No. 400: Budget Deficit Reality, October CPI, Industrial Production
COMMENTARY NUMBER 400
Budget Deficit Reality, October CPI, Industrial Production
November 16, 2011
GAAP-Based 2011 Federal Deficit Likely Within Five- to Seven-Trillion Dollar Range
Effects of High Oil Prices Still Spreading in Broad Economy
October’s Annual Inflation: 3.5% (CPI-U), 3.9% (CPI-W), 11.1% (SGS)
Real Retail Sales and Industrial Production Gained in October
But the Series Share Inflation-Adjustment Issues
PLEASE NOTE: The next regular Commentary is scheduled for tomorrow, Thursday, November 17th, covering October housing starts. It also will include a Special Commentary discussing underlying U.S. economic reality.
—Best wishes to all, John Williams
SPECIAL COMMENTARY – BUDGET DEFICIT REALITY
- Deficit reduction of 1.2-trillion dollars over ten years is little more than statistical noise, given the overly optimistic assumptions underlying the deficit projections.
- The actual annual deficit (on a generally-accepted-accounting-principles [GAAP] basis) likely will be reported in the range of five -to seven-trillion dollars for 2011, with the GAAP shortfalls in 2012 and beyond likely to show ongoing deterioration, irrespective of the Super Committee’s actions.
The White House Office of Management and Budget (OMB) assumes positive economic growth into the future, underlying its budget projections. Assumptions in the September 2011 Mid-Session Review already have gone astray, in the wrong direction. The annual average real GDP growth for 2011 was assumed at 2.6%. With three quarters of reporting now in place, it would surprising if the actual 2011 number got as high as 1.7%). Assumed GDP growth improves into the future, peaking at 4.0% in 2014, and then tapering off into the next decade. As will be discussed in tomorrow’s Special Commentary—Underlying Economic Reality, a more realistic outlook would show a contracting GDP for at least the next several years.
The OMB also assumes average CPI-U inflation of 2.0% or less for 2012 through 2015, and then 2.1% thereafter. The projection for 2011 was 2.8%, but with 10 months now reported, inflation for the year is unlikely to be less than 3.2%. A more realistic outlook would show higher consumer inflation for at least the next several years.
To the extent that reported GDP growth is weaker than assumed, and that CPI-U inflation is stronger than assumed, the resulting federal budget deficit and borrowing needs of the U.S. Treasury will be worse than projected. Bad forecasting of the close-in years has disproportionately large impact on longer-range forecasts such as a 10-year federal budget deficit projection.
GAAP-Based Deficit. The U.S. Treasury reported a cash-based operating deficit for the U.S. government of 1.299-trillion dollars in fiscal 2011 (year-ended September 30th). That was against a 1.294-trillion dollar deficit in 2010. The cash-based reporting has been gimmicked since the days of President Lyndon Johnson, when government accounting began using the cash surplus (tax receipts versus outlays) dedicated to Social Security as part of the general fund. As a result, for decades, the federal government’s reported deficit was understated due to the inclusion of the Social Security cash surplus. Recently, though, the Social Security cash flow turned negative.
The simple cash-based system was gimmicked anew, when the Treasury started to count some of its recent bailout outlays as “investments.” Accordingly, I view the headline deficits as not too meaningful, looking instead at changes in the gross federal debt for indications of cash flow, and to the GAAP-based accounting for meaningful deficit numbers.
My best estimate for fiscal 2010 remains that the GAAP-deficit—based on considering consistent accounting and one-time charges, and including the net present value of unfunded liabilities in Social Security, etc.—was roughly 5.3-trillion dollars (see Commentary No. 340 for details). With continued deterioration in the unfunded liabilities for Social Security, Medicare, etc., and with possible accounting changes (such as the handling of Fannie Mae and Freddie Mac, which largely have been excluded from the accounting), the GAAP-based federal deficit for fiscal 2011 likely was in the range of five- to seven-trillion dollars.
That would put the ratio of gross U.S. government debt and obligations to GDP closing in on six-to-one, the worst of any major Western power. It is difficult to develop numbers for other countries that are on a consistent basis, but I hope to have a well-vetted table of such detail for the revision to the Hyperinflation Report. My best estimate remains that the next-worst ratio within the major economies is the United Kingdom.
It is the GAAP-based deficit that shows the ultimate insolvency of the U.S. government. With an annual deficit in excess of five-trillion dollars, the government could tax salaries and wages at 100% and an annual deficit would remain. The government could eliminate every penny of government spending, except for Social Security and Medicare, and the annual deficit would remain.
A cut of $1.2 trillion dollars over ten years is not too meaningful in such a circumstance. The focus needs to be on balancing the GAAP-based not the cash-based deficit.
The U.S. Treasury is scheduled to publish its formal GAAP-based 2011 financial statements on the U.S. government on December 15th. A fully updated and revamped Hyperinflation Report will be published soon thereafter.
Rest-of-the-World and the Pending Deficit Reduction Program. To the extent that long-term solvency could be restored to the United States government, the required actions would be extremely painful to the populace. It became clear during the recent debt-ceiling negotiations that even looking at hints of what had to be done was politically impossible for those currently controlling the Congress and the White House. Without consistent and very strong political will—which I see largely as lacking in Washington—and without concurrent extraordinary actions, the U.S. economy remains at high risk of devolving quickly into a hyperinflationary great depression. The timing here has been accelerated rapidly by the Federal Reserve and the federal government taking only extreme stop-gap measures that have bought limited time, but that have done little to resolve the U.S. systemic-solvency and economic crises of the last four-to-five years.
The global markets have been in turmoil since the debt-ceiling negotiations ended with the Super Committee solution. It would not take much intensification of U.S. political turmoil to refocus global financial-market attention on the long-range U.S. insolvency—as things stand—and to trigger renewed heavy selling of the U.S. dollar and dollar-denominated assets. More will follow in tomorrow’s Hyperinflation Watch. Again, the general broad outlook has not changed.
Executive Summary—Economic Reporting. With tomorrow’s (November 17th) Special Commentary, on underlying economic reality, today’s economic comments are limited. The general outlooks on the economy, inflation and systemic solvency have not changed from those discussed in the Hyperinflation Special Report (2011) and in recent Hyperinflation Watch sections. The Hyperinflation Watch section will be published next and fully updated in tomorrow’s missive.
October Real Retail Sales and Industrial Production. Both inflation-adjusted retail sales and industrial production were reported with solid monthly gains in October, but there are broader inflation issues that will be addressed in tomorrow’s Special Commentary. Seasonally-adjusted real retail sales gained 0.6% (versus 0.5% not adjusted for inflation) for the month of October, thanks to the 0.1% monthly decline in the CPI. In September, real sales gained 0.8% (versus 1.1% before inflation adjustment).
Seasonally-adjusted October industrial production jumped by 0.7% in the month, versus a revised 0.1% monthly decline in September. September production initially was reported with a 0.2% gain.
October Consumer Price Index (CPI). A 4.3% monthly decline in October gasoline prices was more than could be offset with a small positive seasonal-adjustment, and the adjusted CPI-U notched 0.08% lower for the month as a result. Against stronger monthly inflation in October 2010, the year-to-year annual CPI-U inflation pace softened to 3.53% from 3.87% in September. Outside of the last several months, though, the October annual inflation still was the highest since October 2008.
The SGS-Alternate Consumer Inflation Measures showed lower annual inflation in tandem with the underlying CPI-U series. The 1990-methodology-based alternate measure saw annual inflation at 6.9% in October, down from 7.2% in September, while the 1980-methodology-based alternate measure saw annual inflation at 11.1% in October, versus 11.5% in September.
October’s adjusted monthly decline likely will not be repeated in November. Although seasonal factors for gasoline prices turn negative in November, gasoline prices in November have held even with October, so far, and could increase in tandem with generally rising oil prices. Inflation in non-energy measures increasingly will provide a broad-based rise in prices. In the works is a round of wage/salary and cost adjustments triggered by 4% annual inflation already seen in official CPI reporting.
Reflecting the broadening inflation problem, the CPI-U’s annual “core” inflation rate has risen now for twelve straight months, since the Fed introduced QE2. As shown in the following graph, the annual core rate rose to 2.10% in October versus 1.97% in September, and was up from 0.61% in October 2010.
The usual graphs of the price of gold versus the Swiss franc/U.S. dollar, price of oil and price of silver follow. The plots are suggestive of extreme volatility seen recently in the financial markets. The precious metals and the stronger currencies remain the primary long-range hedges against all the difficulties that lie ahead for the U.S. dollar, as will be discussed in tomorrow’s Hyperinflation Watch.
Industrial Production Gained in October Despite Revisions; September Production Revised to Contraction. In the context of the usual six months worth of revisions, today’s (November 16th) Federal Reserve Board release of seasonally-adjusted October 2011 industrial production showed a monthly gain of 0.68% (up 0.56% net of prior-period revisions) versus September. In turn, what had been a 0.19% gain in September revised to a 0.06% contraction.
Year-to-year growth in October 2011 production was 3.92%, up from a revised 3.10% (previously 3.22%) September increase, and down from the recent relative peak annual growth of 7.75% in June 2010. The year-to-year contraction of 14.83% seen in June 2009, at the end of second-quarter 2009, was the steepest annual decline in production growth since the shutdown of war-time production following World War II.
The “recovery” in industrial production is reflected in the following graphs. Both graphs show the monthly level of the production index. The first of these shows close historical detail for the period beginning in 2000, the second shows the same data in historical context since World War II.
Keep in mind that as with real retail sales and the GDP, a portion of industrial production (largely high tech, such as computers) is estimated by deflating nominal (not adjusted for inflation) numbers with an inflation measure of nature similar to those used in the GDP estimates. Where those inflation estimates are understated, the resulting inflation-adjusted growth is overstated. These issues will be addressed in tomorrow’s (November 17th) Special Commentary—Underlying Economic Reality.
Residential Construction (October 2011). October housing starts are due for release tomorrow, Thursday, November 17th, and should show a continued downside bottom-bouncing trend. Any upside surprise likely would not be statistically meaningful.