The October new orders index dropped 3.3% to 61.7, after September's post-Katrina surge of 13.1% to 63.8. The measure breached its fail-safe point a number of months back, generating an SGS early warning indicator of pending recession.

The Commerce Department provides suspect seasonal factors for this series, and adjusted monthly numbers often can be misleading in the reporting of month-to-month change. This problem is overcome by using year-to-year change on a three-month moving average basis. On that basis, October's index was up 0.3% following September's 2.7% decline. The index gradually has notched lower from its peak annual growth of 36.6% in April of 2004, but with some upturn in the last several months.

Published by the Institute for Supply Management (ISM), the new orders component of the purchasing managers survey is a particularly valuable indicator of economic activity. The index is a diffusion index, where a reading above 50.0 indicates rising new orders. The overall October ISM index softened to 59.1 from September's 59.4. An index level of 50.0 divides a growing versus contracting manufacturing sector. The October employment component increased from 53.1 to 55.0.

Help Wanted Advertising Index (HWA) -- SGS temporarily has suspended its regular analysis of help-wanted advertising due to mistakes being made in Conference Board reporting. The August plunge of four points to 34 was in error, purportedly due to data gathering problems related to Katrina and Rita. August has been revised to 38, with September at 39, but those numbers also are questionable given other numbers indicated by the Conference Board. Reporting will continue of this historically valuable series if and when the reporting issues are resolved.

Housing Starts -- October housing starts fell 5.6% from September, which had gained 2.5% from August. August housing starts were up 0.9% (originally down by 1.3%) from July. Year-to-year, October starts were down 2.3%. On a three-month moving average basis annual growth has slowed to 3.9%, at the brink of generating a recession warning signal.

Money Supply -- Post-Katrina annual money supply growth continued to show solid indications of recession. Before inflation adjustment, M1, M2 and M3 monthly changes for October versus September were up 0.3%, 0.6% and 0.8%, versus down 0.6%, up 0.4% and up 1.0% respectively. Year-to-year rates of change in seasonally-adjusted October and September M1, M2 and M3, respectively, were up 0.6%, up 4.0% and 7.3%, and up 0.3%, 3.9% and 6.6%.

Adjusted for CPI inflation, October's M1, M2 and M3 annual year-to-year rates of change were down 3.6%, down 0.3%, and up 2.9%, respectively, versus down 4.2%, down 0.8% and up 1.8% in September. On a three-month moving average basis, the October annual rates of change were down 3.4%, down 0.2% and up 2.4%, levels that remain well underwater using the old-style CPI.

(NOTE: The circumstances surrounding the Fed's destruction of M3 and the valuable economic signals currently being generated by this series will be detailed in this month's separate supplement due out before Thanksgiving.)


Inflation Indicators

Purchasing Managers Survey (Manufacturing) - Prices Paid -- The October prices paid diffusion index continued to soar, gaining another 7.7% to 84.0, after September's 24.8% jump to 78.0. The current level signals a serious inflation problem. On a three-month moving average basis, October's year-to-year change narrowed to a 4.9% decline versus September's 19.4% drop.

Published by the Institute for Supply Management (ISM), the prices paid component of the purchasing managers survey is a reliable leading indicator of inflation activity. The measure is a diffusion index, where a reading above 50.0 indicates rising inflation.

Oil Prices -- West Texas Intermediate Spot (St. Louis Fed) backed off 4.9% from its historic high monthly average of $65.57 per barrel in September, with October's average at $62.37. Oil prices have sold off sharply into November, but still remain at highly inflationary levels. October prices were up 17.4% from the year before, which was down from the annual growth of 42.7% in September. The narrowing annual growth reflects a sharp increase in oil prices last October.

Spot prices have and will continue to gyrate. Despite this near-term price volatility, high oil prices will continue as a major contributing factor to the inflation side of the current inflationary recession. Oil price changes permeate costs throughout the economy, ranging from transportation and energy costs, to material costs in the plastics, pharmaceutical, fertilizer, chemical industries, etc. Anecdotal evidence is strong that cost pressures have already passed into the so-called "core" inflation sectors.

The effects of oil price volatility affect CPI reporting, downside oil price movements tend to be picked up more quickly and fully by the BLS than are upside movements. For example, the recent plunge in gasoline prices will show up more fully and quickly than did the recent surge in oil prices. Even as currently understated, CPI and PPI inflation should be much stronger than commonly predicted for the next six-to-nine months, partially as a result of continued high oil prices.

U.S. Dollar -- The Shadow Government Statistics' Financial-Weighted U.S. Dollar Index is based on dollar exchange rates weighted for respective global currency trading volumes. October's monthly dollar average surged 2.0% after September's 0.1% softening. Year-to-year change reversed from September's 1.9% decline to October's 2.2% gain. The dollar rally has continued into November.

Reflecting its stronger weighting of the Canadian dollar, October's monthly average of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index had a slightly weaker gain of 1.6%, after September's 0.4% decline. October's rate of annual change also swung from minus to plus, from down 2.7% in September to plus 1.1%.

The relative strength in the financial- versus trade-weighted dollar is about at the level that usually precedes a dollar sell-off.

Despite any political turmoil in Europe, underlying fundamentals remain extraordinarily negative for the greenback. With serious shocks still looming in U.S. economic and fiscal data, heavy selling pressure against the U.S. currency could break at any time, with little warning. New record lows for the dollar still remain likely in the months ahead, despite any overt or covert supportive intervention by any central bank(s).

Generally, the weaker the dollar, the greater will be the ultimate inflation pressure and the eventual liquidity squeeze in the U.S. capital markets.


"REPORTING FOCUS" -- FORTHCOMING CURRENT SUPPLEMENTAL REPORTS

* Federal Reserve Elimination of Money Supply M3

* SGS Standard Consumer Price Index (Part II)

Money Supply M3 -- The Federal Reserve Board is eliminating reporting of monetary aggregate M3 purportedly because of its irrelevance and cost. As will be shown in this pre-Thanksgiving report, the information provided in M3 helps to predict both inflationary pressures and economic activity. Therein lies the most likely motivation for eliminating the data.

SGS Standard Consumer Price Index (Part II) -- This post-Thanksgiving report will complete the introduction of SGS's alternative CPI measure, the SGS Standard CPI, including the formal reporting methodology, first reporting results and a reconstructed historical data base that will link back to pre-Jimmy Carter official CPI reporting.


UPCOMING "REPORTING FOCUS" FOR DECEMBER

* 2005 GAAP Financial Statements of the United States Government

Next month's "Reporting Focus" will be published as a separate supplemental report on December 19th, based on the scheduled U.S. Treasury release of the 2005 GAAP financial statements on December 15th. The latest Treasury reporting will be assessed against both the accounting-gimmicked official federal deficit numbers and prior GAAP reporting.

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Best wishes to all for a happy Thanksgiving! Also, many thanks to everyone who extended their kind wishes while I was under the weather.

December's Shadow Government Statistics is scheduled for release on Wednesday, December 7, 2005. The monthly newsletter regularly is scheduled for posting on the Wednesday following the Friday release of the employment statistics. The posting of the next SGS on the website as well as any supplements or interim alerts, will be advised immediately by e-mail.


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