JWSGS - MAY 2007 EDITION - June 6, 2007


Issue Number 31

June 6, 2007


GDP Contracted Net of Nonsensical Personal Consumption Surge

Seasonal Factor Distortions Boosted Payrolls Again

M3 Growth at 33-Year High

Fed Remains Impotent

Stock Market Turmoil, Dollar Sell-Off and Gold Boom Just Matter of Time


PLEASE NOTE: Targeted for publication on June 25th is a Special Supplement on Hyperinflation that includes updated material along with an edited compilation of SGS materials published over time, including the recent Hyperinflation Series. Added will be new material from readers' reactions, questions and observations related to the recent Series. Please feel free still to offer any comments or raise your questions in the next week or so by e-mail to johnwilliams@shadowstats.com. Also, please read the note at the end of this month's edition on timing for the June/July SGS (targeted July 9th) and newsletter timing going forward. Updated SGS Ongoing M3 annual growth rates, U.S. Dollar measures and the SGS Alternate GDP were posted to the Alternate Data Series tab of www.shadowstats.com on June 2nd. Best wishes to all -- John Williams


Last month's key data generally showed a worsening inflationary recession. Relative monthly strength, reported for several indicators of business activity, were not too meaningful. Where the affected numbers are highly volatile, of suspect quality or subject to unusual seasonal factors, countertrend reporting usually is just a one-month aberration. Changes in economic direction are foreshadowed by shifts in leading indicators, not by shifts in coincident or lagging indicators, and most of the better indicators continue to confirm a deepening economic contraction. On the inflation front, annualized CPI inflation, year-to-date April, is running 4.8% to 7.4% (seasonally adjusted or unadjusted). Annual growth in the SGS Ongoing M3 has broken above 13%, rivaling levels seen before the severe 1973/1975 inflationary recession.

Slowing Economy. The revised first quarter's 0.6% annualized real (inflation-adjusted) GDP growth (0.4% Gross National Product growth, 0.3% contraction in supposedly GDP-equivalent Gross Domestic Income), with a 95% confidence interval of +/- 3%, was statistically indistinguishable from a contraction.

In fact, any minor corrections to the clearly flawed reporting would have generated the first formal quarterly GDP contraction of the current recession. For example, real retail sales, as reported by the St. Louis Federal Reserve, grew at an annualized quarterly rate of 2.4% in the first quarter, but the Bureau of Economic Analysis (BEA) estimate of related components in GDP showed 5.3% growth. The hot consumption items included surging auto sales (not commonly recognized by the auto industry) and surging furniture and household equipment sales for all those new homes that are not being built. The difference is a swing from 0.6% growth to a 0.2% contraction.

Historical reporting patterns would favor some added downside restatement in the next GDP revision. Further, next month's annual revisions would be a solid bet for generating two quarters of contracting real GDP growth, if the data were honest. Somehow, though, this most highly politicized of series is likely to show its revised weaker historic growth distributed through recent past history so as to avoid the reporting of any quarterly contractions.

In other reporting, housing remains in trouble, although monthly gains in starts and new home sales stirred some wishful market thinking of an upturn. As shown below, the three-month moving-average annual change in housing starts remains deep in recession territory.

Plunging building permits and annual contractions in new and existing home sales suggest there has been no shift in the underlying housing fundamentals.

There was an outright contraction in April retail sales. Monthly gains in industrial production and durable goods orders were tempered by not-so-positive trends in annual change.

May payrolls surprised market expectations on the upside, thanks largely to seasonal factor distortions. Help-wanted advertising contracted in April, and although recent new claims for unemployment have shown a less-negative economic trend, the economic negative remains.

The improvement seen in the purchasing managers manufacturing survey in April and May, should prove fleeting, if indeed the data are being warped by poor quality seasonal factors, as I suspect. If the manufacturing series continues to gain in the next couple of months, such would be suggestive of perhaps a proverbial "dead cat bounce" in the manufacturing sector.

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).

Market Concerns Shifting Towards Inflation Risk. On the inflation front, both the CPI and PPI showed solid monthly inflation gains that have been tempered by heavy seasonal adjustments in the first half of 2007, while annual inflation was somewhat softer in April. Oil prices remain strong and gasoline prices may be peaking, temporarily, close to record highs. Mounting tensions in the Middle East and the onset of the hurricane season offer meaningful upside risks to energy costs.

M3 Growth Invites Unfortunate Historical Comparisons. Barely beating out the annual M3 growth rate of 13.2% in November 2001's post-terrorist attacks liquefaction, May 2007's annual M3 growth rate of 13.3% is the highest since August 1973 (see this month's Money Supply section and the Reporting/Market Focus on M3).

Money growth had soared in the early 1970s as the failing U.S. dollar caused Nixon to abandon the U.S. currency's last link to gold in 1971, and to float the greenback early in 1973. The 13.3% M3 growth in August 1973 actually was in a downtrend.

As of August 1973, the U.S. dollar had declined 23% against the Deutschemark since the beginning of the year. Vice President Spiro Agnew's resignation, the Arab-Israeli war and the Arab oil embargo were just two months away. Already starting to unfold was a severe inflationary recession. Richard Nixon's popularity as President would hit its historic nadir in October 1973 -- not during Watergate -- a feat exceeded on the downside only recently by the historic low ratings given to President Bush.

The overall 4.9% peak-to-trough contraction in Gross National Product, during the recognized November 1973 to March 1975 recession, officially is the worst downturn of the post-World War II era. At the time of the 13.3% M3 growth in August 1973, official CPI inflation was 7.4%. Inflation would peak at 12.3% in December 1974, near the end of the 1973/1975 recession.

A variety of factors combined to create the particularly difficult economic environment in the 1970s, and excessive money growth was one of them. A number of factors also have combined to create the current untenable conditions in the economy and financial markets. In the early 1970s, however, trade largely was in balance, the U.S. was not yet a net-debtor nation and the federal budget deficit was containable. Today, any way the twin deficits are viewed, they are out of control, the largest ever seen for a major country, and the U.S. is the world's largest net-debtor nation.

As an aside, the depth of the 1973/1975 recession was exceeded by the combination of the successive declines in the 1980 and 1981/1982 double-dip recession, which also was inflationary.

Muted-to-Exuberant Market Reactions. Responding to these less-than-happy factors during the last month: the U.S. dollar generally was a little stronger, except for its notable ongoing decline against the Canadian dollar; gold and oil prices softened minimally; the Treasury yield curve flattened out and actually now shows a net positive slope; and stocks continued their mindless bubbling.

An inflationary recession combined with eventual massive selling pressure against the U.S. dollar is the worst of all worlds for the U.S. equity and credit markets. Benefiting from the coming turmoil should be gold and silver prices.

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 "preliminary" estimate revision, 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 2.2% versus the official year-to-year gain of 1.9%.

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. The annual inflation measures eased a notch or two in April. Oil prices have been volatile, but remained high and generally are trending higher. Beyond related higher energy and material costs increasingly permeating broad economic activity, gasoline prices continue to spike 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 April 2007

2007 Measure Jan Feb Mar Apr I.1 Core PCE Deflator 2.2% 2.4% 2.1% 2.0% I.2 Core Chained-CPI-U 2.3% 2.4% 2.1% 2.0% I.3 Core CPI-U 2.7% 2.7% 2.5% 2.3% I.4 PCE Deflator 1.9% 2.3% 2.3%r 2.2% I.5 Chained-CPI-U 1.9% 2.2% 2.5% 2.3% I.6 CPI-U 2.1% 2.4% 2.8% 2.6% I.7 Pre-Clinton CPI-U 5.4% 5.7% 6.2% 6.0% I.8 SGS Alternate Consumer Inflation 9.9% 10.0% 10.2% 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.


The general outlook for the markets remains unchanged. Ongoing equity market strength keeps moving away from reality, with an ultimate heavy sell-off and protracted bear market looming at some point not too far down the road.

The U.S. dollar remains on the edge of the abyss, with only the element of timing an issue as to when the greenback begins a terrible downward spiral. Coincident with that selling will be a liquidation of dollar denominated assets held outside the United States, along with a corresponding spike in U.S. interest rates and sell-off in equities.

Benefiting from this market turmoil should be gold, one of the better hedges against all the economic displacements that are continuing to unfold.

In this environment, with the U.S. financial markets dependent on foreign capital for liquidity, the Fed has its hands tied. Chairman Bernanke keeps giving the markets mixed signals and positive spins, where the best the Fed can hope for is to forestall, for as long as possible, a likely financial market meltdown.

The potential for a U.S. dollar sell-off remains the primary risk to the Fed raising interest rates. With market liquidity at stake, defense of the dollar will outweigh considerations of a faltering economy, at least initially. Only the threat of a systemic domestic financial collapse is likely to push the Fed to an easing stance in the near-term.

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 -- The Dow Jones Industrial Average and other popular equity indices keep hitting historic highs, while the underpinning fundamentals push historic negative extremes. When reality catches up with delusion, the downside adjustments to stock prices should be quite large.

General background note: 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 should follow.

U.S. Credit Market -- As discussed last month, little action can be expected from the Fed, until either a dollar panic or systemic liquidity issues force its hand.

Rising inflation usually means upside pressure on long-term interest rates and relative to short-term rates. The inflow of foreign liquidity to the markets has kept long-term rates flat and has inverted the yield curve (short-term yields higher than long-term yields) for some time.

That changed in the last month, with the yield curve actually resuming a more-normal net positive slope as suggested by the following graph of the relative constant-maturity yields on the three-month Treasury bill and 10-year Treasury note.

While the change, to a certain extent, may reflect shifting market expectations, it also may reflect a developing shift in foreign investor activity. Once the dollar dumping begins, the long-term yields should spike relatively sharply with an increasingly positive slope to the yield curve.

U.S. Dollar -- The U.S. dollar gained against most of the major currencies last month, except against the Canadian dollar, where the exchange rate appears headed for a parity not seen for three decades.

Despite the extraordinarily negative fundamentals discussed below, heavy dollar selling has not hit, yet. The timing of the move against the dollar remains uncertain, but it likely will come sooner (next several months), rather than later, with little or no warning. The proximal trigger may be a surprise, but likely will come from a universe of bad economic statistics, missteps by the Administration or a central bank, negative trade or market developments in Asia, or a terrorist attack or even still-likely military action against Iran. Broad selling pressure should be strong 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 trading was mixed in May, 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 May 2007, the monthly dollar average rose by 0.26%, after declining 1.76% in April. The May 2007 average index level of 50.22 (base month of January 1985 = 100.00) was down 3.19% from May 2006, with April 2007 down 7.49% from the year before. The index's historic low was 48.98 in April 1995.

Dropping to a new all-time low, however, May's monthly average of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index (TWD) fell by 0.84%, after April's 1.67% decline. The May 2007 index level of 56.99 (base month of January 1985 = 100.00) was down 2.78% from the year before, against April's 4.78% annual decline.

The variance of the gain in the FWD versus the decline in the TWD can be explained by the sharp monthly decline of the U.S. dollar against the Canadian dollar, where the latter receives a much heavier weighting in the TWD.

Gold -- The monthly-average gold price (London afternoon fix per Kitco.com) averaged $666.86 per troy ounce in May, following April's all-time high average of $679.37. The minor monthly decline was despite stories of mounting central bank gold sales. Silver averaged $13.15 per troy ounce in May, down from $13.74 in April.

While high price volatility is common with gold trading, and despite central-bank manipulations and intervention, the upside potential for the precious metal remains explosive, particularly when heavy dollar selling begins. Still, 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 around $670, oil is around $65 and the Swiss franc is near $0.82. Look for all three measures to trade significantly higher in the months ahead.


The Big Three Market Movers

Most major economic reports now are coming in on the soft side of expectations, while inflation results generally have been at the upper end of expectations. Nonetheless, there have been several recent reports such as April jobs and new home sales that had their monthly gains hyped into economic turnarounds. As discussed in the Opening Comments and in the sections ahead, spurious countertrend reports tend to be one-month aberrations. The economy does not turn quickly, and certainly not without major upside shifts in key leading indicators.

Nonetheless, market sentiment increasingly has settled into the possibility of a mix of recession and inflation, although the full extent of the economy's plight is far from broad recognition. With the President's positive rating still bottom bouncing at a 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 some 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 tend to 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 May payroll employment was reported up by 157,000 (147,000 net of revisions) not much outside the 95% confidence interval of +/- 129,000. The May increase followed a revised April gain of 80,000 (previously 88,000). Annual growth in May payrolls notched higher to 1.39% from 1.36% in April, the lowest level since the closing days of the last recession.

Once again, the monthly payrolls appear to have been boosted by the use of inappropriate seasonal factors. 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 shown monthly gains in April and May of 26,000 and 146,000, respectively, for a total of 172,000. Such compares with the reported gains of 80,000 and 157,000, or a total of 237,000 for the two months.

The jobs number also was supported by a positive monthly fudge or bias factor (now called the birth-death adjustment, which overestimates employment growth during recessions). May's bias factor of 203,000 (up from 201,000 in May 2006) was down from 271,000 in April. The June 2006 bias was 166,000.

From the statistically-sounder household survey, seasonally-adjusted May employment coincidentally also gained 157,000 (the two series are not reconcilable), after employment fell by 468,000 in April. 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 May U.3 unemployment was 4.46% +/- 0.23%, virtually unchanged from April's 4.45%. On an unadjusted basis, U.3 held at 4.3% in May. The broader U.6 rate on an unadjusted basis also held at 7.9% in May, with the seasonally-adjusted U.6 rate holding at 8.2% in May against April. Net of "discouraged workers" defined away during the Clinton Administration, actual unemployment continues to run about 12%.

The May employment data were against a background of declining help-wanted advertising, somewhat less economically-negative new claims for unemployment insurance and a weaker showing in the May purchasing managers survey manufacturing employment component, although the services component improved (see respective sections). These background numbers remain consistent with continued weakness in official jobs and unemployment reporting.

Next Release (July 6): The June payroll survey should swing back to the weak side of expectations. Look for the unemployment rate to enter a period of fairly regular upturns.

Gross Domestic Product (GDP) -- The "preliminary" estimate revision of annualized real (inflation-adjusted) growth for the first quarter of 2007 was 0.6496% +/- 3%, down from an initial estimate of 1.26%, and still statistically indistinguishable from a quarterly contraction. One has to go to the unpublished third decimal point in the GDP estimates to come up with annualized growth of 0.6%, otherwise it calculates out to 0.7%. The first-quarter's tepid growth was down sharply from the fourth quarter's reported 2.45%. Measured year-to-year, annual GDP growth in the first quarter slowed to 1.90% from an initial estimate of 2.06%, and from 3.13% in the fourth quarter.

An understated adjustment for the widened trade deficit and a liquidation of inventories provided the bulk of the downward revision. That was partially offset by an upward revision to personal consumption that had no relationship to underlying reality. As discussed in the Opening Comments, that one factor, among others, made the difference between growth and contraction.

GDP inflation held its strong initial gain, with the first quarter's implicit price deflator reflecting annualized inflation of 4.0% versus the previously reported 3.97%, and up from 1.67% in the fourth quarter.

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 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 2.2% contraction in the first quarter deepening from the 1.5% decline in the fourth quarter (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 published along with the "preliminary" GDP.

First-quarter real GNP -- GDP net of the international flows in factor income (interest and dividend payments) -- was up at an annualized quarterly rate of just 0.40%, down from 3.49% in the fourth quarter.

First-quarter real GDI -- the supposedly equivalent income side of GDP -- actually contracted by 0.32%, following the fourth quarter's 4.47% gain.

Next Release (June 28): Usually the "final" estimate revision of first-quarter 2007 GDP would be little more than statistical noise. When there is such a sharp first revision, however, the second often takes it a little further in the same direction. Then there are the annual revisions due on July 27th. While prior-period growth most certainly will revise lower, as discussed in recent SGS newsletters, political massaging should keep a quarterly contraction from surfacing.

Consumer Price Index (CPI) -- The BLS reported the seasonally-adjusted April CPI-U (I.6) up by 0.42% (0.65% unadjusted) +/- 0.12% (95% confidence interval) for the month, following March's 0.61% (0.91% unadjusted) monthly inflation gain. Annual inflation eased back to 2.57% in April from 2.78% in March. Annualized year-to-date inflation through April was 4.81% adjusted, 7.44% unadjusted.

Annual inflation for the Chain Weighted CPI-U (C-CPI-U) (I.5) -- the substitution-based series that appears destined to replace the CPI-U -- was 2.35% in April versus 2.46% in March.

Adjusted to pre-Clinton (1990) methodology (I.7), annual CPI growth was about 5.9% in April, down from 6.2% in March, while the SGS Alternate Consumer Inflation Measure (I.8), which reverses gimmicked changes to official CPI reporting methodologies back to 1980, held at roughly 10.2% in April. The eight levels of annual inflation, I.1 to I.8, are shown in the table in the Alternate Reality section, along with the graph of SGS Alternate Consumer Inflation.

Next Release (June 15): Annual inflation generally will continue rising into at least the third quarter of 2007. Seasonally-adjusted, monthly CPI-U increased by 0.55% in May 2006. Any monthly reporting above or below that for the pending release of May 2007 CPI will add or subtract directly to or from the current annual CPI-U inflation rate. Reporting risks favor an upside surprise to modest market expectations. A renewed upside movement in core inflation also is overdue.

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 April 2007, the gimmicked deficit was $144.9 billion versus $265.7 billion in April 2006, compared with the rolling deficits of $203.7 billion in March 2007 and $326.8 billion in March 2006. For May 31, 2007, the gross federal debt stood at $8.829 trillion, up $472 billion from May 2006, which in turn was up $579 billion from May 2005. 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.

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 softened (an economic positive) but has continued in positive territory (an economic negative). On a smoothed basis for the 17 weeks ended May 26th, annual growth was 2.7%, down from 6.4% for the 17 weeks ended April 28th.

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 -- April's seasonally-adjusted real earnings declined by 0.5%, following March's revised 0.1% gain (previously a 0.1% drop). Annual growth slowed to 0.9% in April from 1.6% in March.

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 -- April's seasonally-adjusted retail sales declined by 0.23% (plus 0.13% net of revisions) +/- 0.9% (95% confidence interval), following 0.97% growth (previously 0.68%) in March. With monthly CPI up by 0.42% in April, not only were seasonally-adjusted monthly retail sales down by roughly 0.65% after inflation, they were 0.3% below the sales of December 2006.

On a year-to-year basis, April retail sales were up 3.17% before inflation and just 0.60% after inflation, compared with respective annual growth numbers for March of 4.37% and 1.59%.

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 Release (June 13): May retail sales should come in below relatively strong market expectations and below the rate of inflation on both a monthly and possibly a year-to-year basis.

Industrial Production -- Seasonally-adjusted industrial production rose by 0.7% (0.4% net of revisions) in April, following March's revised 0.3% decline (previously a 0.2% drop). Despite the monthly gain, with prior period revisions in place, April's annual growth slowed to a near-recessionary 1.88%, down from 2.07% in March.

Next Release (June 15): Look for June industrial production to move again towards a pattern of contraction. Eventually, monthly contractions in this series should become regular, with annual growth turning negative.

New Orders for Durable Goods -- For April, the usually volatile durable goods orders gained 0.6% (1.4% net of revisions) on a seasonally-adjusted basis, and revisions this time were from the annual benchmark, which had negligible impact in the aggregate. March now shows a 5.0% gain (previously 3.4%). April's annual change was a gain of 4.7%. On a three-month moving-average annual basis, though, change was a 0.3% contraction, following a 0.8% contraction in March, still suggestive of less-than-robust economic activity.

The closely followed nondefense capital goods news orders fell by 0.8%, following March's 11.4% (previously 11.7%) month-to-month jump. April's annual growth rate for nondefense capital goods was 11.0%.

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 March 2007 was reported at $63.9 billion, up from a revised $57.9 billion (previously $58.4 billion) in February. While, the March deterioration reflected some catch-up from underreporting of recent months, the March deficit remains shy of reality. The unexpected trade deterioration was a factor in the downside "preliminary" revision to first-quarter GDP.

Next Release (June 8): Odds favor the April trade deficit showing continued deterioration, recovering further from recent understatement. Reporting risk generally remains on the negative side of consensus forecasts, and a surprise sharp deterioration would dampen early expectations of second-quarter GDP growth. The months ahead should see a pattern of regularly increasing deficits that once again will be setting new records.

Consumer Confidence -- May confidence measures rose both on a monthly and annual basis. The Conference Board's May Consumer Confidence rose by 1.6% month-to-month, after a revised 1.8% drop (was down 3.9%) in April. May's annual change was a gain of 3.2% (slowing to a 0.2% gain on a three-month moving-average basis).

For May, the University of Michigan's Consumer Sentiment rose by 1.4%, following a 1.5% decline in April. May's year-to-year change was a gain of 11.6% (firming to a 3.3% gain on a three-month moving-average basis).

The bounce in these lagging, not leading, indicators tends to reflect more the tone of the popular financial media, rather than any turn in economic activity.

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 -- Patterns of annual growth in consumer and commercial borrowing were mixed, though generally stronger, in the most recent reporting.

Seasonally-adjusted consumer credit (which includes credit cards and auto loans but not mortgages) grew by 0.6% in the month of March, with annual growth picking up to 5.1% from 4.6% in February. 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. Even with a minor pick-up in activity, still-restrained consumer debt expansion places constraint on economic growth.

Commercial borrowing remains strong on a year-to-year basis, with annual growth in commercial paper outstanding rising to 19.6% in May from 17.7% in April. Annual growth in commercial and industrial loans was 11.7% in April, slightly easier than the 12.7% in March. 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.

Producer Price Index (PPI) -- April finished goods PPI rose a seasonally-adjusted 0.7% (1.0% unadjusted), versus March's 1.0% (1.4% unadjusted). Annual PPI in April held at 3.2%, same as in March. Annualized seasonally-adjusted April PPI inflation for the last three months was a hardly-tepid 12.7%. Seasonally-adjusted intermediate and crude goods rose 0.9% and fell 1.5%, respectively, for the month of April.

Next Release (June 14): Despite the random volatility in monthly price variations, PPI inflation reporting over the next six-to-nine months should continue to exceed market expectations. The core PPI inflation rate is overdue for 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 May ISM manufacturing index gained minimally to 55.0 from February's 54.7. At work here still appears to be largely the poor-quality seasonal factors supplied by the Commerce Department. The May employment index, however, fell back to 51.9 from April's reading of 53.1. If bad seasonal factors indeed are in play, as I suspect, the series should see some meaningful weakness in the next couple of months. Otherwise, continued gains in the index would be suggestive of some bounce in activity, albeit from impaired levels.

The May new orders index rose to 59.6 from April's 58.5. 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 May new orders index was down 0.6% versus the 6.5% decline in April.

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 May services sector index rose to 59.7 from 56.0 in April. Both the services employment and prices paid components, however, have some meaning. The May employment component was up, increasing to 54.9 from April's 51.9. 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 29 in April, along with a downward revision to March's reading from 30 to 29. The April number was down 14.7% from the year before, with some of the unusual-weather distortions of recent months resolved with revision.

Viewed on a three-month moving-average basis, April's year-to-year change was a contraction of 19.1%, versus March's revised 19.3% (was 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 -- As shown in the graph in the Opening Comments, the three-month moving average annual 23.4% contraction for April housing starts remains deep in recession territory. April seasonally-adjusted starts rose by 2.5% +/- 13.3% (95% confidence interval) on a monthly basis, after a 2.7% gain in March. The current numbers reflect the impact of annual benchmark and seasonal-adjustment revisions. The year-to-year April 2007 change was a contraction of 16.1%, versus 24.1% in March, with the improvement an artifact of a plunge in the April 2006 numbers. The series continued to signal an ongoing recession.

In addition to April's plunge in building permits (which I do not use usually, because of long-term historical inconsistencies), the homes sales data have tended to confirm the housing contraction and recession. Keep in mind that these series are highly volatile on a month-to month basis. In April reporting, new home sales were up 16.2% +/- 16% (95% confidence interval) but still were down 10.6% from April 2006. April existing home sales fell 2.6% for the month and were down 10.7% for the year.

Money Supply -- As discussed and shown in the Opening Comments, annual growth in the SGS Continuing M3 appears to have increased to a 33-year high, at 13.3% in May, up from 12.8% in April. Money supply M3 is also revisited in this month's Reporting/Market Focus.

Based on three weeks worth of underlying data, the May annual growth estimate is preliminary, and although it reflects higher growth than the month before, the pace of gain reflects some deceleration following April's accelerating rate of growth. Barring a significant shift in the four-week numbers, the next update on May M3 will follow with the upcoming June 17th Flash Update, when full monthly data 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 indicated M3 levels below are our best estimate and are provided at specific subscriber request. Keep in mind that regular revisions in the related Fed series 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. 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 $ Tril $ Tril % Yr/Yr

Jan 07 11.352 10.225 11.03% Feb 11.459 10.331 10.92% Mar 11.610 10.396 11.67% Apr (r) 11.791 10.455 12.77% May (p) 11.924 10.528 13.26%

(p) May 2007 is estimated based on three 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 of data for May, annual growth in May for monthly M1 fell by 1.4%, versus a 0.2% contraction in April, while May M2 annual growth was 6.6%, up from 6.5% in April.

Inflation Indicators

Purchasing Managers Surveys: Prices Paid Indices -- The May prices paid indices were mixed in movement but remained high in inflation territory, suggestive of ongoing inflation issues in both purchasing managers surveys.

Still generally moving with oil price changes, the price index movements have remained volatile. On the manufacturing side, the May price index notched back to 71.0 from April's 73.0. On a three-month moving average basis, May's annual change was down by 2.6% versus April's 1.5% decline. The manufacturing price indicator is not seasonally adjusted and, therefore, is a better indicator of pricing activity. Keep in mind that the oil market was particularly strong at this time last year.

On the non-manufacturing side, the seasonally-adjusted May prices diffusion index jumped to 66.4 from 63.5 in April. On a three-month moving average basis, however, May's annual change moved into negative territory, down 4.4%, versus April's gain of 2.7%.

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) eased to $63.46 per barrel in May from $63.97 in April. Against last year's particularly high oil prices, year-to-year change continued to weaken, with May's average price down 10.5% at an annual pace, where April's average was down 8.2%. Price movement remains volatile, with current oil prices trading slightly above May's average.

Meaningful upside risks to oil prices remain in play, both from the hurricane season and ever-mounting Middle Eastern political tensions. Forecasts remain for a particularly active hurricane season, while oil and gasoline prices have started the season at levels already at or above those seen post-Katrina.

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 (May 2007) -- Money Supply M3 Revisited

The first anniversary the Federal Reserve's abandonment of M3 reporting passed recently without much fanfare. Ostensibly, the series was abandoned due to its lack of relevance and high cost of preparation. Neither reason given has much merit, which leaves open the question as to why the series was abandoned. Given the historically high annual growth currently seen in the SGS Ongoing M3 reporting, is it possible that the U.S. central bank did not want the domestic and global markets to contemplate the significance of what was then (March 2006) looming double-digit growth in the broad money measure?

As to reporting, annual growth in the still-reported M2 now is 7%, and the non-M2 components of M3 are averaging about 25%. The two dominant non-M2 components, large time deposits and institutional money funds still are reported weekly by the Fed in some usable form. With most of the needed data still being reported, how much can the Fed be saving by not publishing the full series?

As to relevance, of course, part of the issue may be tied to the meaningfulness or quality of the underlying economic series (GDP, CPI, etc.) that are being assessed against M3. The graph below shows growth in M3 and SGS Ongoing M3 plotted versus the CPI-U and the SGS Alternate Consumer Price Measure.

In the post-1987 liquidity panic era, annual M3 growth has a negative 40% correlation with annual CPI-U inflation, suggesting that higher M3 growth leads to lower inflation. Wait until the Wall Street hypesters start spinning that one! In contrast, M3 has a positive 71% correlation with the SGS inflation measure, suggesting that higher M3 growth has some relationship to higher inflation.

The Federal Reserve has been in a long-term liquidity trap, where pumping up of the money supply generally has not stimulated normal economic growth in the post-1987 era. Excessive liquidity did help to build stock-market and housing bubbles, which helped boost economic growth from the standpoint of a perceived wealth effect and extraordinary debt expansion.

The Fed's pushing on string, however, never addressed the underlying structural collapse in economic activity, the long-term decline in inflation-adjusted household income, with a meaningful portion of the U.S. manufacturing base moving offshore. Therein lies the heart of the current economic crisis. Without a new gimmick from the Fed aimed at somehow buying more time, the economy is foundering based on negative fundamentals that cannot be turned quickly (as in decades), and certainly not with excessive money supply pumping. Without sustainable real income growth there can be no sustainable economic growth.

The Fed can hide whatever numbers it chooses, the government can massage its economic statistics as much as it wants, but the underlying reality of a deteriorating inflationary recession remains in place. What the politicians are missing is that Main Street U.S.A., which tends to vote its pocketbook, does not believe the gimmicked data and has an amazingly good sense as to what is going on. The reference there was to Main Street not Wall Street.

Upcoming Reporting/Market Focus for June/July -- Hyped Economic Myth of the Moment

With hyped stories unfolding irregularly on the various economic reports during the last month, including jobs reporting, CPI and housing, the June/July Reporting/Market Focus will zero-in on a popular economic myth of the moment as press time nears.


PLEASE NOTE: The June/July "Shadow Government Statistics" newsletter is targeted for the week of July 9th, which will allow for both the analysis of the June employment data and the quarter-end financial results. The timing of the week following the employment report release seems to be the most practical in terms of having the timely and comprehensive key data in the various analyses, and that schedule will be adhered to as much as possible, going forward. There will remain at least two intervening Flash Updates covering key data the weekend after release.

In order to get the newsletter month back in sync with the calendar, subscription expirations will be adjusted to cover the one month pick up in calendar timing. Postings on the Web site of monthly newsletters, interim Flash Updates and Alerts are advised immediately by e-mail.

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