JWSGS - APRIL 2007 EDITION - May 7, 2007


Issue Number 30

May 7, 2007


April Payroll Contraction Appears to Have Been Masked

M3 Growth Surges to 9-11 Liquefaction Levels and Worse

Mounting Inflationary Recession Has Hobbled Fed

Intensifying Dollar Sell-Off and Gold Boom Loom


PLEASE NOTE: Reader comments on the Hyperinflation Series have been significant. Those reactions and observations will be published in a follow-up hyperinflation section in the May SGS. Please feel free still to offer your comments or raise your questions by e-mail to johnwilliams@shadowstats.com. Also, this month, in response to subscriber demand, we publish our estimates of the seasonally-adjusted monthly average levels of M3. With a number of caveats, the detail will be found in the Money Supply section of the Reporting Perspective. The updated annual M3 growth rates and U.S. Dollar measures have been posted to the Alternate Data page of www.shadowstats.com. Best wishes to all -- John Williams


Knees would be knocking audibly in the credit markets, if the Fed still reported M3 growth. Annual growth (SGS Ongoing M3 series) accelerated sharply in April to 12.9%, from 11.7% in March. The last time annual M3 growth approached 13%, the Fed was liquefying the financial system in the wake of the 9-11 terrorist attacks. Before that, the year was 1981 and official annual CPI inflation was running about 10%. If 10% inflation sounds familiar, that is roughly the level of annual CPI inflation that would be reported today using the CPI methodologies of 1980. Exacerbating the financial catastrophe that slowly is unfolding for the U.S. markets, the economy is in a deepening recession and the U.S. dollar has begun suffering nascent selling pressures. In terms of monthly averages, gold already is at an all-time high, and the trade-weighted dollar is at an all-time low. Out of touch with reality, the Dow Jones Industrial Average keeps bouncing to new highs.

As evident in the accompanying graph, the increase in annual M3 growth has started to show marked acceleration. There is little evidence of net neutral Fed policy here; liquidity is being pumped in to the system. This growth reflects not only acceleration in underlying annual M2 growth, but also 20%, plus or minus, annual growth in the non-M2 components. While this activity will do little to help the economy, it will enhance the prospects for higher inflation. The April growth rate is based on three weeks-plus of data. The final estimate for April M3 will be published next weekend, when full underlying data for the month will be available.

General background note: Historical annual growth data for the money supply series, including the ongoing SGS estimates of M3, are available for download on the Alternate Data page of www.shadowstats.com. See the August 2006 SGS for methodology.

The current M3 annual growth is within several percentage points of its all-time high (since the Fed estimates began in 1960). Once beyond that, the modern U.S. monetary system will be in uncharted waters. Growth peaks generally have been seen around recessions, with the Fed trying to stimulate the economy, or at times when the Fed was attempting to salve the financial markets.

Peak M3 growth of 16.4% was seen in June 1971, with annual CPI inflation at 4.6%. Wage and price controls and the final U.S. abandonment of any link of the dollar to gold followed in August 1971. The next M3 peak was at 12.4% in May 1978 followed by 13.0% in December 1981. Gold prices peaked in January 1980, and annual CPI inflation hit its peak of 14.8% in March 1980. CPI fell below 10% as 1981 closed out.

The Fed again began flooding the system with liquidity as the stock-market bubble burst in 2000 and 2001, but the pace of M3 growth accelerated in response to the financial-system disruptions surrounding the 9-11 terrorist attacks. M3 hit its near-term annual growth peak of 13.3% in November 2001, a level that easily could be topped in the next month or two. M3 growth above 14% would be the highest since 1973, which was followed shortly by 10-plus percent CPI inflation.

A Hobbled Fed. The Fed's Federal Open Market Committee has a meeting this week, and no change in the targeted federal funds rate is anticipated for the pending Wednesday-afternoon statement. Once again, the Fed likely will meet market expectations as much as possible, so as to be non-disruptive. The Fed faces both inflation and recession, with little ability to counter either circumstance.

Raising interest rates can help contain inflation, when inflation is being driven by strong economic demand. The current pricing problems are related to commodity supply distortions, which will be exacerbated by mounting dollar weakness and rapidly-growing broad money supply.

Lowering interest rates can help a faltering economy, during the downleg of a normal business cycle, but this is not a normal business cycle. The downturn reflects a long-term structural change that has shifted much of the U.S. manufacturing base and wealth offshore. The result has been impaired real (inflation-adjusted) income growth, growth that has not been able to keep up with inflation.

Without sustainable real income growth, there can be no sustainable real economic growth. Short-term boosts to economic activity can be had through the expansion of debt and the liquidation of savings, but both those options are short-lived and currently are pushing against their practical limits.

Never has the Fed faced such severe economic difficulties with the financial markets so heavily dependent on foreign capital for liquidity. Foreign investors are flush with dollars from the extraordinarily massive U.S. trade deficit. It is the liquidation and repatriation of those dollars and dollar-denominated assets that has the Fed scared. Once that process starts, the U.S. central bank will have little choice but to boost interest rates, at least initially, in defense of the dollar and irrespective of domestic economic conditions.

Only the threat of a systemic domestic financial collapse is likely to push the Fed to an easing stance. That, however, will be the beginning of the process that eventually will trigger a hyperinflation. Indeed, the basic elements for a dollar collapse and an eventual hyperinflationary environment in the United States remain locked in place (see the Hyperinflation Series in the December 2006 to March 2007 SGSs).

The Economy Slows. The past month generally has been one of downside economic surprises for the financial markets. First-quarter GDP growth slowed to 1.3% from 2.5%, real retail sales were flat, industrial production contracted, annual housing growth was the worst it had been since the bottom of the last recession, help-wanted advertising sank, new claims for unemployment insurance rose, employment growth was weak as unemployment rose, consumer confidence measures fell and new orders for durable goods showed a sharp annual contraction. The only "positive" numbers were a small improvement in the trade deficit and some pickup in the purchasing managers surveys, but those series appeared to have unusual reporting quality issues.

Shown below is the pattern of real, annual growth in new orders for durable goods. To adjust for the sharp monthly volatility of the series, a six-month moving average has been used. The CPI-U was used for deflation, as the GDP component deflators are of much worse quality than is the CPI. So adjusted, annual durable goods change has turned negative in a manner generally seen only in recessions, although not all of the suggested recessions are recognized formally as such.

The series has other problems, such as the cessation of reporting of semiconductor orders in 2002. Nonetheless, the annual contraction in the series is consistent with the deepening recession indicated in other economic measures, such as retail sales and housing.

PLEASE NOTE: A "General background note" provides a broad background paragraph on certain series or concepts. Where the language used in past and subsequent newsletters usually has been or will be identical, month-after-month, any text changes in these sections will be highlighted in bold italics upon first usage. This is designed so that regular readers may avoid re-reading material they have seen before, but where they will have the material available for reference, if so desired.

General background note: The U.S. economy is in a protracted and deepening structural recession that will prove to be the second leg of a double-dip recession, which began in 2000/2001. The current downleg was signaled in mid-2005 by a series of leading indicators used for that purpose by SGS. With neither traditional fiscal nor monetary stimulus available to help turn economic activity, the current circumstance is likely to evolve into a hyperinflationary depression (see December 2006 SGS).

Inflation Surges. On the inflation front, price increases, as measured in the GDP, surged at an annualized 4.0% in the first quarter, up from a 1.7% inflation rate in the fourth quarter. Annual PPI inflation for April jumped to 3.2% from 2.5%, while annual April CPI inflation rose to 2.8% from 2.4%.

Gasoline prices have been rising due to short-term supply disruptions, and oil prices have been holding above $60 per barrel. With hurricane season less than a month away, and the with the Middle East remaining the proverbial powder keg amidst other global political tensions, risks to oil prices -- and correspondingly to inflation -- remain sharply on the upside. Also adding to upside inflation pressures are intensifying selling of the U.S. dollar and accelerating broad money growth.

The Current Environment Is Not Conducive to Stable Financial Markets. As the inflationary recession increasingly has gained market recognition, selling of the U.S. dollar and buying of gold have picked some momentum. The credit and equity markets appear to have been relatively immune to the unfolding crisis, so far.

An inflationary recession, compounded by dollar dumping, is about as bad a nightmare as the stock and credit markets can face. The big question is in the uncertain timing of the big break in the dollar. These circumstances, however, can evolve very quickly, with little or no warning. The outlook for gold in this environment remains bright.

Alternate Realities. General background note: This section updates the Shadow Government Statistics (SGS) alternate measures of official CPI and GDP reporting. When a government economic measure does not match common public experience, it has little use outside of academia or the spin-doctoring rooms of the Federal Reserve, White House and Wall Street. In these alternate measures, the effects of gimmicked methodological changes have been removed from the official series so as to reflect more accurately the common public experience, as embodied by the post-World War II CPI and the pre-Reagan-Era GDP. The methodologies for the series are discussed in the August 2006 SGS (see Archives page at www.shadowstats.com).

GDP. The alternate first-quarter GDP growth reflects the "advance" estimate, with many of the methodological gimmicks of recent decades removed. The alternate first-quarter inflation-adjusted annual growth rate (year-to-year, as opposed to the popularly-touted annualized quarter-to-quarter rate) for GDP was a decline of roughly 2.1% versus the official gain of 2.1%.

General background note: Historical data on both the official and SGS-Alternate GDP series are available for download on the Alternate Data page of www.shadowstats.com. The Alternate GDP numbers tend to show deeper and more protracted recessions than have been reported formally or reflected in related official reporting. Nonetheless, the patterns shown in the alternate data are broadly consistent with the payroll employment and industrial production series (as revised), which are major indicators used by the National Bureau of Economic Research in determining the official timing of U.S. business cycles.

CPI. While the gimmicked annual core inflation measures eased in March, annual inflation in the standard inflation measures continued to rebound. Oil prices have remained volatile, but generally have been trending higher. Beyond related higher energy and material costs increasingly permeating broad economic activity, gasoline prices are spiking due to supply problems. Both core and regular annual inflation reporting should rise sharply in the months ahead.

                             Eight Levels of Inflation
                  Annual Inflation for December 2006 to March 2007

2006 2007 Measure Dec Jan Feb Mar I.1 Core PCE Deflator 2.1% 2.2% 2.4% 2.1% I.2 Core Chained-CPI-U 2.3% 2.3% 2.4% 2.1% I.3 Core CPI-U 2.6% 2.7% 2.7% 2.5% I.4 PCE Deflator 2.2% 1.9% 2.3% 2.4% I.5 Chained-CPI-U 2.4% 1.9% 2.2% 2.5% I.6 CPI-U 2.5% 2.1% 2.4% 2.8% I.7 Pre-Clinton CPI-U 5.8% 5.4% 5.7% 6.2% I.8 SGS Alternate Consumer Inflation 10.0% 9.9% 10.0% 10.2%

Notes: I.1 to I.3 reflect the core inflation rates, respectively, of the substitution-based personal consumption expenditure (PCE) deflator, the Chained-CPI-U and the geometrically-weighted CPI-U. I.4 to I.6 are the same measures with energy and food inflation included. The CPI-U (I.6) is the measure popularly followed by the financial press, when the media are not hyping core inflation. I.7 is the CPI-U with the effects of geometric weighting (Pre- Clinton Era as estimated by SGS) reversed. This is the top series in the CPI graph on the SGS home page www.shadowstats.com. I.8 reflects the SGS Alternate Consumer Inflation measure, which reverses the methodological gimmicks of the last 25 years or so, plus an adjustment for the portion of Clinton-Era geometric weighting that is not otherwise accounted for in BLS historic bookkeeping.

General background note: Historical data on both the official and SGS-Alternate CPI series are available for download on the Alternate Data page of www.shadowstats.com. The Alternate CPI numbers tend to show significantly higher inflation over time, generally reflecting the reversal of hedonic adjustments, geometric weighting and the use of a more traditional approach to measuring housing costs, measures all consistent with the reporting methodology in place as of 1980.


With certain measures showing gold at an all-time high and the U.S. dollar at an all-time low, some financial-market segments have begun to pick up on what has started to unfold before the public. With Wall Street's vested interest in touting the stock and bond markets, and with Wall Street dominating the popular financial media, the full scope of issues and the implications for the markets from an inflationary recession, a weakening U.S. dollar and an uncontained GAAP-based annual federal deficit of $4.6 trillion still are not widely discussed.

Ahead lie a sharp decline in equity prices, a sharp spike in long-term interest rates, a heavy sell-off in the U.S. dollar and soaring gold prices. The proximal trigger for all this remains likely to be the dollar and its accelerating demise.

General background note: The U.S. economy remains in a severe, structural inflationary recession, saddled with an impotent Fed and a federal government that is fiscally bankrupt in all but name. In combination, these factors offer the worst of all environments to the financial markets. Ahead lie higher long-term interest rates and much lower U.S. equity prices. On the plus side is the outlook for gold, which provides a solid hedge against many of the problems that have started to surface. Key to the near-term movements of these markets remains the fate of the U.S. dollar.

U.S. Equities -- Up, up and away soars the Dow Jones Industrial Average, along with other popular equity indexes. Current stock-market euphoria reminds me of a bunch of drunken partygoers who have made the decision to watch and ride out a Category-5 hurricane from a beach house on a barrier island, with the eye of the storm bearing down on them. There even may be a partygoer or two who thinks he can make it to the mainland just in time, even though the bridges already are beginning to wash out.

The approaching financial maelstrom already has come over the horizon. When it hits, those investors who have taken shelter in cash, gold and outside the U.S. dollar will be the ones with the wealth and assets available to take advantage of the extraordinary investment opportunities that will follow.

U.S. Credit Market -- Little action can be expected from the Fed, until either a dollar panic or systemic liquidity issues force its hand. With rising inflation, pressure should be on the upside for long-term interest rates, but the inflow of foreign liquidity to the markets has kept long-term rates flat.

When the tidal surge from dollar dumping hits, however, longer term yields will spike, as underlying Treasury securities get dumped.

U.S. Dollar -- As discussed below, the trade-weighted dollar has hit an all-time low, and the financial-weighted dollar is only a couple of percent behind. Nonetheless, heavy dollar selling has not hit, yet. The move against the dollar likely will come quickly, with little or no warning. The proximal trigger could range from a bad economic statistic, a misstep by the Administration or a central bank, or a negative trade development in Asia, to a terrorist attack or even a still-likely military action against Iran. Whatever sets off the selling, it is a good bet to come within the next several months. Broad selling should be heavy enough to overcome any short-lived central bank intervention.

General background note: In terms of underlying fundamentals that tend to drive currency trading, the dollar's portfolio could not be worse. Relative to major trading partners, the U.S. economy is much weaker, interest rates are lower, inflation is higher, fiscal and trade-balance conditions are abysmal, and relative political stability is at a nadir. The President's approval rating commonly has moved currency trading in the past, and it is at the lowest level seen in the post-World War II era. Relative political stability issues are compounded by the presence of a Congress hostile to the President. Generally, the greater the magnitude of the dollar selling, the greater will be the ultimate inflation pressure and liquidity squeeze in the U.S. capital markets.

As shown in the following graph, the U.S. dollar moved lower again in April, setting a new low on a trade-weighted basis.

General background note: Historical data on both dollar series are available for download on the Alternate Data page of www.shadowstats.com. See the July 2005 SGS for methodology.

U.S. Dollar Indices. The Shadow Government Statistics' Financial-Weighted U.S. Dollar Index (FWD) is based on dollar exchange rates weighted for respective global currency trading volumes. For April 2007, the monthly dollar average fell by 1.76% after a 1.11% decline in March. The April 2007 average index level of 50.09 (base month of January 1985 = 100.00) was down 7.49% from April 2006, following an annual rate of decline of 7.41% in March. The index's historic low was 48.98 in April 1995.

Dropping to an all-time low, April's monthly average of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index (TWD) fell by 1.67%, after March's 1.02%.

The April 2007 index level of 57.47 (base month of January 1985 = 100.00) was down 4.78% from the year before, against March's annual decline of 4.44%.

General background note: The biggest difference between the FRB and the SGS series is the much heavier weighting of the Canadian dollar in the TWD versus the FWD.

Gold -- The monthly-average gold price (London afternoon fix per Kitco.com) hit an all-time high of $679.37 per troy ounce in April 2007. That beat out the prior monthly-average high of $676.51 in May 2006, when daily trading set a high of $725.00, and the previous high of $675.31 in January 1980, when daily trading hit an all-time high of $850.00.

In like manner, silver had a good month, showing its strongest monthly average in more than two decades, at $13.74 per troy ounce.

Although the nature of gold trading is such that high volatility likely will continue, as will sporadic central-bank manipulation and intervention, the upside potential remains explosive, particularly when heavy dollar selling begins. Look for new monthly and daily highs in the months ahead.

General background note: As discussed in the Hyperinflation Series (see the December 2006 to March 2007 SGSs), the eventual complete collapse of the U.S. dollar -- the world's reserve currency -- will force the creation of a new international currency system. Gold likely will be structured into any replacement system, in an effort by those organizing the new currency structure to gain public acceptance.

The updated gold versus oil and Swiss franc graphs show April averages. As we go to press, gold is trading shy of $690, oil is under $64 and the Swiss franc is near $0.825. Look for all three measures to trade significantly higher in the months ahead.


The Big Three Market Movers

Most economic reports now are coming in on the soft side of expectations, while inflation results generally have been at the upper end of expectations. Accordingly, market sentiment increasingly has shifted towards the heretofore "unthinkable" combination of recession and inflation. Nonetheless, the full extent of the economy's difficulties is far from being recognized fully. With the President's positive rating setting a new record low, and with the Fed fearful of a market meltdown, recent and upcoming releases of major series have been, and likely will continue to be, subject to massaging for both the perceived political needs of the Administration and the heavy financial market needs of an impotent Federal Reserve Board.

General background note: Against lagging and still largely distorted market expectations, most near-term economic reporting will continue to surprise the markets on the downside, while most inflation reporting should continue to surprise the markets on the upside.

Employment/Unemployment -- Seasonally-adjusted April payroll employment was reported up by 88,000 (62,000 net of revisions) +/- 129,000, a gain that was statistically indistinguishable from a contraction. The April increase followed a revised March gain of 177,000 (previously 180,000). Annual growth in April payrolls slid to 1.37%, the lowest level since the closing days of the last recession, down from 1.46% in March.

Based on prior-period revisions, skewed seasonal factors and an enhanced bias factor, the April data appear to have been massaged so as to avoid showing a monthly payroll contraction. Reversing the pattern of most recent months, the Bureau of Labor Statistics (BLS) reported major downward (instead of upward) revisions to previously published data, and seasonal factors became skewed again. Where the monthly year-to-year changes in both the seasonally-adjusted and unadjusted series should be the same, applying the base unadjusted growth rates to the adjusted series would have reduced the monthly jobs gain from 88,000 to just 32,000.

The jobs number also was boosted by an overly positive monthly fudge or bias factor (now called the birth-death adjustment, which overestimates employment growth during recessions) of 317,000. That was an increase of 46,000 in the monthly bias factor against the 271,000 used for April 2006. The May 2006 bias eased to back to 201,000.

Further, from the statistically-sounder household survey, seasonally-adjusted April employment plunged by 468,000, after rising by 335,000 in March. This number reflects the change in the number of people who have at least one job, versus the payroll survey that counts the number of jobs.

Also from the household survey, the seasonally-adjusted April U.3 unemployment rate rose to 4.45% +/- 0.23% from 4.40% in March, a change that was statistically indistinguishable from a drop in the unemployment rate. On an unadjusted basis, U.3 narrowed to 4.3% in April from March's 4.5%. The broader U.6 rate on an unadjusted basis fell to 7.9% in April, from 8.3% in March, while the seasonally-adjusted U.6 rate rose to 8.2% in April, from March's 8.0%. Net of "discouraged workers" defined away during the Clinton Administration, actual unemployment continues to run about 12%.

Against a background of declining help-wanted advertising, rising new claims for unemployment insurance and stronger showings in the April purchasing managers survey employment components (see respective sections), continued weakness remains likely in official jobs and unemployment reporting.

Next Release (June 1): The May payroll survey also should be weaker than consensus forecasts. Look for a continued uptrend in the unemployment rate.

Gross Domestic Product (GDP) -- The "advance" estimate of annualized real (inflation-adjusted) growth for the first quarter of 2007 was 1.26% +/- 3%, and statistically was indistinguishable from a quarterly contraction. First-quarter growth was down sharply from the fourth quarter's reported 2.45% growth and was the weakest showing since the end of the last recession. Measured year-to-year, annual GDP growth in the first quarter slowed to 2.06% from 3.13% in the fourth quarter.

GDP inflation soared, with the first quarter's implicit price deflator reflecting annualized inflation of 3.97%, up from 1.67% in the fourth quarter.

The slowing economic growth reflected a widening in the trade deficit, net of oil price changes, but such still was shy of reality. Where residential investment contracted, personal consumption expenditure was up at a 2.7% annualized pace. The latter measure was much stronger than indicated by weakening retail sales. The mid-year GDP annual benchmark revision remains likely to introduce major downside revisions to both recent and current GDP reporting.

Although the GDP report is the government's broadest estimate of U.S. economic activity, it is also the least meaningful and most heavily massaged of all major government economic series. Published by the Bureau of Economic Analysis (BEA), it primarily has become a tool for economic propaganda. Adjusting for methodological distortions built into GDP reporting over time, the SGS Alternate GDP measure suggests economic reality is much weaker than officially reported. Alternate year-to-year annual contractions continue, with an annual 2.1% contraction in the first quarter deepening from the 1.5% decline in fourth-quarter 2006 GDP (see the graph in the Alternate Reality section in the Opening Comments).

Official estimates for real, annualized, quarterly first-quarter growth in gross national product (GNP) and gross domestic income (GDI) were not published, given the known vagaries of the "advance" estimate.

Next Release (May 31): Barring surprises to the March trade deficit, the "preliminary" estimate revision to first-quarter 2007 GDP should come in weaker than consensus forecasts, reflecting deteriorating underlying economic fundamentals. A worse-than-expected widening of the trade deficit would add to the downside revision pressures.

Consumer Price Index (CPI) -- The BLS reported the seasonally-adjusted March CPI-U (I.6) up by 0.61% (0.91% unadjusted) +/- 0.12% (95% confidence interval) for the month, following February's 0.40% (0.54% unadjusted) gain. Annual inflation rose to 2.78% in March, up from 2.42% in February. Annualized three months inflation through March was 4.71% adjusted, 7.23% unadjusted.

Annual inflation for the Chain Weighted CPI-U (C-CPI-U) (I.5) -- the substitution-based replacement series for CPI-U as increasingly touted by the "see-no-inflation crowd" -- also increased, up to 2.46% in March from 2.18% in February.

Adjusted to pre-Clinton (1990) methodology (I.7), annual CPI growth was about 6.2% in March, up from 5.7% in February. The SGS Alternate Consumer Inflation Measure (I.8), which reverses gimmicked changes to official CPI reporting methodologies back to 1980, was 10.2% in March, up from 10.0% in February.

The eight levels of annual inflation, I.1 to I.8, are shown in the table in the Alternate Reality section, as is the plot of the SGS Alternate Consumer Inflation number.

Next Release (May 15): Annual inflation generally will continue rising into at least the third quarter of 2007. Seasonally-adjusted, monthly CPI-U increased by 0.6% in April 2006. Any monthly reporting above or below that for the pending release of April 2007 CPI will add or subtract directly to or from the current annual CPI-U inflation rate. Reporting should be on the upside of market expectations, with renewed upside movement in core rates.

Other Troubled Key Series

Federal Deficit -- General background note: The federal government's fiscal 2006 (fiscal year-end September 30th) deficit, prepared based on generally accepted accounting principles (GAAP), widened to $4.6 trillion from 2005's $3.5 trillion. Those numbers dwarfed the officially-gimmicked 2006 federal budget deficit of $248.2 billion, which was down $70.8 billion from 2005's $318.5 billion (see the December SGS).

General background note: Although it lacks the accrual accounting of the GAAP numbers, the change in gross federal debt bypasses several of the reporting manipulations and is a better indicator of actual net cash outlays by the federal government than is the official, gimmicked deficit reporting. As of fiscal year-end 2006, the gross federal debt stood at $8.507 trillion, up $574 billion from 2005, which in turn was up $554 billion from 2004.

For the rolling 12 months through March 2007, the gimmicked deficit was $203.7 billion versus $326.8 billion in March 2006, compared with the rolling deficits of $192.7 billion in February 2007 and $312.6 billion in February 2006. For April 30, 2007, the gross federal debt stood at $8.840 trillion, up $484 billion from April 2006, which in turn was up $591 billion from April 2005. As of March 2007, the gross federal debt was $8.850 trillion, up $479 billion from March 2006, which in turn was up $594 billion from March 2005.

General background note: The Administration and Congress continue playing bookkeeping games. Even so, the gimmicked deficit should widen this year, as government finances suffer increasingly from tax revenue losses due to the intensifying recession and relative tax receipt declines after the expiration of recent tax incentives. While GDP growth estimates can be gimmicked, incoming tax receipts (based on consistently applied tax policies) remain an independent estimate of underlying economic reality and eventually will reflect the economy's mounting difficulties.

Initial Claims for Unemployment Insurance -- Annual growth in initial claims has continued to increase (an economic negative) in tandem with job market deterioration. On a smoothed basis for the 17 weeks ended April 28th, annual growth was 6.4%, up from 5.5% for the 17 weeks ended March 31st.

General background note: More often than not, week-to-week volatility of the seasonally-adjusted weekly claims numbers is due to the Labor Department's efforts to seasonally adjust these numbers around holiday periods, such as Easter and Memorial Day. The Labor Department has demonstrated an inability to do such adjusting successfully. When the new claims series is viewed in terms of the year-to-year change in the 17-week (four-month) moving average, however, such generally is a fair indicator of current economic activity.

Real Average Weekly Earnings -- March's seasonally-adjusted real earnings declined by 0.1%, following February's revised unchanged reading (previously a 0.3% drop). Annual growth slowed to 1.6% in March from a revised 1.8% (was 1.5%) in February. Reported (and revised) sharp increases to monthly average hourly earnings and hours worked are highly suspect.

General background note: Gyrations in the poor quality of reported CPI growth account for most month-to-month volatility in this series. Adjusting for the major upside biases built into the CPI-W inflation measure used in deflating the average weekly earnings, annual change in this series shows the average worker to be under severe financial stress in an ongoing recession.

Retail Sales -- March's seasonally-adjusted retail sales rose by 0.68% (0.28% net of revisions) +/- 0.9% (95% confidence interval), following 0.50% growth (previously 0.08%) in February. With monthly CPI up by 0.61% in March and 0.40% in February, monthly sales barely were beating inflation and, in fact, were down minimally for the quarter. With all the growth puff in retail sales coming from downward revisions to prior reporting, the St. Louis Fed shows March 2007 retail sales on the downside of flat versus December 2006.

On a year-to-year basis, March retail sales were up 3.8% before inflation adjustment and up 1.0% after inflation adjustment, compared with respective annual growth numbers for February of 3.5% and 1.1%

General background note: Real (inflation-adjusted) year-to-year growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession, and a signal first was generated in this business cycle back in June 2006.

Next Releases (May 11): April retail sales should continue coming in below market expectations and below the rate of inflation on both a monthly and year-to-year basis.

Industrial Production -- Seasonally-adjusted industrial production fell by 0.2% in March, after a revised 0.8% gain in February (previously reported at 1.0%). The March data continued reflecting aftershocks of the unusual weather of the several months, with a 7.0% plunge in utility usage offsetting a 7.6% gain the month before.

Annual growth slowed further to 2.3% in March, down from 3.0% in February. For the first quarter, however, production nearly regained all the losses that had been reported in the fourth quarter.

Next Release (May 16): Look for April industrial production to contract again. Monthly contractions in this series should become regular, with annual growth turning negative.

New Orders for Durable Goods -- As discussed and shown in the graph in this month's Opening Comments, the inflation-adjusted annual growth in the six-month moving average of new orders for durable goods has reached a level that usually is seen during a recession.

For the month of March 2007, the usually volatile durable goods orders rose by 3.4% on a seasonally-adjusted basis, following a 2.4% (was 2.5%) increase in February. On a year-to-year basis, however, orders plunged 3.1%, even before inflation adjustment, and that was against a 0.7% contraction in February.

The closely followed nondefense capital goods orders surged in March by 11.7% month-to-month, following a 9.8% (previously 9.5%) gain in February. March's annual growth rate for nondefense capital was 3.9%, against February's 3.1% gain.

General background note: Durable goods orders lost its status as a solid leading economic indicator when the semi-conductor industry stopped reporting new orders in 2002.

Trade Balance -- The seasonally-adjusted monthly trade deficit for February 2007 was reported at $58.4 billion, down from $58.9 billion (previously $59.2 billion) in January. The "improvement" was more than accounted for by a reported decline in oil prices and oil import volume, although oil prices should have risen, not fallen, in the latest reporting. The distorting effect of inconsistent oil price reporting on the monthly trade data (as touched upon in last month's SGS) will be a topic in an upcoming Reporting/Market Focus.

Next Release (May 10): The March trade deficit finally should show some rebound, from recent understatement, with a long-delayed boost in reported oil prices. Reporting risk generally remains on the upside of consensus forecasts. The months ahead should see a pattern of regularly increasing deficits that once again will be setting new records. A significant surprise to consensus forecasts would impact the revision to first-quarter GDP (a bigger deficit means weaker GDP and vice versa).

Consumer Confidence -- April confidence measures declined both on a monthly and annual basis. The Conference Board's April consumer confidence dropped 3.9% month-to-month, after a 2.7% decline in March. April's annual change was a contraction of 5.3% (a 1.1% gain on a three-month moving average basis).

For April, the University of Michigan's consumer sentiment declined by 1.5%, following a 3.2% drop in March. April's year-to-year change was a decline of 0.3% (a 1.4% gain on a three-month moving average basis).

The slowing and negative annual growth in these lagging, not leading, indicators continues to show that the economy has been in trouble.

General background note: The Conference Board measure is seasonally adjusted, which can provide occasional, but significant distortion. The adjustment does not make much sense and is of suspect purpose, given that the Conference Board does not release the unadjusted number. The Michigan survey is unadjusted. How does one seasonally-adjust peoples' attitudes? Also, beware the mid-month Consumer Sentiment release from the University of Michigan. Its sampling base is so small as to be virtually valueless in terms of statistical significance.

Short-Term Credit Measures -- Annual growth in consumer and commercial borrowing continued mixed in the most recent reporting. Some measures of bank loan delinquencies and charge-offs are discussed in this month's Reporting/Market Focus. This section will update those quarterly data as they become available.

Seasonally-adjusted consumer credit (which includes credit cards and auto loans but not mortgages) had not been updated when this newsletter was written. Consumer credit grew by just 0.1% in the month of February, with annual growth at 4.5%, following 4.4% in January and 4.6% in December. In the current environment, where inflation-adjusted growth in income is not adequate to support meaningful growth in the personal consumption component of GDP, GDP growth only can come from temporary debt expansion or savings liquidation. Consumer debt expansion has stalled on a monthly basis, suggesting a major constraint on economic growth.

Commercial borrowing remains strong on a year-to-year basis, although annual growth in commercial paper outstanding slowed to 17.7% in April, from 19.3% in March. Annual growth in commercial and industrial loans was 12.7% in March, down from 13.1% in February. Where solid growth in the commercial credit measures can signal credit needs tied either to rising sales and receivables/inventory, or to slowing sales and slowing collections and involuntarily rising inventories. Slowing growth usually is a sign of slowing economic activity.

Producer Price Index (PPI) -- March finished goods PPI rose a seasonally-adjusted 1.0% (1.4% unadjusted) versus February's 1.3% (1.1% unadjusted). Annual PPI inflation jumped to 3.2% in March from February's 2.5%. Seasonally-adjusted intermediate and crude goods rose 1.0% and 3.2%, respectively, for the month of March.

Next Release (May 11): Despite the random volatility in monthly price variations, PPI inflation reporting over the next six-to-nine months remains likely to exceed market expectations. In particular, April's core inflation rate is subject to an upside surprise.

Better-Quality Numbers

General background note: 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 overall April ISM manufacturing index rebounded to 54.7 from March's 50.9. At work here still appears to be largely the poor-quality seasonal factors supplied by the Commerce Department. The April employment index rebounded as well, rising to 53.1 from March's contraction reading of 48.7.

The April new orders index also jumped, rising to 58.5 from March's 51.6. Seasonal-factor distortions are overcome by viewing the series using year-to-year change on a three-month moving average basis. On that basis, the April new orders index fell by 6.5% compared with the 13.0% annual contraction reported as of March.

General background note: 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 below 50.0 indicates contracting new orders. The index gradually has notched lower from its peak annual growth of 42.6% in April of 2004. As an SGS early warning indicator of a major economic shift, the new orders measure breached its fail-safe point in mid-2005, generating a signal of pending recession.

Service Sector Index. The service-sector ISM index does not have much meaning related to overall business activity, since new order activity at law firms, hospitals or fast-food restaurants has little obvious relationship to broad economic activity. That said, the overall April services sector index rose to 56.0 from 52.4 in March. Both the services employment and prices paid components, however, have some meaning. The April employment component notched higher to 51.9 from March's 50.8. The prices paid component is covered in the Inflation Indicators.

Help-Wanted Advertising Index (HWA) -- The Conference Board reported that help-wanted advertising fell to 30 in March from 31 in February. The March number was down 18.9% from the year before and still may be suffering from unusual-weather distortions.

Viewed on a three-month moving average basis, March's year-to-year change was a contraction of 18.4%, versus February's 15.7%. The series still indicates rapidly deteriorating employment conditions. Where the index never recovered from the 2000/2001 recession, its ongoing renewed plunge has signaled a new and rapid contraction in economic activity. Continued deterioration remains likely in the months ahead.

Housing Starts -- Although seasonally-adjusted March housing starts rose by 0.8% (down 0.5% net of revisions) +/- 13.3% (95% confidence interval) on a monthly basis, after a 7.6% (previously 9.0%) gain in February, annual growth tanked. The year-to-year March 2007 change was a contraction of 25.9%, or a plunge of 30.6% on a three-month moving average basis. Such was the lowest reading since the weakest levels of the last recession. The series continued to signal an intensifying recession.

Homes sales data have tended to confirm the housing contraction and deepening recession. In March reporting, new home sales were up 2.4% +/- 14%, but were down year-to-year by 23.5%. March existing home sales fell 8.4% for the month and 11.3% year-to-year.

Money Supply -- Annual growth in the SGS Continuing M3 appears to have jumped to 12.9% in April from 11.7% in March. The April estimate is based on three weeks worth of underlying data and is subject to revision next week. The annual growth rates and their significance are discussed and shown in the graph in the Opening Comments.

At subscriber request, we are publishing here our estimates of the levels of M3 used in calculating the annual M3 growth. This is done to help those who need an approximate M3 measure to compare with nominal GDP, for example. Although the levels are estimates of monthly averages and are based on underlying seasonally adjusted data, little significance should be attached to the implied month-to-month changes. Those data were not particularly significant when the Fed published them, and they sure are not now.

Further, the indicated level is our best estimate, but regular revisions in the related Fed series (such as the one just published for M2) affect historical M3. Usually, annual growth rates hold, although levels may shift a little. We have not attempted, nor do we plan to recreate a revised historical series for an M3 monthly-average level going back in time (except as done below). The purpose of the SGS series was and is to provide monthly estimates of ongoing annual M3 growth. We are comfortable with those numbers and that our estimated monthly growth rates are reasonably close to what the Fed would be reporting, if it still reported M3.

With those caveats on the table, here are the monthly-average levels for M3:

Shadow Government Statistics Ongoing M3 (Estimated seasonally-adjusted monthly average)

Current Yr Before Month $Trillion $Trillion %Yr/Yr

Feb 06 10.331 9.523 8.49% Mar 10.396 9.558 8.77% Apr 10.455 9.612 8.77% May 10.528 9.665 8.93% Jun 10.588 9.726 8.86% Jul 10.669 9.766 9.25% Aug 10.778 9.871 9.19% Sep 10.893 9.959 9.38% Oct 11.026 10.037 9.86% Nov 11.141 10.083 10.49% Dec 11.258 10.154 10.87% Jan 07 11.352 10.225 11.03% Feb 11.459 10.331 10.92% Mar 11.609 10.396 11.67% Apr(p) 11.798 10.455 12.85%

(p) April 2007 is estimated based on 3-plus weeks of data. NOTE OF CAUTION: The estimates of monthly levels best are used for comparisons with other dollar amounts, such as nominal GDP. While the estimates are based on seasonally- adjusted Federal Reserve data, great significance cannot be read into the month-to-month changes, as was the case when the Fed published the series. The most meaningful way to view the data is in terms of year-to-year change.

Based on three weeks-plus of data on April, annual growth in April for monthly M1 fell by 0.4%, versus a 1.1% contraction in March, while annual April M2 growth was 6.6%, up from 6.1% in March. The monetary aggregates will be revisited in next month's Reporting/Market Focus.

Inflation Indicators

Purchasing Managers Surveys: Prices Paid Indices -- The April prices paid indices rose again, suggesting an intensifying inflation environment reflected in both purchasing managers surveys.

In continued line with oil price changes, the price index movements have remained volatile. On the manufacturing side, the April price index soared to 73.0 from 65.5 in March. On a three-month moving average basis, April's annual change was down by 1.5% versus March's 8.5% contraction. The manufacturing price indicator is not seasonally adjusted and therefore is a better indicator of pricing activity.

On the non-manufacturing side, the seasonally-adjusted April prices diffusion index rose to 63.5 from 63.3 in March. On a three-month moving average basis, however, April's annual change moved into positive territory, up 2.7%, following March's decline of 12.0%.

General background note: Published by the Institute for Supply Management (ISM), the prices paid components of the purchasing managers surveys are reliable leading indicators of inflationary pressure. The measures are diffusion indices, where a reading above 50.0 indicates rising prices.

Oil Prices -- The monthly-average West Texas Intermediate spot price (Department of Energy) rose to $63.97 in April, up 5.6% from March's average of $60.56. Year-to-year price change continued to weaken, though, with April's average down 8.2% from the year before, where March's average price was down 3.7%. Price swings remain volatile, with current oil prices trading slightly below April's average.

Risk to oil prices remains on the upside, both from the pending onset of the 2007 hurricane season, and ongoing Middle Eastern political tensions. Forecasts are for a particularly active hurricane season, although similar forecasts did not pan out in 2006. Nonetheless, oil and gasoline prices appear headed for post-Katrina levels, even before the first storm starts moving on the Gulf of Mexico.

General background note: Global political conditions still continue to favor a sharp spike in oil prices in the months ahead, irrespective of any ongoing games playing by the Administration and OPEC. Overhanging the market remains the potential for a change in the dollar-based pricing of oil, particularly as dollar selling intensifies. Where dollar weakness is the equivalent of an oil price cut for oil purchasers denominated in an appreciating currency, market forces tend to push dollar-based oil prices higher, and that exacerbates inflation problems in the United States. Even worse, if oil pricing were shifted to something other than the U.S. currency, U.S. inflationary pressures would be even more intense, since any drop in the dollar would be reflected directly as an increase in the price of foreign oil for U.S. consumption.

General background note: Whether from supply and demand, geo-political or currency pressures, oil prices will remain at highly inflationary levels and will continue as a major contributing factor to U.S. inflation woes. Historically high oil prices still are working their way through all levels of U.S. economic activity, ranging from transportation and energy costs, to material costs in the plastics, pharmaceutical, fertilizer, chemical industries, etc. These broad inflationary pressures will remain intact despite any near-term oil price volatility. Although these pressures may be slow to surface in government reporting of the so-called "core" inflation measures, they will.
Reporting/Market Focus (April 2007) -- Loan Delinquency/Default Rates as Predictors/Indicators of Business Activity

Troubled economic times usually lead to mounting quality problems for consumer and commercial loans. While the history of such series is limited, current measures of the health of consumer lending are showing deterioration, although the signal given is a lagging, not a leading indicator.

The data for the graphs are for loan delinquencies and charge-offs at all commercial banks, seasonally adjusted, and as published by the Federal Reserve Board.

The heavier line shows spikes in credit card charge-offs tied to problems generated in the last recession and from the impact of the enactment of the 2005 bankruptcy law. Following a surge in bankruptcies designed to circumvent the new law, both delinquencies and charge-offs have been rising throughout 2006. Such indicates that roughly 7.9% of consumer credit card debt was in trouble as of year-end 2006.

Mortgages are more likely to become delinquent than to be charged off, as consumers often have had the option of selling or refinancing the property in question, in order to satisfy the mortgage. That said, mortgage delinquencies have been on the rise since the end of 2004, reaching 1.9% as of the end of 2006.

In terms of consumer liquidity, the rapidly spreading and deepening crisis reported in the popular press as to subprime and unconventional mortgages promises tightened credit standards and less liquidity for consumers. These issues, however, have yet to show meaningfully in the Fed's data.

The Short-Term Credit Measures section will update the available loan quality numbers as they become available on a quarterly basis. First-quarter 2007 data should show a marked deterioration with the subprime problem in hand. At such time as commercial lending starts to falter, those loan-quality issues will be addressed as well.

Upcoming Reporting/Market Focus for May -- The Monetary Aggregates: Revisiting M3

The first anniversary has just passed of the Federal Reserve's abandonment of M3 reporting. What happened and is happening are explored with the benefit of a year's hindsight.


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