JOHN WILLIAMS' SHADOW GOVERNMENT STATISTICS


Issue Number 20


June 7, 2006

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Bernanke and New Treasury Secretary -- Tap Dancing on A Land Mine

May Jobs Growth Statistically Indistinguishable from Contraction

Annual CPI to Surge in May and June

Dollar Selling and Gold Buying Have Just Begun


Faltering economic activity and mounting inflation have created a nightmarish conundrum for the political operatives both in the Bush Administration and at the Federal Reserve. Soft economic numbers and high inflation are being spun as "conflicting data." What nonsense! An inflationary recession is in play, and there is little the Administration or the Fed can do about it.

The pabulum fed to the investing public -- that a weak economy means low inflation and interest rates -- cannot work in the current environment. Any conflicts that arise are not in the economic data but in simplistic views on economic activity espoused by Wall Street, or in the statistical manipulation goals of the politicians. Those latter issues explain recent Administration and Fed activities -- ranging from Fed Chairman Bernanke's tap dancing on the inflation outlook to the appointment of a new Treasury Secretary -- all anchored in putting a positive spin on an impossible situation and avoiding a financial-market meltdown before November 7th. The markets are not cooperating. Dollar selling and gold buying have just begun, and so have the negative reactions in the credit and equity markets.

U.S. economic activity is in a long-term structural deterioration that inhibits any sustainable, solid economic growth, due to the inability of the average consumer to enjoy meaningful, inflation-adjusted income growth. At fault are trade policies designed to cripple the domestic manufacturing base and to shift U.S. wealth and better-paying jobs offshore. Compounding exploding government fiscal problems and consumer income issues has been the de facto encouragement of illegal immigration by both the current and prior administrations.

Under these circumstances, inflation driven by robust economic demand would be a happy circumstance, but such is not to be. Rather, the purchasing power of the U.S. dollar is being lost to wasting diseases, eroded by foreign exchange weakness in the trade-deficit plagued greenback, malfeasance in domestic fiscal and monetary policies, and external disruptions such as cartel-orchestrated price surges in oil. All the latter factors are in play.

From the Federal Reserve's perspective, mixed signals are the best that can be offered to the markets. Indications of further faux "tightening" are given to signal Mr. Bernanke's devotion to keeping inflation under control. Alternate suggestions that the Fed at least will pause in hiking interest rates signal Mr. Bernanke's devotion to maintaining solid growth. While the tap dancing may keep the markets guessing and gyrating for a while, the Fed is in an untenable position. Raising rates will do little to contain a non-demand driven inflation, while lowering rates will do little to stimulate the structurally-impaired economy. Stuck with an inflationary recession, the new Fed Chairman will have little choice but to intensify the system's difficulties by opting for more inflation, with the monetization of excessive Treasury debt. Such will become necessary as dollar investors intensify their dumping of the greenback and dollar-related securities.

From the Administration's perspective, the employment report, in particular, offers the opportunity to try to sell two different stories at the same time. No politician wants a recession or a bear stock market on his or her watch. So, coming into the mid-term election, an effort will be made to convince Main Street U.S.A. that unemployment is low and getting better. At the same time, softer payroll data -- so closely followed by the financial markets -- could be used in an attempt to salve inflation-spooked investors.

The selection of Goldman Sachs Chairman Henry M. Paulson as the new Treasury Secretary undoubtedly involved expectations that he would help guide the Administration in handling rattled markets over the next five to six months.






The updated graphs on gold, oil and the Swiss franc suggest that all the political gimmicks, spin doctors and statistical manipulations are not fooling a number of investors. Even with large price swings, gold remains a safe haven in dangerous times. Fundamentals remain highly bullish for gold and extremely bearish for the dollar. Flight from the U.S. currency has become increasingly evident over the last month, as the markets have witnessed deteriorating economic and political fundamentals. Heavy dollar selling appears to loom.

Due to the relative timing of this newsletter and the prior one, there have not been interim updates by the various statistical agencies for certain economic series, including retail sales, industrial production and the trade deficit. Nonetheless, reporting that has taken place generally has not been in the camp of booming growth and contained inflation.




April help-wanted advertising plunged two points to 35, tying a 45-year low that also was touched in May 2003. While help-wanted ads in newspapers in September 1961 were not competing against Internet advertising, the recent plunge still suggests a sharp deterioration in the current economic environment.

In other reports, the minimal monthly payroll growth reported for May was statistically indistinguishable from a contraction. Further, new claims for unemployment deteriorated, the purchasing managers manufacturing survey and its new orders and employment components slowed, while durable goods orders took a monthly plunge. Retail sales, net of inflation, contracted in April and will do so again in May. Most upcoming reports should tend to confirm the intensifying economic downturn.

On the upside for the economy was a booming GDP report, but that remained in the fantasy world created by the Administration's data manipulators.

Inflation readings soared all around, from a rising CPI and stronger "core" inflation, to surging oil prices and inflation readings from the purchasing managers surveys. Due to last year's underreporting of CPI inflation in May and June, reported annual inflation should spike sharply in the next two months.


Updated Recapitulation of Current Outlook

In general, the broad economic outlook has not changed, but the financial markets are beginning to catch up with underlying reality. The 2005 to 2007 inflationary recession continues to deepen. Recession, inflation and risks of intensifying dollar selling are upon us and continue to offer the worst of all environments for increasingly less-Pollyannaish financial markets.

The Shadow Government Statistics' Early Warning System (EWS) was activated in May 2005 and signaled the onset of a formal recession 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 holding near or at their fail-safe points, with four indicators moving beyond 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. The housing starts series appears ready to generate such a signal in the next month or so.

With a false economic boom massaged into first-quarter GDP reporting, negative GDP growth is not likely to surface in regular government reporting until after the November election, given the rampant political manipulation of most key numbers. The National Bureau of Economic Research (NBER) eventually should time the downturn to mid-2005 and announce same also sometime after the election, so as not to be deemed politically motivated in its timing. Of some interest will be the upcoming (July 28th) annual revisions to the GDP that should show a weaker 2005 economy than previously reported.

Whether or not there is a recession will be a hot topic in the popular financial media, with politics helping to fuel the debate as the election campaign heats up. 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 have softened, and the trend will accelerate sharply, with regular monthly contractions seen for both payroll employment and industrial production, although political manipulation can keep the payroll and production 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 finances.

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, major natural disasters or a financial panic.

Market perceptions of the downturn in business activity are mixed. As expectations begin to anticipate weak data, expectations also will be lowered for inflation, although worsening stagflation seems to have gained a good foothold in some consensus thinking. Consensus forecasts generally 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. Gold prices already signal inflation troubles. Fueled by high oil prices, weakness in the U.S. dollar and accelerating Fed monetization of federal debt, inflation will not be brought under control simply by weakness in economic demand. Instead, persistently high prices only will serve to intensify the recession, making it exceptionally 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 an economic downturn.

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

The unfolding inflationary recession is 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. When the system re-stabilizes, post-crisis, there will be exceptional investment opportunities for those who have been able to preserve their wealth, capital and liquidity.


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.)

This month's opening comments review the conflicting pressures on the great manipulators -- the need to keep the economy looking healthy enough to satisfy voters, while keeping the financial markets' inflation concerns low enough to make it through the election without major sell-offs in equities and bonds. Hence, there appears to be a return to the reporting of soft jobs growth, while conflicting unemployment news remains relatively happy. Direct manipulation of key economic data appears to be well entrenched.

With the President's ratings continuing to bottom roll at historic lows, near-term economic reporting will remain gimmicked and managed for as long as possible, again, almost certainly through the election. As a result, reported economic results will continue having less than usual relevance to actual underlying activity, and upcoming reporting of the major series will be determined primarily by political need rather than by the economic factors that should drive the results.

Employment/Unemployment -- Despite continued games playing with seasonal factors, prior-period revisions and further fudge factor expansion, May's 75,000 new payroll jobs were well shy of market expectations. Fortunately for the Administration (see opening comments), however, the unemployment rate dropped.

The popularly followed seasonally-adjusted unemployment rate U-3 for May eased to 4.65% from April's 4.72%, a decline that was well inside the published +/- 0.2% error margin. The unadjusted U-3 unemployment eased to 4.4% from April's 4.5%, and the broader U-6 unemployment measure held at 7.9% in May. May's seasonally-adjusted U-6 rate held at 8.2%. Including the long-term "discouraged workers" defined away during the Clinton Administration, total unemployment remains roughly 12%. The household survey also showed seasonally-adjusted May employment (those people with at least one job) up by 288,000 versus a 47,000 gain in April.

For May, the payroll survey's seasonally-adjusted gain of 75,000 (38,000 net of revisions) was well within the published reporting error of +/- 108,000. This means the reported May gain was statistically indistinguishable from a contraction. The May increase followed a downwardly revised April gain of 126,000 (was 138,000). Annual growth in unadjusted May employment was 1.41%, little changed from April's 1.40%.

May's payroll gain of 75,000 included a positive bias of 211,000 jobs in the "net birth/death" adjustment, a fudge factor that was 20,000 higher than the one used for May 2005.

Gimmicked seasonal factors were evident in the monthly revisions to April. On an unadjusted basis, April payrolls revised to the upside by 2,000, but that translated to a May-jobs-boosting 37,000 downward revision to the seasonally-adjusted April payrolls. The BLS recalculates its near-term seasonal factors every month.

Further, in May and June and in August and September of each year, the school year disrupts the government's calculation of seasonal-adjustment factors. The BLS rarely gets it right. If properly adjusted, educational employment should be relatively flat in those months. In May, 19,000 of the 75,000 seasonally-adjusted new jobs were reported in education.

The latest report was against a background of sharply deteriorating help-wanted advertising, rising new claims for unemployment insurance and a downturn in the May manufacturing purchasing managers employment index (see the respective sections).

Next Release (July 7): The political needs of the Administration remain great and will continue to offset the impact of sharply slowing economic activity in the employment data, perhaps even more so in the unemployment data. While underlying reality would suggest further downside surprises to June reporting, some sort of more-positive result is needed, although against reduced consensus expectations. If unemployment is going to be the vehicle for the good news, then unemployment massaging should hold the current unemployment rate, with further improvement seen before the election.

Gross Domestic Product (GDP) -- As expected, the "preliminary" revised estimate of annualized inflation-adjusted growth for first-quarter 2006 GDP was to the upside, but slightly shy of expectations, meeting mixed political and financial-market needs. Growth revised to 5.31% from initial reporting of 4.82%, rebounding into economic-boom territory from the fourth quarter's tepid 1.65% growth.

The first quarter's reported year-to-year growth revised to 3.59% from 3.47%, up from the fourth-quarter's 3.22%, but still slightly below the third quarter's 3.64%. Final sales -- GDP net of inventory changes -- revised to 5.48% from 5.38%, up from the fourth quarter's 0.25% contraction. The GDP inflation rate (deflator) was little changed at 3.30% versus initial reporting of 3.26%, and down from the prior quarter's 3.47%.

First estimates of alternate first-quarter GDP measures, Gross National Product (GNP) and Gross Domestic Income (GDI) also were published. GNP, which is GDP plus the net trade balance in factor income (interest and dividend payments), showed annualized, inflation-adjusted first-quarter growth of 5.18%, versus 0.72% in the fourth quarter. GDI, the theoretical income-side equivalent of the consumption-based GDP, showed annualized inflation-adjusted first-quarter growth of 5.47%, up from 1.89% in the fourth quarter.

GDP reporting generally is used as political propaganda and usually has little or no relationship to underlying economic reality. Given the long-term upside methodological biases built into the GDP, an annual growth rate slightly into negative territory still would have been closer to reality.

With the annual GDP revision due the end of July, current economic weakness can be redistributed to past history, enabling a solid GDP growth report for the third quarter, right before the election.

Next Release (June 29): The "final" estimate for first-quarter 2006 GDP likely will be no more than statistical noise. The reported growth rate, however, will be revised again on July 28th in the annual revisions to the GDP series. These numbers likely will continue to be dominated by the political needs of the Administration.

Consumer Price Index (CPI) -- The BLS reported the seasonally-adjusted April CPI-U up by 0.60% (0.85% unadjusted) following March's 0.35% (0.55% unadjusted) gain. Seasonal adjustments continue depressing CPI reporting, a pattern that should reverse in July. April's annual inflation rate rose to 3.55% (fortuitously just rounding to 3.5%) from 3.36% in March. As mentioned last month and in this month's opening comments, reported annual CPI inflation should surge in May and June, due to last year's underreporting. July also should surge as negative seasonal factors begin to reverse.

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 of 3.09% in April, up from 3.02% in March.

Adjusted to pre-Clinton methodology, annual CPI growth was about 6.6% as of March, while the SGS Standard CPI, net of all the methodology changes of the last 30 years that were designed to suppress inflation reporting, stood at 7.4%.

Contrasted with the slowly increasing annual Core CPI-U inflation rate, up to 2.3% in April, which excludes the necessities of food and energy, the SGS Base CPI-U that includes only the necessities was up 3.8% in April. The SGS rate, however, still suffers the standard CPI-U methodological understatement.

Next Release (June 14): The May CPI generally should surprise minimal consensus forecasts on the upside. "Core" inflation increasingly will reflect the effects of staggering oil prices working their way through all levels of the economy.

Despite short-term volatility, annual inflation will remain high and should accelerate to the upside as the year progresses, with increasing upside pressures seen not only from oil prices, but also from a weak U.S. dollar. With seasonally-adjusted monthly inflation reported at a minus 0.1% for May 2005, monthly May 2006 inflation above or below that will move the reported annual inflation rate in tandem. In June 2005 the adjusted CPI also declined by 0.1%. Such offers a catch-up window in 2006 in which annual inflation should surge, in line with monthly CPI increases.


Other Troubled Series

To varying degrees, most of the following series have significant reporting problems. All series (including the more trouble free) will be addressed in a monthly "Reporting Focus," with this month's analysis examining Housing Starts and other housing related statistics.

In addition to the big three, other series that have been detailed are:

* The Federal Deficit (an original background article, update in the Alert of July 7, 2005, update in Supplement to December 2005 SGS);
* 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, Part II - June 2005 SGS, M3 update November 2005 Supplement, M2 update March 2006 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);
* Consumer Price Index (an original background article and October 2005 SGS);
* Help Wanted Advertising (January 2006 SGS);
* Purchasing Managers Survey (February 2006 SGS);
* Producer Price Index (April 2006 SGS);
* New Orders for Durable Goods (May 2006 SGS).

Federal Deficit -- There has been no further reporting on the federal deficit since the last newsletter, but gross federal debt numbers have been updated.

As discussed in prior newsletters, the official, accounting-gimmicked 2005 deficit (fiscal year ended September 30th) was $318.5 billion, but it was eleven times higher -- at $3.5 trillion -- on a GAAP basis, per the U.S. Treasury (see the December 2005 SGS Supplement). The official, accounting-gimmicked deficit for 2004 was $412.8 billion.

As of April 2006, the seventh month in fiscal 2006, the twelve-month rolling accounting-gimmicked deficit was $265.7 billion, against $365.9 billion in April 2005, and against $326.8 billion in March 2006.

Separate from the GAAP-based numbers and official deficit reporting, the change in gross federal debt is a fair indicator of actual net cash outlays by the government. As of fiscal year-end 2005, the gross federal debt was $7.933 trillion, up $554 billion from September 2004, which, in turn, was up by $596 billion from September 2003.

The gross federal debt as of May 31, 2006 was $8.357 trillion, up $17 billion from April and up $579 billion from May 2005, which, in turn, was up $581 billion from May 2004.

Going forward, the official federal deficit will inflate, as government finances suffer tax revenue losses from the intensifying recession. While GDP growth estimates can be gimmicked, incoming tax receipts will remain an independent estimate of underlying economic reality.

Initial Claims for Unemployment Insurance -- Annual change in initial claims rose into less negative territory (an economic negative). On a smoothed basis for the 17 weeks ended May 27th, annual change narrowed to a 5.5% decline from May 6th's 8.3% decline.

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 usually is a fair indicator of current economic activity.

Real Average Weekly Earnings -- April's real earnings rose by 0.2% from March, and March's previously reported 0.3% decline versus February was revised to a 0.1% drop. April's real earnings were up 0.4% from the year before, an upside distortion that will be fixed by upcoming annual inflation reporting in May and June.

Volatility in this series comes primarily from variations in reported CPI growth. Allowing for the biases built into the CPI-W series used in deflating the average weekly earnings, annual change in this series signals ongoing severe financial strain on U.S. households and continuing recession.

Retail Sales -- Despite no updated retail sales reporting since the last newsletter, new CPI data add to last month's story. Although April's seasonally-adjusted monthly retail sales rose by 0.5% +/-0.7%, following March's 0.6% gain, April retail sales fell by 0.1% when adjusted for the 0.6% jump in the CPI.

Inflation-adjusted year-to-year growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession. April's annual growth on that basis was about 3.0%, down from March's 4.4%. As reporting of annual CPI inflation surges for May and June, real annual retail sales will fall again below its recession warning threshold, confirming the economic downturn.

Next Release (June 13): May retail sales should come in below already soft expectations, reflecting declining economic activity. Real (inflation-adjusted) growth should be negative, again, on a monthly basis.

Industrial Production -- There has been no updated reporting since the last newsletter. Seasonally-adjusted April production surged 0.8%, on top of March's gain of 0.6%. April 2006 production was up 4.7% versus the year before, following March's 3.8% annual gain.

Next Release (June 15): Still look for industrial production increasingly to mirror the recession, entering a series of regular monthly contractions and a pattern of slowing annual growth, which will surprise market expectations on the downside. Accordingly, look to the May release for some downside shock.

New Orders for Durable Goods -- Again, showing typical volatility, April's seasonally-adjusted new orders for durable goods fell by 4.8% (down by 8.8% net of revisions) after March's 6.6% (previously reported 6.1%) increase. Monthly gyrations continued around large aircraft orders. April's annual growth rate eased back to 7.5% following March's 14.5% (previously reported 19.7%) surge.

The widely followed nondefense capital goods orders fell by 6.0% following March's 11.9% gain (previously 12.1%).

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

Trade Balance -- There has been no new reporting since the last newsletter. As reported, January's record $68.6 billion seasonally-adjusted trade shortfall was followed by $65.6 billion in February and $62.0 billion in March. If the data are being doctored, such will become apparent in the next month or so. The current numbers helped to justify stronger first-quarter GDP growth and its upward revision. There is little question, though, that the trade deficit still is in a phase of meaningful deterioration.

Next Release (June 9): Contrary to the last two month's reporting and consensus expectations for a moderate monthly deterioration, the April trade deficit should widen sharply. Generally, upcoming monthly deficits will surge beyond consensus forecasts, with new record monthly deficits following regularly in the months ahead.

Consumer Confidence -- May Consumer confidence measures were down. The Conference Board's consumer confidence index fell by 6.0%, after April's 2.1% gain (previously up 1.9%), while the University of Michigan's May consumer sentiment plunged fell by 9.5%, after falling 1.7% in April. The preliminary May sentiment reading of 79.0 was used mistakenly for April in last month's newsletter, instead of the final 87.4 reading for April.

On a three-month moving-average basis for May, annual growth in the Conference Board's measure was 5.6%, while the University of Michigan number was down 4.4%. These lagging, not leading, indicators are signaling that the economy remains in recession.

Short-Term Credit Measures -- Since the prior newsletter, new commercial paper outstanding and commercial and industrial loan data have been published; consumer credit has not been updated. Annual growth in short-term credit measures for businesses remains strong, holding double-digit annual percentage growth, while annual growth in consumer credit remained soft at 2.6%.

Seasonally-adjusted consumer credit remained in serious slowdown. Preventing meaningful monthly growth, annual growth slowed from February's 2.7% to 2.6% in March. Without growth in income, growth in personal consumption can be supported over the short-term only by debt expansion or savings liquidation, and consumer debt expansion has come to a halt.

Annual growth in commercial paper outstanding picked up to 17.5% in May following April's 16.4%. Annual growth in commercial and industrial loans inched higher to 12.4% in April from to 12.0% (previously 12.5%) in March. Rising sales can fuel short-term credit needs, but so too can slowing sales, slowing collections and rising inventories.

Producer Price Index (PPI) -- There has been no reporting update since the prior newsletter. The seasonally-adjusted March and April finished goods PPI rose respectively by 0.5% (0.3% unadjusted) and 0.9% (1.0% unadjusted), following February's decline of 1.4% (also down 1.4% unadjusted). While March's annual PPI inflation eased to 3.5% from February's 3.7%, April's annual inflation rate rose to 4.0%.

Next Release (June 13): Despite a large component of random volatility in monthly price variations, PPI inflation reporting over the next six-to-nine months should continue to top market expectations, which are in the 0.5% range for May. "Core" inflation, in particular, should be increasingly stronger than consensus forecasts.

Purchasing Managers Survey (Non-Manufacturing) -- The overall May index fell by 4.6% to 60.1, more than reversing April's gain. 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 have some meaning.

The May employment component rose to 58.0 from 56.5 in April, suggesting a slightly improved employment environment in the service sector.

The prices paid component diffusion index is a general indicator of inflationary pressures. The May index soared again to an extraordinarily high inflation reading, jumping 9.9% to 77.5 from 70.5 in April and up 28.1% from 60.5 in March. On a three-month moving average basis, May's annual growth was 8.4% against April's 0.6% decline.

There is nothing unusually wrong with this survey of the service industry, except it does not have much meaning related to broad economic activity. 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.

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 May new orders index dropped by 6.8% to 53.7, after April's 1.4% decline to 57.6. This measure breached its fail-safe point a year ago, generating an SGS early warning indicator of pending recession.

The Commerce Department provides suspect seasonal factors for the series, and the resulting adjusted monthly numbers 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, the May index increased by 3.6% following April's 5.7% rise. The index gradually has notched lower from its peak annual growth of 42.6% in April of 2004.

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 May ISM index fell to 54.4 from 57.3 in April. An index level of 50.0 divides a growing versus contracting manufacturing sector. The May employment index tumbled to 52.9 from April's 55.8.

Help Wanted Advertising Index (HWA) -- The April help-wanted advertising index plunged 5.4% (7.9% net of revisions) to 35, the lowest reading since May 2003 and a level previously last equaled in September 1961 (see graph in the opening comments). Annual contraction, on a three-month moving-average basis was 6.7% in April versus 6.6% (previously 5.7%) in March. Annual growth has shown sharp deterioration as the index bottom rolls at the worst level seen since the last recession, and before that in the first year of Kennedy's administration.

Housing Starts -- Due to no further reporting since the last issue, housing starts remains at the brink of signaling recession, as discussed in this month's "Reporting Focus." Seasonally-adjusted April housing starts fell by 7.4% after a 6.4% decline in March. Annual change on a three-month moving average basis plunged to a 2.8% decline following March's 3.0% rise. Two more months of starts holding at April's level will have the three-month moving average annual growth rate contracting at more than 10%, a recessionary level.

Money Supply -- Annual growth for both M1 and M2 slowed some in May (4-week average through May 22) to 1.3% and 4.6%, respectively, from April's 1.9% and 4.9%, well within recession territory. Therein is the beauty of the Greenspan/Bernanke version of three-card monte. The broader, but no longer visible, M3 likely has seen annual growth jump to well over 9.0%, a level that would be raising the hackles of the inflation-jittery financial markets. While the Fed may be pushing interest rates higher, it still is not tightening. The U.S. central bank continues to flood the system with liquidity.

Before inflation adjustment, monthly M1 and M2 both declined by 0.2% in May, versus April's 0.4% and 0.3% respective gains. Adjusted for CPI inflation, May's M1 and M2 annual year-to-year rates of change were down 2.6% and up 0.5%, respectively, versus down 1.6% and up 1.4% in April. On a three-month moving-average basis, the May inflation-adjusted annual rates of change were down 2.2% and up 1.0%, levels that remain well underwater using the old-style CPI.

Inflation Indicators

Purchasing Managers Survey (Manufacturing) - Prices Paid -- The May prices paid diffusion index soared by 7.7% to 77.0 on top of April's 7.5% jump to 71.5, well within severe inflation territory. On a three-month moving average basis, May's year-to-year change swung into positive territory, up by 6.4% following April's 4.3% year-to-year decline.

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) hit a new record high average in May of $70.94 per barrel, up 1.8% from the prior record of $69.69 in April. Oil prices persist at extraordinarily inflationary levels, with May's average price up 42.4% from May 2005 and up sharply from April's 31.4% annual gain. Oil prices in early June generally have traded above May's average price.

Spot prices will continue to gyrate. Despite ongoing near-term price volatility, high oil prices will remain 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. Cost pressures already have passed into the so-called "core" inflation sectors and have started surfacing in official reporting.

Oil price volatility affects CPI reporting. Downside oil price movements tend to be picked up more quickly and fully by the BLS in its inflation measures than are upside movements. 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 the persistently high oil prices.

U.S. Dollar -- The U.S. dollar has begun its tumble, albeit reasonably orderly so far. The Shadow Government Statistics' Financial-Weighted U.S. Dollar Index is based on dollar exchange rates weighted for respective global currency trading volumes. For May, the monthly dollar average was down 4.25%, following April's 1.37% decline. May's year-to-year growth also turned negative, down 0.54% after April's 5.29% gain.

In the same direction, May's monthly average of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index dropped 3.89% after April's 1.32% loss. May's rate of annual change turned negative, down by 3.07%, after April's 2.21% increase.

Dollar selling has been sporadic, but intense, at times. In the first several days of June, the greenback has been trading slightly around its May averages. The relative strength in the financial- versus trade-weighted dollar, though somewhat lessened, still remains at a level that usually precedes a major dollar sell-off. Dollar tumbling has just begun.

Underlying fundamentals remain extraordinarily negative for the U.S. currency. With serious shocks looming in U.S. economic and fiscal data and deteriorating domestic politics, heavier selling pressure against the U.S. currency could intensify 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.


June "Reporting Focus" -- Housing Starts and Housing Statistics

The housing market has been slowing since late 2005, although such is not obvious in all reporting. The housing starts series appears to be near generating a recession signal. While the residential investment component of the GDP shows ongoing solid growth as of first-quarter 2006, home sales data show the downturn already is underway.







Due to the volatility in reported monthly housing activity, all the monthly data shown above are smoothed using a three-month moving average and shown in terms of year-to-year change. Since the residential investment growth is adjusted for inflation, its patterns should be comparable to those of the growth in housing units used in the other charts.

Usually, the growth trends in housing starts tend to lead the other housing numbers by six months or so, but the recent housing bubble -- fueled by Mr. Greenspan's artificially depressed mortgage rates -- has been unusual. The housing downturn in the last recession was small, and housing strength of the last several years -- including related consumer ability to borrow against homeowner equity -- has been a basic prop to recent economic activity.

Annual changes in mortgage rates have roughly an 80% negative correlation with annual growth home sales. Higher interest rates translate into softer sales. Interest rates have been rising and still have a long way to go.

As discussed in an earlier newsletter, we use housing starts as a leading indicator to the industry and the economy, instead of building permits, due to changes made in recent years to building permits reporting methodology that are irreconcilable with historical reporting.

Actual home sales, however, seem to be leading housing starts this time around, as developers respond to slowing demand. Existing home sales, which outnumber new homes sales by roughly 6.8 million to 1.2 million per year, began slowing in January 2005. New home sales growth began turning down in August 2005, and housing starts began slowing in November 2005. All three series now are down year-to-year, and the annual contraction in housing starts, on a three-month moving average basis, should exceed 10% by June, signaling a recession.

By a bit of "luck" for the Administration, annual growth in the residential investment component of GDP has held in positive territory through the first-quarter.


Upcoming "Reporting Focus" for July -- Corporate Profits"

Aggregate corporate profits should mirror underlying economic reality, but there are a variety of measures. Some are of good quality, while others are as worthless as GDP reporting. The different series are explored along with a new measure that will be reported and updated quarterly in the SGS.
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July's Shadow Government Statistics is scheduled for release on Wednesday, July 12, 2006. 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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