No. 438—PUBLIC COMMENT ON INFLATION MEASUREMENT

May 15, 2012

________

Consumer Price Index Has Been Reconfigured Since Early-1980s
So As to Understate Inflation versus Common Experience

• CPI no longer measures the cost of maintaining a constant standard of living.
• CPI no longer measures full inflation for out-of-pocket expenditure.
• With the misused cover of academic theory, politicians forced significant underreporting of official inflation, so as to cut annual cost-of-living adjustments to Social Security, etc.
• Use of the CPI to adjust retirement benefits, private income or to set investment goals impairs the ability of retirees, income earners and investors to stay ahead of inflation.
• Understated inflation used in estimating inflation-adjusted growth has created the illusion of recovery in reported GDP.

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PROBLEMS WITH INFLATION ESTIMATION

This public comment reviews and updates the nature of inflation understatement by the U.S. government’s statistical agencies and the rationale and methodology used by ShadowStats.com in compiling the SGS Alternate Consumer Inflation measures.  While much of the following text is new, the concepts all have been explored in earlier writings.  Some of the material here has been repeated from our September 2008 Response to BLS Article on CPI Misperceptions.

 

Real-World Experience and Public Perceptions versus Academic Theories and Political Gimmicks

In 30 years as a private, consulting economist, I have noted a growing gap between government reporting of inflation, as measured by the consumer price index (CPI), and the perceptions of inflation held by the general public.  It has been my experience that the general public believes inflation is running well above official reporting, and that the public’s perceptions tend to mirror the inflation experience that once was reflected in the government’s CPI reporting.

The growing difference in perception versus reality primarily is due to changes made over decades as to how the CPI is calculated and defined by the government.  Specifically, changes made to the definition of CPI methodologies in recent decades have reflected theoretical constructs offered by academia that have little relevance to the real-world use of the CPI by the general public.  Importantly, these changes generally are not understood by the public.

 

What the Public Looks for in an Inflation Measure

Individual use of a CPI measure generally is tied to personal financial decisions or planning, in terms of wage or income growth/adjustment, contract or benefit price adjustments and/or in terms of targeting financial returns that will stay ahead of inflation.

Accordingly, I contend that individuals look to the government’s CPI as a measure of the cost of living of maintaining a constant standard of living, as well as measuring that cost of living in terms of out-of-pocket expenses.

While the CPI at one time was the measure desired by the public, government efforts turned the CPI away from measuring the price changes in a fixed-weight basket of goods and services to a quasi-substitution-based basket of goods, which destroyed the concept of the CPI as a measure of the cost of living of maintaining a constant standard of living.

The use of hedonic quality modeling in adjusting the prices of goods and services has destroyed the concept of the CPI as a measure of out-of-pocket expenses. 

 

The Way It Was

Measurement of consumer inflation traditionally reflected measuring the cost of maintaining a constant standard of living, as measured by a fixed-basket of goods.  Maintaining a constant standard of living, however, is a concept not popular in current economic literature, and certainly not within the thinking or the lexicon of the Bureau of Labor Statistics (BLS), the government’s statistical agency that estimates and reports on consumer inflation.

The changing costs of maintaining a constant standard of living were measured by pricing out a fixed-basket of goods and services—same components, same weighting—period after period.  Whatever the percentage change was in the cost of that basket of goods, that is how much income would have to rise in order for someone to maintain a fixed- or constant-standard of living over the given period.  At least it was a reasonably consistent approximation of same.

Tracking changes in the cost of a fixed-basket of goods was the approach to estimating inflation, going back to at least the 1700s,[i] and prior to 1945, the fixed-basket CPI tracked by the U.S. government actually was known as the Cost of Living Index.[ii]

In the first half of the 20th century, though, the concept of a “constant level of satisfaction” evolved in academia, as a “true cost of living” concept.  The general argument was that changing relative costs of goods would result in consumer substitution of less-expensive goods for more-expensive goods.  Allowing for a substitution of goods within the formerly fixed-basket, the maximization of the “utility” of money held by consumers would allow attainment of “constant level of satisfaction” for the consumer.  This type of inflation-measure is more appropriate for the GDP concept—where it is used today—measuring shifting weightings with actual consumption, rather than the fixed weightings needed to assess the costs of maintaining a constant standard of living.

Where the substitution-based approach was viewed as impractical for a consumer price index, the fixed-basket approach remained the preferred inflation measure.[iii]  The academic thinking in this area remains divided, even today.[iv]

The constant-level-of-satisfaction approach was contrary to the concept of measuring the cost of maintaining a constant-standard-of-living.  In the extreme current circumstance, where the average household cannot stay ahead of even the official CPI inflation rate, consider that shifting household preferences from more-expensive to less-expensive products is forced by limited income.  Maintaining a constant-standard-of-living means being able to consume the same goods in the same quantity, without having to trade-off living quality versus price.

While the average consumer may not be able to maintain his or her current standard of living at the moment, it still is of significant value to know what is needed in income growth to offset the living-standard loss from actual inflation.

 

The Way the Politicians Wanted It

In the early-1990s, political Washington moved to change the nature of the CPI.  The contention was that the CPI overstated inflation (it did not allow substitution of less-expensive hamburger for more-expensive steak).  Both sides of the aisle and the financial media touted the benefits of a “more-accurate” CPI, one that would allow the substitution of goods and services. 

The plan was to reduce cost of living adjustments for government payments to Social Security recipients, etc.  The cuts in reported inflation were an effort to reduce the federal deficit without anyone in Congress having to do the politically impossible: to vote against Social Security.  The changes afoot were publicized, albeit under the cover of academic theories.  Few in the public paid any attention. 

Sam Zuckerman of the San Francisco Examiner, noted “In the 1990s, for example, Republicans wanted to make changes in calculating inflation along the lines recommended by a special commission, including more use of quality adjustments.  By lowering the official inflation rate, such changes promised to reduce the annual cost-of-living adjustments for Social Security and other federal programs.

“[Katherine] Abraham, the Clinton bureau [of Labor Statistics] commissioner, remembers sitting in Republican House Speaker Newt Gingrich’s office:

“ ‘He said to me, If you could see your way clear to doing these things, we might have more money for BLS programs.’ ” [v]

Federal Reserve Chairman Alan Greenspan and Michael Boskin, the chairman of the Council of Economic Advisors, were very clear as to how changing or “correcting” the CPI calculations would help to reduce the deficit.  As described at the time by Robert Hershey of the New York Times, “Speaker Newt Gingrich, Republican of Georgia, suggested this week that fixing the [CPI] index, with its implications for lower spending [Social Security, etc.] and higher revenue [tax bracket adjustments], would provide maneuvering room for budget negotiators …” [vi]

“Alan Greenspan, chairman of the Federal Reserve, is among the other Government officials who have spoken optimistically about financial benefits of a more accurate [CPI] index …” [vii]

“[E]conomists believe one of the most important [CPI upside biases] is when consumers shift their buying patterns in response to changing prices, substituting one product for another. The [CPI] index is based on a fixed market basket of goods and services. But, for example, if the price on an item like steak gets too expensive, consumers may switch to hamburger.” [viii]

The Boskin Commission Report, December 4, 1996, actually used steak and chicken for its substitution example. The examples used in arguing for changing the CPI clearly were tied to prices rising and resulting consumer demand shifting to a lower-quality product.  Simply put, that was the destruction of the cost-of-maintaining-a-constant-standard-of-living issue and was the primary consideration of those seeking to change the CPI, although other issues would come into play.  The drive here was as to get a lower inflation reading, irrespective of whether the data were “more-accurate.” 

 

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Summary of Real-World Needs versus Theoretical Constructs of Academia

 

Maintaining Constant Standard of Living (Fixed-Basket Inflation) versus Substitution in CPI

·       Since the 1700s consumer inflation has been estimated by measuring price changes in a fixed-weight basket of goods, effectively measuring the cost of living of maintaining a constant standard of living.

·       Allowing substitution of lower-priced and lower-quality goods in the basket (i.e. more hamburger when steak prices rise) lowers the reported rate of inflation versus the fixed-basket measure.

·       BLS introduced: Geometric weighting—a purely a mathematical gimmick that automatically reduces the weightings of goods rising in price, and vice versa—it has no demonstrated relationship to consumer substitution of goods based on price changes.  It was explained as a surrogate for a substitution measure.

·       BLS introduced: More frequent re-weightings of the CPI index from every ten years to every two years, which moved the CPI closer to a substitution-based index, but the change was not considered a change in methodology.

·       BLS introduced: Ongoing re-weightings of sales outlets (discount/mass-merchandisers versus Main Street shops), also moving closer to a substitution-based index and creating other constant standard of living issues.

 

Out-of-Pocket Expenses versus Nebulous Quality (Hedonic) Adjustments

·       Traditionally, what a consumer pays out-of-pocket for goods and services reflected adjustments for quality changes that could be directly quantified in a monetary sense.

o   Quality adjustments that can be measured directly in price are legitimate, such as measuring the price differential of an eight-ounce candy bar that is reduced in size to six-ounces but remains priced and packaged in the same sized box as the eight-ounce version.

·       BLS expanded quality adjustments to include the concept of “hedonic” quality adjustments, altering the pricing of goods and services for nebulous quality changes that could not be priced directly and that often are not viewed or recognized by the consumer as a desired improvement.

·       Where the effect here on the pricing of goods and services cannot be quantified directly from a pricing standpoint, the pricing impact is estimated by computer statistical modeling—hedonic adjustment modeling—that has little if any relevance to real-world experience.

·       Where the quality of the product is deemed by the government to have improved (the usual circumstance), prices in the CPI calculations are adjusted lower to offset the higher quality.

·       Usually, though, the purchasing consumer only has the option of paying out-of-pocket the full price for the product, again with little or no concept of the quality improvement being acquired and/or having no chance to opt out of paying for the improvements.

o   In an early example, the government mandated the use of a gasoline formulation that purportedly would improve auto emissions.  That added ten cents per gallon to gasoline costs, but that cost was excluded from CPI calculations.  The person filling his or her gas tank, however, felt the actual out-of-pocket expense.

o   The government later abandoned excluding government-mandated “quality” improvements, such as gasoline additives, from inflation calculations, but the principles here are exactly the same for industry-generated “quality” improvements that are not optional to consumers. 

o   Text books, for example are modeled, where one pricing factor in the hedonic quality model is whether or not there are color pictures in a book.  Unless the student is an art student, the concern usually is not over colored pictures, but rather along the lines of  “What is my out-of-pocket cost for textbooks this semester?”

o   New computer features usually are deemed quality improvements, with a downside price adjustments made in the CPI for the changes, even though a consumer may not want or use the features.

o   The consumer still has to buy those features and pay full cost out-of-pocket, irrespective of what government determines those products are generating in purported hedonic quality benefits that the consumer is not considering or using.

o   I contend that significant feature changes should be treated as a new product introduction, or otherwise ignored.

·       If the use of the hedonic process were legitimate here, it would be applied to all goods and services, but a CPI, so based, soon would come meaningless to the public (as already has happened with the CPI-U).

o   For example, there has been no pricing adjustment (upside in this case) to the costs of air travel for the destruction of travel convenience with the advent of the TSA, or from the downward spiral in U.S. air traveler comfort and convenience resulting from the effects of mergers and acquisitions, and from increasing flight delays due to economizing on aircraft maintenance.

·       Consumer concerns are for his or her out-of-pocket expenses.  What am I paying for my textbooks this semester; what am I paying out-of-pocket to fly from New York to Chicago; or what am I paying out-of-pocket for a computer, even if I am looking just to use limited functions but have no choice but to buy unwanted features?

 

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Net Reduction in CPI-U inflation from Changes in Methodology As Reflected in the CPI-U-RS versus CPI-U Series (1980 to 2010)
Year	Average CPI-U-RS	(1) CPI-U-RS Yr/Yr	(2) Average CPI-U	CPI-U-RS Yr/Yr	(1)-(2) Change in Annual Inflation*	Cumulative Annual Inflation Shortfall
1980	127.1		82.4			0
1981	139.2	9.5%	90.9	10.3%	-0.8%	-0.8%
1982	147.6	6.0%	96.5	6.2%	-0.1%	-0.9%
1983	153.9	4.3%	99.6	3.2%	1.1%	0.1%
1984	160.2	4.1%	103.9	4.3%	-0.2%	-0.1%
1985	165.7	3.4%	107.6	3.6%	-0.1%	-0.2%
1986	168.7	1.8%	109.6	1.9%	0.0%	-0.3%
1987	174.4	3.4%	113.6	3.6%	-0.3%	-0.5%
1988	180.8	3.7%	118.3	4.1%	-0.5%	-1.0%
1989	188.6	4.3%	124.0	4.8%	-0.5%	-1.5%
1990	198.0	5.0%	130.7	5.4%	-0.4%	-1.9%
1991	205.1	3.6%	136.2	4.2%	-0.6%	-2.5%
1992	210.3	2.5%	140.3	3.0%	-0.5%	-3.0%
1993	215.5	2.5%	144.5	3.0%	-0.5%	-3.5%
1994	220.1	2.1%	148.2	2.6%	-0.4%	-4.0%
1995	225.4	2.4%	152.4	2.8%	-0.4%	-4.4%
1996	231.4	2.7%	156.9	3.0%	-0.3%	-4.7%
1997	236.4	2.2%	160.5	2.3%	-0.1%	-4.8%
1998	239.7	1.4%	163.0	1.6%	-0.2%	-5.0%
1999	244.7	2.1%	166.6	2.2%	-0.1%	-5.1%
2000	252.9	3.4%	172.2	3.4%	0.0%	-5.1%
2001	260.0	2.8%	177.1	2.8%	0.0%	-5.2%
2002	264.2	1.6%	179.9	1.6%	0.0%	-5.1%
2003	270.1	2.2%	184.0	2.3%	0.0%	-5.2%
2004	277.4	2.7%	188.9	2.7%	0.0%	-5.1%
2005	286.7	3.4%	195.3	3.4%	0.0%	-5.2%
2006	296.1	3.3%	201.6	3.2%	0.1%	-5.1%
2007	304.5	2.8%	207.3	2.8%	0.0%	-5.1%
2008	316.2	3.8%	215.3	3.8%	0.0%	-5.1%
2009	315.0	-0.4%	214.5	-0.4%	0.0%	-5.1%
2010	320.2	1.7%	218.1	1.6%	0.0%	-5.1%
	Aggregate Methodological CPI-U Reduction				-5.1%

 

What The Changes Did to Inflation

The substitution-related alterations to inflation methodologies were made beginning in the mid-1990s.  The introduction of major hedonic concepts began in the 1980s.  The aggregate impact of the reporting changes since 1980 has been to reduce the reported level of annual CPI inflation by roughly seven percentage points, where 5.1 percentage points come from the BLS’s published estimates of the effects of the individual methodological changes on inflation, shown in the preceding table and as discussed later.  The balance comes from my estimates of the changes not formally estimated by the BLS.  The effects are cumulative going forward in time.

With the support of academic expertise affirming the correctness of the new methodologies, the effects of the reduction in the pace of reported inflation and in the related spiking of reported inflation-adjusted economic growth, have been discussed openly at different times.  Consider examples from the 1999 Economic Report of the President Report (Report). [ix]

“A final reason for the slowing of reported price indexes has been methodological changes to both the CPI and the indexes used in the national income accounts.  In general, these changes have reduced the measured rate of inflation.  For the CPI, methodological changes made from 1995 through 1998 reduced the rate of inflation by about 0.44 percentage point.  Changes to be introduced in 1999 and 2000 will reduce it by an additional 0.24 percentage point.”  Again, these are cumulative changes going forward.

The Report continued, describing the benefits of reduced inflation rate reporting in adding to reported GDP growth, “The BEA [Bureau of Economic Analysis] has also recently switched [1997] from using the CPI to using the producer price index (PPI) to deflate physicians’ services and the services of government and for-profit hospitals. … Because the PPI measures of these prices have been increasing less than the comparable CPIs, the changes reduce the rate of increase of the chain-weighted price index for GDP and raise real [inflation-adjusted] GDP growth.  These changes, in addition to those passed through from the CPI, will have cumulated to raise the annual growth rate of real GDP by 0.29 percentage point by 2000.”

That cumulated GDP growth rate boost for those several years really should have been 0.54 percentage point, accounting for new hedonic adjustments.[x]

Keep in mind that the CPI changes of 0.68% were an aggregate for those years and need to be carried forward—added back in—on a cumulative basis if one wanted to remove the effects of the methodological from future data.  Against the aggregated 0.68% reduction in the reported inflation, the BLS’s related CPI-U-RS series shows an aggregated reduction in the reported inflation of 0.7%, as discussed in the next two sections.

 

Measuring the Methodological Impacts Going Back and Forward in Time

The BLS has created a CPI-U-RS (RS stands for research series) that is designed to restate inflation history as if all the current substitution and hedonic adjustment methodologies always have been in place.  Limited effects of the artificially lowered historical inflation can be seen with the following graph.

The narrow red line shows median household income, deflated by the CPI-U-RS, as having been much stronger than the series shown by the thicker blue line, which was deflated by the higher inflation in the traditional CPI-U.  The CPI-U versus the CPI-U-RS is detailed in the table.

 

 

While the difference between current methodologies, going in back in time, may appear small, that is because the recent years of the CPI-U since 2000 already include the bulk of the changes, so largely they are identical in terms of year-to-year change between the CPI-U and CPI-U-RS.  In the earlier years, the changes average less than half of a percent, but those changes reflect the incremental decline in annual inflation triggered by the various methodological changes.

Reverse engineering the CPI-U-RS to as to reconstruct the CPI-U, as if the various changes had not been made, requires carrying forward the effects of the changes on a cumulative basis.  The cumulative effect is seen in the last column of the table.

 

SGS-Alternate Consumer Inflation Measures

What we have done in creating the SGS-Alternate Consumer Inflation Measures is to reverse engineer the CPI-U-RS series, adding in estimates of the inflation effects of factors not otherwise estimated by the BLS, such as more-frequent (two-years versus ten-years) reweighting of the CPI series.

The two SGS series are based on the methodologies in place as of 1980 and separately as of 1990.  The estimated lost inflation is added back in, over time, as described in the methodology (1980-based) published each month in the Commentary that covers the CPI reporting:

The SGS-Alternate Consumer Inflation Measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS (the series is not recalculated).  Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that neither reflects the constant-standard-of-living concept nor measures adequately most of what consumers view as out-of-pocket expenditures.  Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the annual impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact not otherwise published by the BLS.

 

Artificially-Low Inflation Estimates Have Created the Illusion of Recovery

Separately, to varying degrees, artificially depressed inflation rates have created misleading indications of economic growth in various economic series, including the GDP, industrial production and real retail sales as otherwise deflated by the CPI-U.  This is discussed in some detail in Hyperinflation 2012, with assumptions discussed in Chapter 5, beginning on page 38.

 

 

 

HYPERINFLATION 2012

SPECIAL COMMENTARY NUMBER 414

January 25, 2012

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U.S. Hyperinflationary Great Depression Moves Ever Closer

U.S. Government and the Federal Reserve Effectively Have Destroyed
Global Confidence in the U.S. Dollar

Systemic-Solvency and Economic Crises Have Not Abated

Precursors to Ultimate Dollar Disaster Are in Place;
2014 Remains the Outside Timing for Same

 

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Hyperinflation 2012 is the fifth in a series of related writings going back to 2006.  It updates and replaces the Hyperinflation Special Report (2011) of March 15, 2011, which preceded: the U.S. government’s demonstration of a lack of political will to address the country’s long-range insolvency; the downgrade of the “AAA” rating of U.S. Treasury securities; an ensuing U.S. dollar panic, dollar support operations and extremely unstable U.S. and global financial markets; a temporary shift in market focus to Euro-era issues; and growing recognition of the ongoing and deepening economic and systemic-solvency crises.  Nonetheless, the outlook has changed little.  With the passage of 10 months since the last report (updated circumstances have been covered regularly in weekly Commentaries), events just have continued to move this pending ultimate financial crisis into much closer time proximity.    

In turn, the 2011 report updated and replaced the Hyperinflation Special Report (2010 Update) of December 2, 2009, which preceded: the Fed’s formal monetization of U.S. Treasury debt aimed at debasing the U.S. dollar; the sharpest post-World War II annual decline in broad money growth; the pronouncement of an official end to the 2007 recession despite no meaningful recovery; passage of the Administration’s health insurance legislation; and the mid-term election.  Yet, the outlook had changed little.  With the passage of 15 months since the prior report (updated circumstances were covered regularly in weekly Commentaries), again, events just had moved the hyperinflation crisis into closer time proximity.    

In turn, the 2010 report updated and replaced the Hyperinflation Special Report version of April 8, 2008, which was published post-Bear Stearns, but pre-Lehman, pre-TARP, pre-recession recognition and pre-2008 presidential election.  The April 2008 report updated and expanded upon the three-part Hyperinflation Series that began with the December 2006 SGS Newsletter, which predated public recognition of the 2007 economic and systemic-solvency crises.

This missive includes significant new material in addition to much of the same basic text that was in the 2011 edition, along with revisions and updates reflecting the still-unfolding economic and systemic-solvency crises.

__________

Contents

 

Chapter 1—Overview and Executive Summary

Events Moving at an Accelerating Pace Towards the Great Collapse

Graph 1: Federal Reserve Notes per Ounce of Gold

Background

Has the Euro Been Used as a Foil Against the Dollar?

Impact of Fed Monetization of U.S. Treasuries in QE2

Graph 2: Fed Monetization of Treasury Debt

Graph 3: Core Inflation from QE2

Crises Brewed by Federal Government and Federal Reserve Malfeasance

Saving the System at Any Cost

U.S. Economy Is Not Recovering

Hyperinflation Nears

Chapter 2—Defining the Components of a Hyperinflationary Great Depression

Deflation, Inflation and Hyperinflation

Recession, Depression and Great Depression

Chapter 3—Two Examples of Hyperinflation

Some Lessons from History

Weimar Republic

Graph 4: German Paper Marks per U.S. Dollar 1922 to 1923

Graph 5: Log Scale, German Paper Marks per U.S. Dollar 1922 to 1923

Zimbabwe

Chapter 4—Current Economic and Inflation Conditions in the United States

Economic Reality

Structural Consumer Liquidity Problems

Graph 6: Merchandise Trade Balance

Graph 7: Household Income Dispersion

Graph 8: Average Weekly Earnings (1967 CPI-W Dollars)

Graph 9: Annual Median Household Income (1967 Dollars)

Graph 10: Median Household Income Index (Monthly)

CPI No Longer Reflects Costs of Maintaining Constant Standard of Living.

Graph 11: Annual Consumer Inflation, CPI versus SGS Alternate.

Early Impact of Dollar Debasement

Graph 12: Gold versus Swiss Franc

Graph 13: Gold versus Oil

Graph 14: Gold versus Silver

Income, Credit and Willingness to Spend

Consumer Credit Still Shrinking Net of Student Loan Surge

Graph 15:  Consumer Credit Outstanding

Markets Are Flying Blind with Distorted Economic Reporting

Already in Depression, Economy Continues to Bottom Bounce

Graph 16: Real M3 versus Formal Recessions

Historical Perspective on the Economic Data

Graph 17: Year-to-Year Change Monthly Payroll Employment

Graph 18: Year-to-Year Change Quarterly Real GDP

Graph 19: Year-to-Year Change Annual Real GDP

Chapter 5—Key Economic Reporting Varies by Inflation Assumptions

Economic Reporting Free of Inflation And Inflation Corrected

Graph 20: Payroll Employment Level

Graph 21: Consumer Confidence

Graph 22: Housing Starts Beginning 2000

Graph 23: Housing Starts Post-World War II

Graph 24: Real GDP Level, Official Version

Graph 25: Inflation-Corrected Real GDP Level

Graph 26: Headline Real Retail Sales

Graph 27: Inflation Corrected Headline Real Retail Sales

Graph 28: Headline Industrial Production Level

Graph 29: Inflation-Corrected Industrial Production

Chapter 6—Historical U.S. Inflation and U.S. Dollar Debasement

Graph 30: Consumer Inflation 1665 to 2011

Graph 31: Log-Scale Consumer Inflation 1665 to 2011

Table I: Loss of U.S. Dollar Purchasing Power

Chapter 7—Federal Reserve, Systemic Solvency and Inflation versus Deflation

Preventing Systemic Collapse at All Costs

“Helicopter Ben” on Preventing Deflation

Monetary Base and Money Supply Growth

Graph 32: Monetary Base, Leve

Graph 33: Monetary Base, Year-to-Year Change

Graph 34: M3, Monthly Year-to-Year Change

Graph 35: Year-to-Year U.S. Money Supply Growth with SGS M3 Continuation

Banks Not Increasing Lending into the Regular Flow of Commerce

Graph 36: Commercial and Industrial Loans

Graph 37: Commercial Paper Outstanding

Inflation and Money Growth

Chapter 8—U.S. Government Cannot Cover Existing Obligations

Annual GAAP-Based Federal Deficits at $5 Trillion

Federal Debt and Net Present Value of Unfunded Liabilities Exceed $80 Trillion

Graph 38: Total Federal Obligations as Percent of GDP

Annual Deficits of $5 Trillion Are Not Sustainable

Table II: U.S. Government GAAP Accounting, Deficits and Obligations

Chapter 9—Hyperinflationary Great Depression

Move Towards Hyperinflation Accelerated by Current Fed and Government Actions

Lack of Physical Cash

Possible Short-Term Electronic Relief for Individuals

Barter System

Financial Hedges and Investments

Graph 39: Year-End DJIA, Current versus Constant Dollar

Graph 40: Log-Based, Year-End DJIA, Current versus Constant Dollar

Possible Official Actions and Responses/External Risks

Closing Comments—Other Issues

Political Considerations

Common Sense

Recommended Further Reading

 

 

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Chapter 1—Overview and Executive Summary

A fair amount of the text in this chapter is repetitive from the prior hyperinflation report, but conditions have not changed much.  The text reflects new developments and updated data where appropriate.

Events Moving at an Accelerating Pace Towards the Great Collapse

Little has changed in the basic outlook.  The U.S. economic and systemic-solvency crises of the last five years continue to deteriorate.  Yet they remain just the precursors to the coming Great Collapse: a hyperinflationary great depression.  The unfolding circumstance will encompass a complete loss in the purchasing power of the U.S. dollar; a collapse in the normal stream of U.S. commercial and economic activity; a collapse in the U.S. financial system, as we know it; and a likely realignment of the U.S. political environment.  Outside timing on the hyperinflation remains 2014, but events of the last year have accelerated the movement towards this ultimate dollar catastrophe.  Following Mr. Bernanke’s extraordinary efforts to debase the U.S. currency in late-2010, the dollar had lost its traditional safe-haven status by early-2011.  Whatever global confidence had remained behind the U.S dollar was lost in July and August.  That was in response to the lack of political will—shown by those who control the White House and Congress—to address the long-range insolvency of the U.S. government, and as a result of the later credit-rating downgrade to U.S. Treasury debt.

Those latter circumstances triggered something of dollar selling panic, particularly as reflected in the corresponding buying of gold and Swiss francs, but various interventions, misdirection and manipulations helped to quell the currency disorders.  Still, many financial markets were left rocking with the aftershocks of a major shift in the global view of the U.S. dollar. 

The economy has underperformed and likely will continue to underperform consensus forecasts by a significant margin.  In turn, weaker-than-expected economic growth will mean significantly worse-than-expected federal budget deficits, Treasury funding needs and banking-system solvency conditions. 

With the U.S. election just nine months off, political pressures will mount to favor fiscal stimulus measures instead of restraint.  The Fed should be forced to provide new “easing” in an effort to continue propping the banking system (the explanation will be an effort to boost the economy).  Given the Treasury’s funding needs, the easing likely will in the form of renewed buying of U.S. Treasuries, with the Fed remaining lender of last resort there.  Consistent with the precedent set in 2008, the Fed, and likely the Treasury, also will remain in place to do whatever is needed, at whatever cost, to prevent systemic collapse in the United States.  All of these actions, though, have costs in terms of higher domestic inflation and intensified dollar debasement

The U.S. dollar remains highly vulnerable to massive, panicked selling, at any time, with little or no warning.  The next round of Federal Reserve or U.S. government easing or stimulus could be the proximal trigger for such a currency panic and/or for strong efforts to strip the U.S. currency of its global reserve currency status.

As the advance squalls from this great financial tempest come ashore, the government could be expected to launch a variety of efforts at forestalling the hyperinflation’s landfall, but such efforts will buy little time and ultimately will fail in preventing the dollar’s collapse.  The timing of the early days—the onset—of full-blown hyperinflation likely will be coincident with a broad global rejection of the U.S. dollar, which, again, could happen at any time.

With no viable or politically-practical way of balancing U.S. fiscal conditions and avoiding this financial economic Armageddon, the best action that individuals can take at this point remains to protect themselves, both as to meeting short-range survival needs as well as to preserving current wealth and assets over the longer term.  Efforts there, respectively, would encompass building a store of key consumables, such as food and water, and moving assets into physical precious metals and outside of the U.S. dollar.

The following graph of Federal Reserve notes versus gold gives a suggestion of how the markets have been discounting the mounting U.S. fiscal and dollar problems since at least 2000.

 

Graph 1: Federal Reserve Notes per Ounce of Gold

Background

By 2004, fiscal malfeasance of successive U.S. Administrations and Congresses had pushed the federal government into effective long-term insolvency (likely to have triggered hyperinflation by 2018).  GAAP-based (generally accepted accounting principles) accounting then showed total federal obligations at $50 trillion—more than four-times the level of U.S. GDP—that were increasing each year by GAAP-based annual deficits in the uncontainable four- to five-trillion dollar range.  Those extreme operating shortfalls continue unabated, with total federal obligations at $81 trillion—more than five-times U.S. GDP—at the end of the 2011 fiscal year.  Taxes cannot be raised enough to bring the GAAP-based deficit into balance, and the political will in Washington is lacking to cut government spending severely, particularly in terms of the necessary slashing of unfunded liabilities in government social programs such as Social Security and Medicare.

Bankrupt governments—unable to raise adequate cash to cover obligations—invariably crank up the currency printing presses to do so, creating a hyperinflation.  The federal government and Federal Reserve’s actions in response to, and in conjunction with, the economic and financial crises of 2007, however, accelerated the ultimate process—both in terms of fiscal deterioration and global perception of the issues—moving the outside horizon for hyperinflation from 2018 to 2014.  Even so, over the last several years, the government and Fed’s actions and policies, and economic and financial-market developments have continued to exacerbate the circumstance, such that there is significant chance of the early stages of the hyperinflation breaking at any time.  Key to the near-term timing remains a sharp decline in the exchange rate value of the U.S. dollar, with the rest of the world effectively moving to dump the U.S. currency and dollar-denominated paper assets.

Has the Euro Been Used as a Foil Against the Dollar?

As the U.S. dollar came under heavy selling pressure in September 2011, the global markets suddenly shifted their focus to the euro-area solvency crises, selling euros against dollars.  That event has happened so frequently in recent years, and it appears so counterintuitive, that I suspect the euro has been used on more than occasion as a foil, distracting global currency trading from the perils of the U.S. dollar, since the United States remains the elephant in the bathtub of sovereign solvency problems.

Nonetheless, the euro area has significant sovereign-solvency concerns.  To the extent those issues could threaten the U.S. banking system, presumably the Fed has taken actions or has a plan in place to prevent a U.S. systemic collapse that could be triggered by a euro-related problem.  I do not know what will happen within the euro area, but its solvency issues likely will be worked through.  The circumstance for the more-serious U.S. solvency and the U.S. dollar issues likely will not have as happy a resolution.

Impact of Fed Monetization of U.S. Treasuries in QE2

The current U.S. financial markets, financial system and economy remain highly unstable and increasingly vulnerable to unexpected shocks.  At the same time, the Federal Reserve and the federal government are dedicated to preventing systemic collapse and broad price deflation.  To prevent any imminent collapse—as has been seen in official activities of the last several years—they will create and spend whatever money is needed, including the deliberate debasement of the U.S. dollar with the intent of increasing domestic inflation.  As shown in Graph 2, those efforts included effective full monetization of recent net Treasury debt issuance.  During the period of QE2, and prior to the debt ceiling being hit, the Federal Reserve more than fully monetized net Treasury issuance in the same period.

The effects of QE2 included debasing the U.S. dollar.  As the dollar weakened against other currencies, oil prices soared, and that spiked U.S. consumer inflation.  Although the Fed likes to tout “core” inflation, net of food and energy costs, the oil inflation also has begun to spread into the broader economy.

Graph 2: Fed Monetization of Treasury Debt

Graph 3: Core Inflation from QE2

 

 

As shown in Graph 3, annual “core” CPI-U inflation has risen for fourteen straight months, through December 2011, as a result of the Fed’s actions and remains an indication of a nascent, building inflation cycle.  The resulting inflation here is just a foretaste of consumer inflation that likely would result from ongoing Fed “easing” actions.

The efforts to stave off systemic collapse also have resulted in uncontrolled fiscal excesses by the federal government.  The deliberate monetary and fiscal abuses have resulted in de-stabilizing pressures against the U.S. currency, in generally rising gold and silver prices, and in the nascent pickup in reported U.S. consumer inflation.  That inflation has been driven by unhealthy monetary policy, instead of by healthy economic demand. 

Crises Brewed by Federal Government and Federal Reserve Malfeasance

The economic and systemic crises, triggered by the collapse of debt excesses that had been encouraged actively by the Greenspan Federal Reserve, have been centered on the U.S. financial system.  Recognizing that the U.S. economy was sagging under the weight of structural income impairment created by government trade, regulatory and social policies—policies that limited real (inflation-adjusted) consumer income growth, where the average U.S. household could not stay ahead of inflation or make ends meet—then-Federal Reserve Chairman Alan Greenspan played along with the political and banking systems.  He made policy decisions to steal economic activity from the future, fueling economic growth of the last decade largely through debt expansion (see Structural Consumer Liquidity Problems). 

The Greenspan Fed pushed for ever-greater systemic leverage, including the happy acceptance of new financial products—instruments of mispackaged lending risks—designed for consumption by global entities that openly did not understand the nature of the risks being taken.  Spreading the credit risks of banks among other industries, for example, was encouraged actively by the Fed as healthy and stabilizing for both the domestic and global financial systems.  Also complicit in this broad malfeasance was the U.S. government, including both major political parties in successive Administrations and Congresses.

As with consumers, though, the federal government could not make ends meet.  Driven by self-serving politics aimed at appeasing that portion of the electorate that could be kept docile through ever-expanding government programs and spending, political Washington became dependent on ever-expanding federal deficit spending, unfunded obligations and debt. 

Purportedly, it was Arthur Burns, Fed Chairman under Richard Nixon, who first offered the advice that helped to guide Alan Greenspan and a number of Administrations.  The gist of the imparted wisdom was that if the Fed or federal government ran into economic or financial-system difficulties, the federal budget deficit and the U.S. dollar simply could be ignored—or sacrificed.  Ignoring them would not matter, it was argued, because doing so would not cost the incumbent powers any votes. 

Back in 2005, I raised the issue of an inevitable U.S. hyperinflation with an advisor to both the Bush Administration and Fed Chairman Greenspan.  I was told simply that “It’s too far into the future to worry about.”   

Indeed, attempting to push the big problems further into the future continues to be the working strategy for both the Fed, under Chairman Ben Bernanke, and the current Administration and Congress.  

In a February 25, 2011 speech, Federal Reserve Vice Chairman Janet Yellen examined the results of the recent use of “unconventional policy tools” by the Fed: “Each of these policy tools tends to generate spillovers to other financial markets, such as boosting stock prices and putting moderate downward pressure on the foreign exchange value of the dollar.” 

While Wall Street may hail any artificial propping it can get from the Fed’s efforts to support the markets, more than “moderate” related declines in the U.S. dollar’s exchange rate destroy any illusions of stock gains and savage the U.S. consumers’ dollar purchasing power.  A declining dollar can turn U.S. stock profits into losses for those living outside the dollar-denominated world, as funds are converted back to the strengthening currency domestic to the investor.  Inflation driven by dollar weakness will do the same for those in a U.S. dollar-denominated environment, where, eventually, inflation can turn U.S. stock profits into real (inflation-adjusted) losses (see Financial Hedges and Investments).

Indeed, the U.S. dollar and the budget deficit do matter, and the future is at hand.  As the federal budget deficit spirals well beyond sustainability and containment at an accelerating pace, and as the Fed moves with great deliberation to debase and to impair the purchasing power of the U.S. dollar, to generate rising consumer inflation, the day of ultimate financial reckoning appears to be breaking.

Saving the System at Any Cost

The Federal Reserve and the U.S. Treasury moved early in the current solvency crisis to prevent a collapse of the banking system, at any cost.  It was the collapse of the banking system and loss of depositor assets in the early-1930s that intensified the Great Depression and its attendant deflation.  A somewhat parallel risk was envisioned in 2008 as the system passed over the brink.  The decision was made to avoid a deflationary great depression.

Effective financial impairments and at least partial nationalizations or orchestrated bailouts/takeovers resulted for institutions such as Bear Stearns, Citigroup, Washington Mutual, AIG, General Motors, Chrysler, Fannie Mae and Freddie Mac, along with a number of further troubled financial institutions.  The Fed moved to provide whatever systemic liquidity would be needed, while the federal government moved to finance corporate bailouts, to guarantee any instruments or entities it had to, and to introduce large amounts of short-lived stimulus spending.

Curiously, though, the Fed and the Treasury let Lehman Brothers fail outright, which triggered a foreseeable run on the system and markedly intensified the systemic solvency crisis in September 2008.  Whether someone was trying to play naive political games, with the public and Congress increasingly raising questions of moral hazard issues, or whether the U.S. financial wizards missed what would happen or simply moved to bring the crisis to a head, still remains to be seen.

In the still-early days of the crises, the Obama Administration pushed ahead with its social agenda, introducing major new government programs such as federal government control of healthcare and health insurance.  Irrespective of stated goals of not increasing the federal deficit further, the resulting healthcare/insurance legislation will have a severely negative impact on the federal deficit—as will most other new legislation and “stimulus” efforts, either from massive net expenses, or from losses in tax revenues in an ever-weakening economy.

The U.S. Government’s 2011 GAAP-based financial statements (see Chapter 8—U.S. Government Cannot Cover Existing Obligations) showed an ongoing annual GAAP-based deficit of about $5 trillion, a circumstance that remains uncontrollable.

Efforts to save the system at any cost likely will continue as long as possible, with the government spending whatever money it and the Federal Reserve need to create, until such time as the global financial markets rebel.  The ultimate cost here, though, will be in inflation and the increasing debasement of the purchasing power of the U.S. Dollar, and an eventual dollar collapse beyond any government or Federal Reserve control.

U.S. Economy Is Not Recovering

New in Chapter 5—Key Economic Reporting Varies by Inflation Assumptions, the effects of inflation assumptions are explored in terms of key reporting series.  Corrected for understated inflation, the GDP, real retail sales and industrial production series show patterns similar to inflation-free measures, such as payroll employment, consumer confidence and housing starts.  The adjusted data tend indicate that the economy is not in recovery.

Economic activity in the United States began to decline in 2006 or early-2007, and it plunged from late-2007 into 2009 at a pace not seen since the Great Depression.  Subsequently, economic activity has been bottom-bouncing, with some boosts from short-lived stimulus effects.  Without any fundamental turnaround in structural consumer-income problems that have been driving the downturn, and with contracting, inflation-adjusted systemic liquidity, the economy has started to slow anew.

Despite pronouncements of an end to the 2007 recession and the onset of an economic recovery, the U.S. economy still is mired in a deepening structural contraction, which eventually will be recognized as a double- or multiple-dip recession.  Beyond the politically- and market-hyped GDP reporting, key underlying economic series show patterns of activity that are consistent with a peak-to-trough (so far) contraction in inflation-adjusted activity in excess of 10%, a formal depression (see Recession, Depression and Great Depression).

Existing formal projections for the federal budget deficit, banking system solvency, etc. all are based on assumptions of positive economic growth, going forward.  That growth will not happen, and continued economic contraction will exacerbate fiscal conditions and banking-system liquidity problems terribly.

Hyperinflation Nears

As previously noted, before the systemic-solvency crisis began to unfold in 2007, the U.S. government already had condemned the U.S. dollar to a hyperinflationary grave by taking on debt and obligations that never could be covered through raising taxes and/or by severely slashing government spending that had become politically untouchable.  Also, the U.S. economy already had entered a severe structural downturn, which helped to trigger the systemic-solvency crisis. 

Bankrupt sovereign states most commonly use the currency printing press as a solution to not having enough money to cover obligations.  The alternative here would be for the U.S. eventually to renege on its existing debt and obligations, a solution for modern sovereign states rarely seen outside of governments overthrown in revolution, and a solution with no happier ending than simply printing the needed money.  With the creation of massive amounts of new fiat dollars (not backed by gold or silver) comes the eventual full destruction of the value of the U.S. dollar and related dollar-denominated paper assets.

The U.S. government and the Federal Reserve have committed the system to its ultimate insolvency, through the easy politics of a bottomless pocketbook, the servicing of big-moneyed special interests, gross mismanagement, and a deliberate and ongoing effort to debase the U.S. currency.  Yet, the particularly egregious fiscal and monetary responses to economic and solvency crises of the last five years have exacerbated the government’s solvency issues, bringing the great financial tempest close enough to making landfall that the hairs on the backs of investors necks should be standing on end.

Numerous foreign governments/central banks have offered unusually blunt criticism of U.S. fiscal and Federal Reserve policies as the crisis has expanded, but the perceived self-interests of the U.S. government and Fed always will come first in setting domestic policy.  Where both private and official demand for U.S. Treasuries had been increasingly unenthusiastic, the Fed—the U.S. central bank—effectively has been fully funded Treasury needs for most of 2011, with its “quantitative easing,” becoming a euphemism for Fed monetization of U.S. Treasury debt.    

Further easing by the Fed is likely in the months ahead, as the ongoing economic turmoil triggers significant further fiscal deterioration.  Those actions should pummel heavily the U.S. dollar’s exchange rate against other major currencies.  Looming with uncertain timing is a panicked dollar dumping and dumping of dollar-denominated paper assets, which remains the most likely event as proximal trigger for the onset of hyperinflation in the near-term. 

The early stages of the hyperinflation would be marked simply by an accelerating upturn in consumer prices, a pattern that already was initially in response to QE2.  Also, money supply velocity (see Inflation and Money Growth) will spike, as the U.S. dollar, again, comes under heavy and even disorderly selling pressure, with both domestic and foreign holders getting rid of their dollar holdings as quickly as possible.  One factor that can contribute to rising velocity is the current circumstance where U.S. investors cannot get a safe return that beats inflation, as reported by the government.  Investors can do better by buying a store of products that are rising price, rather than by holding cash or a Treasury bill.

Given the current lack of political will by those controlling the U.S. Government to address the fiscal solvency issues, the U.S. has no way of avoiding a financial Armageddon.  Various government intervention tactics might slow the process for brief periods, and the system always is vulnerable to external shocks, such as wars and natural disasters.  Government actions could include supportive dollar intervention, restrictions on international capital flows, wage and price controls, etc.  Effects of any such moves in delaying the onset of full hyperinflation, though, would be limited and short-lived.  There is no obvious course of action or external force at this point of the process that meaningfully would put off the nearing day of reckoning. 

What lies ahead will be extremely difficult, painful and unhappy times for many in the United States.  The functioning and adaptation of the U.S. economy and financial markets to a hyperinflation likely will be particularly disruptive.  Trouble could range from turmoil in the food distribution chain and electronic cash and credit systems unable to handle rapidly changing circumstances, to political instability.  The situation quickly would devolve from a deepening depression, to an intensifying hyperinflationary great depression.

While resulting U.S. economic difficulties would have broad global impact, the initial hyperinflation should be largely a U.S. problem, albeit with major implications for the global currency system. 

For those living in the United States, long-range strategies should look to assure safety and survival, which from a financial standpoint means preserving wealth and assets. Also directly impacted, of course, are those holding or dependent upon U.S. dollars or dollar-denominated assets, and those living in “dollarized” countries.

Physical gold (sovereign coins priced near bullion prices) remains the primary hedge in terms of preserving the purchasing power of current dollars.  In like manner, silver is in this category.  Also, holding stronger major currencies such as the Swiss franc, Canadian dollar and the Australian dollar, likely are good hedges (see Financial Hedges and Investments).

In terms of survival on a day-to-day basis, U.S.-based individuals should be building a store of goods in preparation for a manmade disaster, much as they would for a natural disaster such as an earthquake.  Economic activity probably would devolve to a barter system, but such could take months to become fully functional (see Barter System).  

  

  

Chapter 2—Defining the Components of a Hyperinflationary Great Depression

Other than for the expansion on the definition of the CPI-U-RS and additions of C-CPI-U and “core” inflation, and for revised contraction detail on the “Great Recession,” the text here is little changed from the prior hyperinflation report.

Deflation, Inflation and Hyperinflation

Inflation broadly is defined in terms of a rise in general prices usually due to an increase in the amount of money in circulation.  The inflation/deflation issues defined and discussed here are as applied to consumer goods and services, not to the pricing of financial assets, unless specified otherwise.

In terms of hyperinflation, there have been a variety of definitions used over time.  The circumstance envisioned ahead is not one of double- or triple- digit annual inflation, but more along the lines of seven- to ten-digit inflation seen in other circumstances during the last century.  Under such circumstances, the currency in question becomes worthless, as seen in Germany (Weimar Republic) in the early 1920s, in Hungary after World War II, in the dismembered Yugoslavia of the early 1990s and most recently in Zimbabwe, where the aggregate pace of hyperinflation likely was the most extreme ever seen.

The historical culprit generally has been the use of fiat currencies—currencies with no hard-asset backing such as gold—and the resulting massive printing of currency that the issuing authority needed to support its spending, when it did not have the ability, otherwise, to raise enough money for its perceived needs, through taxes or other means.

Ralph T. Foster (hereinafter generally cited as Foster) in Fiat Paper Money, The History and Evolution of Our Currency (see Recommended Further Reading) details the history of fiat paper currencies from 11th Century Szechwan, China, to date, and the consistent collapse of those currencies, time-after-time, due to what appears to be the inevitable, irresistible urge of issuing authorities to print too much of a good thing.

Here are the definitions:

Deflation: A decrease in the prices of consumer goods and services, usually tied to a contraction of money in circulation.  Formal deflation is measured in terms of year-to-year change.

Inflation: An increase in the prices of consumer goods and services, usually tied to an increase of money in circulation. 

Hyperinflation: Extreme inflation, minimally in excess of four-digit annual percent change, where the involved currency becomes worthless. A fairly crude definition of hyperinflation is a circumstance, where, due to extremely rapid price increases, the largest pre-hyperinflation bank note ($100 bill in the United States) becomes worth more as functional toilet paper/tissue or wallpaper than as currency.

As discussed in Chapter 6—Historical U.S. Inflation and U.S. Dollar Debasement, the domestic economy has been through periods of both major inflation and deflation, usually tied to wars and their aftermaths.  Such, however, preceded the U.S. going off the domestic gold standard in 1933 and abandoning international gold convertibility in 1971.  The era of the modern fiat dollar generally has been one of persistent and slowly debilitating inflation.

As to the reporting of inflation, the following notes detail the various measures of consumer systemic prices referenced in this report:

 

The Consumer Price Index (CPI): The CPI is the primary consumer inflation measure published by U.S. Government, through the Bureau of Labor Statistics (BLS), Department of Labor:

CPI-U (Consumer Price Index for All Urban Consumers):  The CPI-U is the monthly headline inflation number (seasonally adjusted) and is the broadest in its coverage, representing the buying patterns of all urban consumers.  Its standard measure is not seasonally adjusted, and it never is revised on that basis except for outright errors.

C-CPI-U (Chained CPI-U):  The C-CPI-U is a fully substitution-based (as opposed to the former fixed basket of goods) inflation measure, like the deflator used for personal consumption expenditure in the GDP.  The C-CPI was designed by the government as a replacement for the CPI in calculating cost-of-living adjustments (COLA) for government programs such as Social Security.  With the C-CPI showing the lowest inflation of the CPI measures, the concept has been viewed positively by Congress as a way to reduce the federal deficit (the basic concept was used before when redefining the CPI).  Unlike the CPI reporting, which is set forever on a not-seasonally-adjusted basis, once reported, the C-CPI-U faces revisions for two years.  That could become a major issue in the C-CPI replacing the CPI in COLA adjustments.

CPI-W (CPI for Urban Wage Earners and Clerical Workers):  The CPI-W covers the more-narrow universe of urban wage earners and clerical workers and is used in determining cost-of-living adjustments in government programs such as Social Security. Otherwise its background is the same as the CPI-U.

CPI-U-RS (Current Methods CPI):  The CPI-U-RS is the current CPI-U with its history restated as if all the new methodologies introduced since the 1980s had been in place from day one.  The involved changes have moved the CPI away from being a measure of inflation for a fixed basket of goods and services, away from being a measure of the cost of living of maintaining a constant standard of living, away from fully accounting for inflation in out-of-pocket expenses. 

In government reporting, the measure has been used primarily by the Census Bureau in deflating income measures in its annual poverty survey.  The use of the resulting lower historical inflation rates shown in the CPI-U-RS, versus the CPI-U, has the effect of making current inflation-adjusted data, such as income, look relatively stronger on an historical basis.

SGS Alternate CPI-U Measure:  The SGS Alternate CPI Measure (based on 1980 reporting methodologies) is an attempt to reverse methodological changes to CPI inflation since 1980 that have changed the CPI concept from being a measure of the cost of living needed to maintain a constant standard of living, to a measure of a cost of living that reflects a declining standard of living.  It is based primarily on a reverse engineering of the CPI-U-RS. (See Response to BLS Article on CPI Misperceptions for further details).

GNP/GDP Implicit Price Deflator (IPD):  The IPD is the rate of inflation for the aggregate economy (including consumer, business, housing, government and trade sectors) that is used in deflating nominal or current-dollar Gross National Product (GNP), Gross Domestic Product (GDP) and components of same, to “real,” constant-dollar or inflation-adjusted levels.

Core Inflation:  Inflation net of food and energy cost.  This is a concept popularized by the Federal Reserve in an effort to report and focus on the lowest possible inflation rate that the government could produce.  Over periods of a year or more, the use of “core” inflation is nonsensical in terms of measuring consumer inflation that has any relationship to common experience.

Recession, Depression and Great Depression

A couple of decades back, I tried to tie down the definitional differences between a recession, depression and a great depression with the Bureau of Economic Analysis (BEA), the National Bureau of Economic Research (NBER) and a number of private economists.  I found that there was no consensus on the matter, where popular usage of the term “depression” had taken on the meaning of a severe recession, so I set some definitions that the various parties (neither formally nor officially) thought were within reason.

If you look at the plot of the level of economic activity during a downturn, you will see something that looks like a bowl, with activity recessing on the downside and recovering on the upside.  The term used to describe this bowl-shaped circumstance before World War II was “depression,” while the downside portion of the cycle was called “recession,” and the upside was called “recovery.”  Before World War II, all downturns simply were referred to as depressions.  In the wake of the Great Depression of the 1930s, however, a euphemism was sought for describing future economic contractions, so as to avoid evoking memories of that earlier, financially painful time.

Accordingly, a post-World War II downturn was called “recession.”  Officially, now, the deepest post-World War II recession was from December 2007 through June 2009, with a peak-to-trough contraction in the inflation-adjusted quarterly GDP activity level of 5.1% (revised from the 4.1% in place as of the prior hyperinflation report).  That was worse than the 3.7% contraction from August 1957 through April 1958, which involved a steel strike, and a 3.2% contraction in the November 1973 to March 1975, which more commonly is viewed as the worst post-World War II recession prior to 2007.  The 2007 recession also has been declared the longest since the first down-leg of the Great Depression.  I’ll contend, though, that the 2007 downturn is ongoing and that it still is much deeper than has been indicated officially (see Chapter 4—Current Economic and Inflation Conditions in the United States).  Here are the definitions:

Recession: Two or more consecutive quarters of contracting real (inflation-adjusted) GDP, where the downturn is not triggered by an exogenous factor such as a truckers’ strike.  The NBER, which is the official arbiter of when the United States economy is in recession, attempts to refine its timing calls, on a monthly basis, through the use of economic series such as payroll employment and industrial production, and it no longer relies on the two quarters of contracting GDP rule.

Depression: A recession, where the peak-to-trough contraction in real growth exceeds 10%.

Great Depression: A depression, where the peak-to-trough contraction in real growth exceeds 25%.

On the basis of the preceding, there has been the one Great Depression, in the 1930s.  Most of the economic contractions before that would be classified as depressions.  All business downturns since World War II—as officially reported —have been recessions.  Using a somewhat narrower “great depression” definition of a contraction in excess of 20% (instead of 25%), the depression of 1837 to 1843 would be considered “great,” as would be the war-time production shut-down in 1945.

As explored in Chapter 4—Current Economic and Inflation Conditions in the United States, the current downturn would qualify as a “depression” per the above definitions, and it should evolve into a “great depression,” as normal commercial activity grinds to a halt in a hyperinflation.  Nonetheless, the term “Great Recession” has entered the popular lexicon for the current downturn.  Given the financial pain that will be attributed to the Great Recession—if that terminology holds—those naming future such events likely will be looking to come up with a different descriptor for a “recession” in the post-collapse period.

 

Chapter 3—Two Examples of Hyperinflation

Aside from the new first section, the text is little changed from the prior hyperinflation report.

Some Lessons from History

Ralph T. Foster (Foster) in Fiat Paper Money, The History and Evolution of Our Currency (see Recommended Further Reading) details the history of fiat paper currencies from 11th Century Szechwan, China, to date.  He recounts the consistent collapse of those currencies, time-after-time, due to what appears to be the inevitable, irresistible urge of issuing authorities to print too much of a good thing.  The United States is no exception, already having obligated itself to liabilities well beyond its ability ever to pay off—and the obligations continue to mount—while the currency printing presses already are running overtime.

Among numerous instances of hyperinflation in the last one hundred years, two are highlighted here.  First, the Weimar Republic hyperinflation of the early 1920s is close enough to what I envision for the United States so as to provide some cautions as to the scope of the runaway inflation.  Second, the Zimbabwe hyperinflation in the first decade of the 21st Century provides an example of an economy continuing to function through such a currency crisis, thanks to functioning black markets.  The United States does not have a back-up system for its currency, black market or otherwise.

Weimar Republic

Foster closes his book’s preface with a particularly poignant quote from a 1993 interview of Friedrich Kessler (1901-1998), a law professor whose university affiliations included, among others, Yale and the University of California Berkeley.  From firsthand experience, Kessler described the Weimar Republic hyperinflation:

“It was horrible.  Horrible!  Like lightning it struck.  No one was prepared.  You cannot imagine the rapidity with which the whole thing happened.  The shelves in the grocery stores were empty.  You could buy nothing with your paper money.”

The hyperinflation in Germany’s Weimar Republic is along the lines of what likely will unfold in the United States.  The following two graphs plot the same numbers, but on different scales. The data are the monthly averages of the number of paper German marks that equaled one dollar (gold-backed) in 1922 and 1923, with that number acting as something of a surrogate for the pace of inflation. 

Graph 4 is a simple arithmetic plot, but the earlier detail is masked by the extreme numbers of the final several months, suggestive of the extraordinarily rapid and large rise in the pace of inflation.  The second plot, Graph 5, is on a logarithmic scale, where each successive power of ten represents the next tick mark on the vertical scale.

While the hyperinflation did hit rapidly, annual inflation in January 1922 already was more than 200%, up from as low as 6% in April 1921.  The existing currency was abandoned at the end of 1923.

Graph 4: German Paper Marks per U.S. Dollar 1922 to 1923

Graph 5: Log Scale, German Paper Marks per U.S. Dollar 1922 to 1923

Milton Friedman and Anna Jacobson Schwartz noted in their classic A Monetary History of the United States that the early stages of the Weimar Republic hyperinflation was accompanied by a huge influx of foreign capital, much as had happened during the U.S. Civil War.  The speculative influx of capital into the U.S. at the time of the Civil War inflation helped to stabilize the system, as the foreign capital influx into the U.S. in recent years had helped to provide relative stability and strength to the equity and credit markets.  Following the Civil War, however, the underlying U.S. economy had significant untapped potential and was able to generate strong, real economic activity that covered the war’s spending excesses.

Post-World War I Germany was a different matter, where the country was financially and economically depleted as a penalty for losing the war.  Here, after initial benefit, the influx of foreign capital helped to destabilize the system.  “As the mark depreciated, foreigners at first were persuaded that it would subsequently appreciate and so bought a large volume of mark assets…”  Such boosted the foreign exchange value of the German mark and the value of German assets.  “As the German inflation went on, expectations were reversed, the inflow of capital was replaced by an outflow, and the mark depreciated more rapidly… (Friedman p. 76).”

Indeed, in the wake of its defeat in the Great War, Germany was forced to make debilitating reparations to the victors—particularly France—as well as to face loss of territory.  From Foster (Chapter 11):

“By late 1922, the German government could no longer afford to make reparations payments.  Indignant, the French invaded the Ruhr Valley to take over the production of iron and coal (commodities used for reparations).  In response, the German government encouraged its workers to go on strike.  An additional issue of paper money was authorized to sustain the economy during the crisis.  Sensing trouble, foreign investors abruptly withdrew their investments.

“During the first few months of 1923, prices climbed astronomically higher, with no end in sight…  The nation was effectively shut down by currency collapse.  Mailing a letter in late 1923 cost 21,500,000,000 marks.”

The worthless paper German mark became useful as wallpaper and toilet paper, as well as for stoking fires.

The Weimar circumstance, and its heavy reliance on foreign investment, was closer to the current U.S. situation than it was to the U.S. Civil War experience.  In certain aspects, the current U.S. situation is even worse than the Weimar situation.  It certainly is worse than the Civil war circumstance.  

Unlike the still largely untapped economic potential of the United States 147 years ago, today’s U.S. economy is languishing in the structural problems of the loss of its manufacturing base and a shift of domestic wealth offshore; it is mired in an economic contraction that is immune to traditional economic stimuli.  As the U.S. government has attempted in recent decades to assuage electorate discontent with ever more expensive social programs; as the Federal Reserve moved to encourage debt expansion as a remedy for lack of real, inflation-adjusted, income growth; the eventual bankruptcy of the U.S. dollar was locked in.  The problem here was taken on and created willingly by U.S. government officials—embraced by both major political parties—not imposed by a victorious and vengeful enemy of war.

In the early 1920s, foreign investors in Germany were not propping up the world’s reserve currency in an effort to prevent a global financial collapse, and they did not know in advance that they were doomed to take a large hit on their German investments.  In today’s environment, both central banks and major private investors know that the U.S. dollar is a losing proposition.  They either expect and/or hope that they can get out of the dollar in time to avoid more-severe losses than already taken, or, in the case of the central banks, that they can forestall the ultimate global economic crisis.  Such expectations and hopes have dimmed markedly in the last several years, as the untenable U.S. fiscal condition has gained much broader public and global recognition.  

Zimbabwe

Hyperinflation in Zimbabwe, the former Rhodesia, was a quadrillion times worse than it was in Weimar Germany.  Zimbabwe went through a number of years of high inflation, with an accelerating hyperinflation from 2006 to 2009, when the currency was abandoned.  Through three devaluations, excess zeros repeatedly were lopped off notes as high as 100 trillion Zimbabwe dollars. 

 

 

 

 

 

The cumulative devaluation of the Zimbabwe dollar was such that a stack of  100,000,000,000,000,000,000,000,000 (26 zeros) two dollar bills (if they were printed) in the peak hyperinflation would have be needed to equal in value what a single original Zimbabwe two-dollar bill of 1978 had been worth.  Such a pile of bills literally would be light years high, stretching from the Earth to the Andromeda Galaxy. 

In early-2009, the governor of the Zimbabwe Reserve Bank indicated he felt his actions in printing money were vindicated by the recent actions of the U.S. Federal Reserve.  If the U.S. went through a hyperinflation like that of Zimbabwe’s, total U.S. federal debt and obligations (more than $80 trillion with unfunded liabilities) could be paid off for much less than a current U.S. penny.

This sign in a restroom facility at a South African border station with Zimbabwe speaks for itself.

 

 

 

 

 

What helped to enable the evolution of the Zimbabwe monetary excesses over the years, while still having something of a functioning economy, was the back-up of a well-functioning black market in U.S. dollars.  The United States has no such backup system, however, with implications for a more rapid and disruptive hyperinflation than seen in Zimbabwe, when it hits.  This will be discussed later.

Chapter 4—Current Economic and Inflation Conditions in the United States

Economic Reality

Before examining how the current circumstance can evolve into a hyperinflationary great depression, it is worth assessing the nature of the present economic and inflation conditions in the United States, along with likely near-term developments in those areas.  Underlying economic activity is reviewed in this chapter based on traditional but inconsistent reporting, and it is explored in the next chapter based on adjustments to related underlying inflation reporting. 

As to the broad outlooks, they have not changed since the prior hyperinflation report.  The economic recession/depression is structural and ongoing in nature, with growth well below official estimates, and with no recovery likely in the foreseeable future.  Inflation deliberately is understated by the U.S. government, and has shown an initial increase in inflation from the Federal Reserve’s dollar debasement policies and the ensuing increase in oil prices.

It’s All in the Inflation Assumptions.  Simply put, key series such as payroll employment, housing starts and consumer confidence indicate that an economic collapse began in 2006 or 2007 and continued into 2009, with roughly a three-year period of bottom-bouncing activity following the collapse, instead of showing economic recovery during the same post-collapse period of time.

In contrast, the GDP now is reported showing full recovery, with third-quarter 2011 activity having regained the GDP level seen before the recession began.  Real (inflation-adjusted) retail sales and industrial production both show some fair rebound, but no major series has shown full recovery other than the GDP.  The difference between the two sets of series is that those showing no recovery are not otherwise affected by inflation.  Those showing recovery or some rebound, however, are dependent on underlying inflation assumptions.  Corrected for more realistic inflation numbers, the latter series show the same collapse and bottom-bouncing patterns as seen in former, more-reliable series.  This is shown in detail in the next Chapter 5—Key Economic Reporting Varies by Inflation Assumptions.

Wall Street and Political Hype on the Economy and Inflation Are Overly Optimistic.  As heavily touted on Wall Street, the official version of the current U.S. economic circumstance is that business activity is enjoying normal growth, having recovered to levels last seen before the severe recession of 2007-2009.  Reported consumer inflation is higher, but contained, with rising “core” inflation getting less headline coverage than it did the year before.

If this happy picture were real, the Federal Reserve would not be panicking, printing new money and attempting to liquefy the system at an unprecedented pace in QE2, and ongoing speculation of a new round of easing would not be floated every couple of days by Wall Street, looking for a quick fix.  If the economy really were recovering and on a positive track, the Administration and Congress would not be positioning themselves to handle an economically- and financially-impaired electorate in advance of what is likely to be a tumultuous 2012 election.

Indeed, anecdotally, Main Street U.S.A. is not seeing this near-perfect economic environment, either.  Common perception remains that the economy and labor conditions are much worse than the happy news in GDP and jobs reporting, and that inflation is running well above the price increases indicated by the government’s consumer inflation estimates. 

The SGS assessment of the current circumstance generally is in line with the common experience.  The economy still is in broad contraction, with consumer inflation—viewed from the standpoint of the cost of maintaining a constant standard of living (as the CPI initially was intended) and of reflecting out of pocket expenses—running well above official inflation.  Irrespective of the measure, consumer inflation has moved higher in response to Federal Reserve efforts to create inflation.

Suffering from a deteriorating structural shift in consumer liquidity, the U.S. economy went into a severe contraction, starting slowly in late-2006, but plunging by the end of 2007 through early-2009.  Since then the broad economy has been bottom-bouncing at a low-level plateau of activity, with spikes seen in the activity of several important series such as retail sales and industrial production from short-lived stimulus effects, bad underlying inflation assumptions and from distortions in a post-World War II economic reporting system that never was designed to handle a downturn of the present nature and severity.

Broad economic activity has remained stagnant since the collapse, bottom-bouncing and likely to slow anew, and such should painfully evident in the months ahead.  Since the National Bureau of Economic Research (NBER)—official arbiter of U.S. recessions—has formally timed the recession, peak-to-trough, from December 2007 to June 2009, the renewed downturn eventually should gain official recognition as the second down-leg of a multiple-dip recession, with its onset likely timed from third-quarter 2010.

Considered in the pages ahead is the nature of the structural consumer-income problems driving the downturn; economic reporting quality issues that have arisen from an unprecedented downturn in the era of modern economic reporting.

Structural Consumer Liquidity Problems

Until structurally-impaired real (or inflation-adjusted) household income and liquidity fundamentally turn around, there can be no sustainable recovery in U.S. economic activity.  The consumer accounted for 73% of reported third-quarter 2011 U.S. GDP.

The U.S. economy is in a deepening structural change that has resulted from U.S. trade, social and regulatory policies driving a goodly portion of the U.S. manufacturing and technology base offshore.  As a result, a large number of related, high paying jobs have disappeared for U.S. workers.  Accordingly, U.S. consumers have found increasingly that their household incomes fail to keep up with inflation. Without real growth in income, there cannot be sustained economic growth.  Growth driven solely by debt expansion, as encouraged by the Greenspan Fed of recent years, ultimately is not sustainable; it is temporary, as has become painfully obvious to many in the still-evolving systemic-solvency crisis. 

Shown in the following Graph 6, the U.S. trade deficit—in general deterioration since the early-1970s— initially narrowed in the current downturn, with weaker U.S. consumption and with a short-lived collapse in oil prices.  Yet, the trade shortfall resumed its net deterioration in the last couple of years.  The brief period of deficit narrowing reflected no fundamental shift in circumstances, no healthy move in U.S. economic activity towards a basic improvement in the trade balance, or in a shift towards reinvigorating the U.S. manufacturing base. 

 

Graph 6: Merchandise Trade Balance

 

The gradual deterioration in inflation-adjusted wages and household income has resulted in a record level of the variance or dispersion in household income, as shown in the next Graph 7, and that has negative longer term economic implications.  Variance in income is low when the distribution of income levels is heavily concentrated in the middle, and it is high when more of the income distribution is pushed into the extremes of high- and low-income levels, with a weaker middle-income range.

A person earning $100,000,000 per year is not going to buy that many more automobiles than someone earning $100,000 per year.  The stronger the middle class is, generally the stronger will be consumption and the economy. 

Historically, extremes in income variance have been followed by financial panics and economic depressions, which then tend to redistribute income towards the middle.  Income variance today is higher than it was coming into 1929 and 1987, and it is nearly double that of any other “advanced” economy.  At a peak in 2006, the measure dipped as systemic crises broke in 2007.  Yet, U.S. income dispersion moved higher again in 2008, 2009 and 2010 (the most recent reporting) setting a new historic high.

Graph 7: Household Income Dispersion

Graph 8: Average Weekly Earnings (1967 CPI-W Dollars)

Graph 9: Annual Median Household Income (1967 Dollars)

Graph 10: Median Household Income Index (Monthly)

Graphs 8, 9 and 10 show officially-reported weakness in inflation-adjusted income. Graph 8 shows real average weekly earnings (production and supervisory workers), as reported and deflated by the Bureau of Labor Statistics (BLS) using the regular CPI-W.  Real wages never recovered their pre-1973 recession peak.  As wages dropped through the decades, the number of people in an average household that had to work—in order to make ends meet—increased.  If the shown wages were deflated using the SGS-Alternate CPI Measure (discussed later in this section), the wage line would continue sloping downward, subsequent to 1996.

Graph 9 reflects median (the middle measure instead of average) U.S. household income over the years.  The bottom dark-blue line shows income deflated by the regular CPI-U, a measure somewhat broader than the CPI-W used in the wage plot.  Those inflation-adjusted numbers show that median household income never recovered its pre-2001 recession peak and stood below its level of 1969, as of 2010.  Even deflated by the CPI-U-RS (current methods) used in Census Bureau reporting—discussed below—the pre-2001 recession peak also has not been recovered.  The BLS uses the CPI-U or CPI-W for deflating its official income series; the Census Bureau has been playing games with the CPI-U-RS.  I know no other use of the “RS” series in major economic reporting.

Graph 10 reflects a new series on median household income that shows a seasonally-adjusted monthly index deflated by the CPI-U.  The income index plunged through 2008 into 2011.  I expect further downturns will be seen here.  There is nothing here to support the concept, let alone the possibility of an economic recovery.

The broad point on inflation-adjusted U.S. consumer income is that it is inadequate to sustain growing, inflation-adjusted economic activity.  In the absence of income growth, debt expansion can act as a short-term prop for the economy, but that is not available at present.  The system is in the throes of a solvency crisis, with banks having reduced lending to consumers.  The consumer is in an unprecedented liquidity crisis, constrained by shrinking income and by limited credit.

CPI No Longer Reflects Costs of Maintaining Constant Standard of Living

In the last several decades, the BLS introduced a variety of new methodologies into the calculation of the CPI, with the effect of reducing the level of reported CPI inflation. The general approach was to move the CPI away from its traditional measuring of the cost of living of maintaining a constant standard of living.  The introduction of hedonic adjustments also has eliminated the concept of the CPI reflecting actual out-of-pocket expenditures.

The lower the rate of inflation that is used in deflating a number, the stronger will be the resulting inflation-adjusted level or growth.  The CPI-U-RS is the CPI with its history restated as if all the new methodologies had been in place from day one.  The impact of the methodological changes in calculating inflation is evident in the two lines in Graph 9: Annual Median Household Income (1967 Dollars), with the upper, red CPI-U-RS line showing stronger relative growth.

By reverse-engineering the CPI-U-RS, current inflation reporting can be estimated as though it were free of the inflation-dampening methodologies.  Such has been done with the SGS-Alternate Consumer Inflation Measure (based on 1980 methodologies).  The SGS measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS (the series is not recalculated).  Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept.  Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the annual impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact not otherwise published by the BLS.

As plotted in following graph, the gap between the SGS measure (blue line) and the CPI-U (thinner red line) effectively is the shortfall in official inflation reporting that otherwise would have offset declining standards of living.  This is one reason why individuals who have their income tied to the CPI find it increasingly difficult to make ends meet (see Response to BLS Article on CPI Misperceptions for further details).

Graph 11: Annual Consumer Inflation, CPI versus SGS Alternate

Early Impact of Dollar Debasement

Regardless of the inflation measure, inflationary pressures surfaced from the Fed’s efforts at dollar debasement.  A weakening U.S. dollar placed upside pressure on dollar-denominated oil prices and other dollar-denominated commodity prices, including food, which in turn began pushing annual inflation higher.  This is not inflation generated by strong economic demand, but rather inflation driven by the Federal Reserve’s monetary efforts to weaken the dollar.  While global supply problems or political concerns also have affected food and energy commodity prices, movements against the dollar seem to have been the primary moving force behind getting oil prices to their current elevated levels.

 

Graph 12: Gold versus Swiss Franc

Graph 13: Gold versus Oil

Graph 14: Gold versus Silver

Shown in Graphs 12, 13 and 14 are powerful fundamentals that either drive U.S. inflation or reflect market expectations of the longer-term domestic inflation outlook.  The currency, oil and gold markets have seen extreme volatility in the last couple of years, and they likely will continue to be volatile in the year ahead.  Reflecting the inflationary pressures from a weaker dollar and higher oil prices, ongoing solvency issues for the United States, and continued dollar debasement efforts by the Federal Reserve—including the apparent recent loss of the U.S. dollar’s traditional safe-haven status, and a severe loss of global confidence in the dollar—the Swiss franc, gold and silver have hit historic or multi-decade (silver) highs in the last year, before the heavy selling and market manipulations in late-2011.

Income, Credit and Willingness to Spend

The income shortfalls experienced by many individuals and households—in terms of being able to maintain or to improve standards of living—often were met by consumer debt expansion.  Such was encouraged by a Federal Reserve that recognized the U.S. economy would face stagnation or a slowdown without a surge in consumer credit. 

Keep in mind that the Federal Reserve is not a government entity, but rather a private corporation owned by private banking interests.  Irrespective of federal government mandates that the Fed pursue polices to maintain stable economic growth and to contain inflation, the Fed’s primary mission has been to protect the banking system, to keep that system solvent and profitable.

Explosive growth in the use of credit cards and the expansion of home equity loans as sources of consumer liquidity, fueled consumer liquidity, fueled consumer spending, gave consumers a false sense of financial security and helped banking-system profitability.

As housing activity began to fall off in 2006, and as the recession and the financial and bank solvency crises became apparent to authorities in 2007 and 2008, lending to consumers dried up by mid-2008.  Impaired bank balance sheets limited banks’ lending abilities.  Income problems, which had been masked by excessive consumer debt growth, suddenly were exacerbated by collapsing credit.

Consumer Credit Still Shrinking Net of Student Loan Surge

The following Graph 15 shows total consumer credit outstanding (excluding mortgages) since 2000.  The recent downturn in consumer credit was the most severe of the post-World War II era, and followed the general pattern of the economic collapse in the ongoing downturn, with an ensuing period of bottom-bouncing. 

The recent gains in consumer credit are deceiving.  Since the near-term trough of the series in September 2010, the $54.1 billion increase in consumer credit outstanding as of November 2011 was more than accounted for by a $136.1 billion increase federal government student loans, not to lending that might fuel consumer spending.  Otherwise, consumer credit and bank lending to consumers still are contracting on a month-to-month and annual basis.

Graph 15:  Consumer Credit Outstanding

Beyond having the income and/or credit, however, consumers also need the willingness to spend.  There is something of a surrogate measure for this willingness in the Conference Board’s consumer confidence index (shown later in Graph 21: Consumer Confidence).  December 2011’s reading was more than 50% below the levels seen in the halcyon days pre-2001 recession, when debt excesses were not viewed by most as a particular problem.  At present, consumers have neither the physical ability nor the willingness to prop up the U.S. economy in the manner to which the Federal Reserve and the big-deficit spenders in Washington, D.C. have become accustomed.

Neither the federal government nor the Federal Reserve can address easily the fundamental structural problems tied to consumer liquidity.  Stimulus efforts have been limited to one-time or otherwise short-lived efforts to provide temporary boosts to consumer disposable income.  Until income growth gains sustainably relative to inflation, and/or credit is flowing freely enough to boost willing consumption, there is no chance for sustained economic growth or economic recovery in the United States.

Markets Are Flying Blind with Distorted Economic Reporting

Seasonal-Factor Warping.  A note of caution is offered here as to the quality of current and recent economic reporting.  The significance of month-to-month data has been heavily impaired by the extraordinary severity of the current economic downturn, both in terms of duration and depth.  Most modern economic reporting was put in place after World War II, designed to handle generally positive growth in the broad economy, with occasional downturns in the business cycle.

Reporting of month-to-month and quarter-to-quarter data usually were based on seasonal adjustments, where repetitive patterns tied to holiday, school year, etc. activity were removed statistically from the numbers, theoretically leaving patterns due to just shifting economic activity.  Seasonal adjustments were based on patterns of activity over a number of years, with the most-recent year receiving the heaviest weighting.  In recent years, key series such as nonfarm payrolls and retail sales have been reported using “concurrent” seasonal-factor adjustments, where the adjustments are recalculated each month, using the latest month’s data.

When the seasonal factors are meaningful, they tend to remain stable over time, with little variation in the distribution of monthly patterns from the year-to-year or even month-to-month re-estimations.   Extreme volatility of economic activity in the last several years has outweighed and distorted regular seasonal factor patterns.  As result, annual and monthly recalculations of the seasonals have been showing highly unstable patterns, which, in turn, have thrown off the significance of reported monthly and quarterly changes, well beyond previously recognized reporting error confidence intervals.

Of particular concern with the “concurrent” adjustments made to payrolls and retail sales, for example, is that the monthly revisions from the unstable seasonal-factor recalculations have been significant.  While those revisions affect data going back for years, the government only shows revisions to the last two months (with retail sales they also show the last two months from one year ago), freezing all the other data in place.

The problem in terms of analyzing these data is that reported monthly gains or losses often reflect no more than the unstable seasonal factors shifting activity patterns around during the year, not changes in economic activity.  Those analyzing the numbers, though, cannot see what is happening.  The historical data are inconsistent with the latest reporting, since the fully revised history simply is not published.   

Loss of Survey Base Inflates Reported Activity / Distorts Rules of Thumb.  In a deep and protracted downturn, companies go out business.  If a company fails to report its payrolls, sales or orders, however, the government generally assumes that the company still is active and estimates what that company should be reporting.

Also, economic activity has sunk to such low levels, that regular measures of change followed closely by the financial markets—such as new claims for unemployment insurance—are not signaling economic recovery, as they turn less negative.  Some analysts look at historical patterns and conclude that when new claims drop below a certain level that the economy is improving.  In the current circumstance, layoffs have been so severe that the universe of potential further layoffs has been meaningfully reduced.  Under such circumstances, rules of thumb may not work well.

Corporate Revenues and Profits.  Unusually severe economic times also can affect reported corporate performance.  The current downturn has not hit all sectors or all companies with equal vigor, and, as often is the case, downturn and recovery will vary sharply across the commercial spectrum.  Nonetheless, company financials are always worth a close look. 

Publicly held corporations usually enjoy the flexibility and creativity needed to show strong financial results even when the economy is down; or least they can help guide market expectations in terms of earnings, etc.  Creative accounting—often involving throwing future losses into one-time charges for downsizing or such—usually is well accepted by investors, even when that cutting of productive assets has gone beyond the fat, through the muscle and into the bone.  Asset valuations also may enjoy gimmicked accounting practices in difficult times. 

Further, companies holding assets outside the U.S. dollar can boost their dollar-based picture, when the U.S. currency is under pressure.  Also, against extremely weak prior-year profits or revenues, impressive year-to-year growth rates can help paint a happy picture for investors. 

Already in Depression, Economy Continues to Bottom Bounce

Near-Term Economic Activity. As discussed in the regular SGS Commentaries, the U.S. economy remains in a structural recession/depression that is or is going to get a great deal worse.  Due to the NBER calling a formal end to the 2007 recession, however, the ongoing difficulties here will be recognized as a double- or multiple-dip downturn.  As will be discussed shortly, the contraction in business activity so far in the extreme downturn since 2006/2007 likely would qualify as a “depression” per SGS definitions (see Recession, Depression and Great Depression).

Shown in Graph 16, inflation-adjusted, year-to-year change in broad money supply (M3) generates a reliable signal in advance of recessions, or, in the case where a recession already is underway (as in the 1973 and 2007 recessions), a pending intensification of the downturn.  The lead-time usually is six-to-nine months.  Some recessions start without a money contraction, and upturns in money do not always lead economic upturns, but whenever real, broad systemic liquidity is in contraction, the economy always will follow.  The downturn signal is generated when the inflation-adjusted annual money growth (which adjusted for the velocity of money is the theoretical equivalent of real GDP) first turns negative   (see Inflation and Money Growth).

In the current circumstance, a downside signal was generated in December 2009.  After protracted bottom-bouncing, the economy appears to have turned down anew around September/October 2010, as will be discussed in the next chapter.  The year-to-year upturn in the series as of December 2011 is of no particular meaning; again, the reliable signal only is on the downside.

Graph 16: Real M3 versus Formal Recessions

 

Historical Perspective on the Economic Data

Traditional Year-to-Year View.  The current downturn, as reported, already is the longest and the deepest business contraction since the first down-leg of the Great Depression in the early 1930s.  Such is reflected in payroll employment and GDP growth plotted in the following graphs.  The quarterly GDP numbers are available only back to 1947.  If one counts the war-production shutdown at the end of World War II as a normal business cycle, then the current downturn is the deepest since then, but still the longest since the early 1930s.  The respective depths of the Great Depression and post-war production contractions are based on annual data available back to 1929.

While the official peak-to-trough contraction in the downturn since fourth-quarter 2007 GDP now is 5.1% (second-quarter 2009 trough), most of the better economic series are showing or have shown contractions that are more consistent with a peak-to-trough GDP contraction in excess of 10% (depression range), as indicated by payroll employment, retail sales and industrial production, while others such as housing starts showing contractions of greater than 25% (great-depression range).  These issues will be covered in the next chapter, along with evidence of even greater annual down turn in major economic series.

Graph 17: Year-to-Year Change Monthly Payroll Employment

Graph 18: Year-to-Year Change Quarterly Real GDP

Graph 19: Year-to-Year Change Annual Real GDP

 

 

 

 

Chapter 5—Key Economic Reporting Varies by Inflation Assumptions

 

Economic Reporting Free of Inflation And Inflation Corrected

Economic Measures—It’s All in How Inflation is Measured.  The following ten graphs are divided between those economic series that reflect no inflation adjustments (Graphs 20 to 23), and those that are dependent on underlying inflation assumptions (Graphs 24 to 29).  The difference is that series free of inflation adjustment show that the economy turned down in 2006 or 2007, plunged into 2008 or 2009 and has not recovered meaningfully, showing something close to bottom-bouncing ever since.  The series adjusted for inflation plunge into 2009, but then recover or show some reasonable upside gains. 

I contend that the latter case is due to the use of understated inflation rates when the series are deflated, which results in overstatement of the reported, inflation-adjusted growth.  Corrected for more reasonable rates of inflation, these series in the second grouping of GDP, real (inflation-adjusted) retail sales and industrial production start to look like those in the first grouping, payroll employment, consumer confidence and housing starts. 

The Economy Has Yet to Recover.  Is the U.S. economy booming anew, or is it still bottom-bouncing in a deep contraction that now exceeds in duration the first-leg of the Great Depression?  The differences in published data that support one or the other extreme circumstance are tied to how the government handles inflation estimates, with the more-troubled economy the likely reality.

In line with common experience, I contend that the U.S. economy has been in trouble since at least 2000, when it entered a recession that dragged into 2003.  Business activity then began collapsing in 2006, hit a bottom in 2009 and has been bottom-bouncing since.  The outlook for the U.S. economy remains bleak, with continued and deteriorating bottom-bouncing ahead.  I figure there have been 60 months of recession so far, in the current downturn, which tops the 43 months officially estimated for the first down-leg of the Great Depression.

The happier, official version of U.S. business activity is that the economy went through a shallow recession between March 2001 and November 2001, with a much deeper downturn beginning in December 2007 and ending in June 2009.  Since then, U.S. economic activity has recovered fully and now exceeds pre-2007 recession levels.

Where some widely followed economic series such as real retail sales and industrial production show increasing activity, only GDP reporting shows a full recovery.  Those series also all are adjusted by inflation with gimmicked underlying assumptions.  Other series such as payrolls, household income, consumer confidence and housing starts support the more dire circumstance.  Those series, except for household income, are not subject to inflation adjustments.  The implication for household income, which is deflated by the CPI-U, is that the decline is even more severe than suggested by the official numbers (see Graph 10: Median Household Income Index (Monthly)).

Plots of these indicators are shown and discussed, and, where appropriate, viewed with different inflation assumptions.  All the graphs plot monthly or quarterly levels of activity, indexed to January 2001 or first-quarter 2001 equal to 100.  Exceptions to the indexing are real retail sales and industrial production—before inflation correction—and housing starts, which are displayed as otherwise published in the regular Commentaries.  Where used, the shaded areas represent officially pronounced periods of recession.

Payroll Employment.  Consider Graph 20 of payroll employment.  Where employment traditionally has been considered a coincident indicator of economic activity, payroll levels suggest the 2001 recession ended in 2003, not 2001, and that the 2007 recession still is not over; at least there has been no meaningful rebound in economic activity.  The payroll level in December 2011 remained below payroll levels not only pre-2007 recession, but also pre-2001 recession.

Consumer Confidence.  Graph 21 of consumer confidence reflects the 2001 recession crashing into 2003, with no full recovery.  The downturn begins before the end of 2007, and basically has been bottom-bouncing near historic lows in the post-plunge period.  

Housing Starts.  Graphs 22 and 23 show plunging activity starting in 2006 and running into 2009, with bottom-bouncing in the post-plunge era

GDP and Inflation.  Graphs 24 and 25 are based on GDP reporting.  The Graph 24 reflects official levels of real (inflation-adjusted) GDP activity (indexed to first-quarter 2000 equals 100).  It shows no clear 2001 recession, with growth generally in an uptrend until the official December 2007 to June 2009 recession, and with third-quarter 2011 business activity fully recovered from the recession.

A significant issue with official GDP reporting is the nature of the inflation rate used to deflate the series.  The lower the inflation rate used in the GDP’s implicit price deflator (IPD), the stronger will be the inflation-adjusted level and growth reported for the real GDP.  Back in the 1980s, the Bureau of Economic Analysis (BEA) introduced the concept of hedonic adjustments in determining the IPD.  Hedonic adjustments altered (usually reduced) inflation estimates, based on nebulous quality concepts that had no relationship to real-world common experience.  The effect was to reduce the IPD inflation artificially.  Other major countries initially avoided the concept in their GDP calculations, with a number of papers discussing how the U.S. hedonic methodologies gave an artificial boost to reported U.S. economic performance, productivity, etc. relative to the rest of the world.  I estimate the hedonics currently reduce the annual IPD by about two percentage points.

There is no easy way to reconcile the official GDP activity with payroll employment activity, without considering the inflation issue, and the explanation is not in sudden, miraculous gains in productivity, which simply is a residual of poor-quality numbers.  The payroll employment numbers are surveyed and eventually benchmarked.  Despite all the issues I have with the employment series, the numbers eventually become fairly solid.  In contrast, the GDP estimates are heavily guessed at and modeled, including the IPD.

Backing-out the two-percentage point IPD understatement generates the “Inflation-Corrected Real GDP” in Graph 25 graph, which is more consistent with the payroll numbers than is the “Headline GDP.”  With corrected inflation, the GDP shows the 2001 recession beginning in 2000 and extending into 2003.  The 2007 recession begins in 2006, hits a bottom in 2009 and the bottom-bounces thereafter.  A small upside bounce is turning down again.

I am attempting to make a simple point here as to how differing assumptions on inflation can throw off official reporting, meaningfully.  The inflation-corrected number in the graph is not the same measure as the SGS-Alternate GDP Measure, which also adjusts for hedonics.  There are a number of other factors involved in that measure, which complicate the discussion but show an even more-negative “corrected” GDP (see the Alternate Data and Primer tabs on www.shadowstats.com for more detail).

Retail Sales.  Graph 26 shows the official real retail sales series.  As with official real GDP reporting, reporting of real retail sales (deflated with the CPI-U by the St. Louis Federal Reserve) uses understated inflation, with the result of overstated levels of real growth and activity.  Instead of the CPI-U, I have used the SGS-Alternate Consumer Inflation Measure (1990) to deflate the nominal retail sales number, adding about three percentage points back into annual inflation on the recent CPI-U.  As was discussed earlier, the Bureau of Labor Statistics (BLS) has changed methodologies in recent decades so that the CPI no longer reflects the cost of living for maintaining a constant standard of living, and it no longer reflects what most people consider full out-of-pocket expenses, as a result of using hedonic adjustments.

The inflation-corrected real retail sales in Graph 27 shows a 2000 to 2003 recession, a plateau of activity into the next downturn, which begins in 2006, a trough in 2009 and bottom-bouncing thereafter.  As a result of the new deflation of retail sales, the series more closely reflects that patterns seen in consumer confidence and household income, particularly in terms of the 2003 to 2006 plateau in activity.

Industrial Production.  Graph 28 shows the official industrial production series.  The production index includes components, such as computers, where the volume is calculated from dollar amounts that are deflated by hedonically-dominated inflation estimates.  Adjusted for a 0.6% inflation differential, the inflation-corrected industrial production in Graph 29 shows the 2011 recession, a period of stagnation, a downturn beginning about mid-2007, plunging into mid 2009, with a slow uptrend to date, nothing close to a recovery.

There is no question that the government has taken actions in recent decades to depress inflation reporting artificially.  As a result, inflation-adjusted economic growth has been overstated, and that helps to account for the discrepancies seen between GDP estimates and employment patterns.  Accordingly, the employment estimates are closer to common experience.

The estimated inflation-corrected series indeed are estimates, approximations, but they show that the general softer economic growth patterns are in place irrespective of the precise level of inflation understatement by the government.  I believe the estimates used here to be reasonably conservative.

 

Graph 20: Payroll Employment Level

Graph 21: Consumer Confidence

Graph 22: Housing Starts Beginning 2000

Graph 23: Housing Starts Post-World War II

Graph 24: Real GDP Level, Official Version

Graph 25: Inflation-Corrected Real GDP Level

Graph 26: Headline Real Retail Sales

Graph 27: Inflation Corrected Headline Real Retail Sales

Graph 28: Headline Industrial Production Level

Graph 29: Inflation-Corrected Industrial Production

 

 

Chapter 6—Historical U.S. Inflation and U.S. Dollar Debasement

 

Fire and Ice

Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.

– Robert Frost

 

Updated text in this chapter includes year-end 2011 inflation data, an expanded “Loss of Purchasing Power Table,” and expanded comments on the inflation/deflation issues.   

As to the fate of the developing U.S. great depression, it will encompass the fire of a hyperinflation, instead of the ice of deflation seen in the major U.S. depressions prior to World War II.  What promises hyperinflation this time is the lack of monetary discipline formerly imposed on the system by the gold standard; a fiscally bankrupt federal government; and a Federal Reserve dedicated to debasing the U.S. dollar and to preventing a banking system collapse at all costs.  

Both the federal government and the Federal Reserve demonstrated in 2008 and in the months and years following that they will not tolerate a systemic collapse and a great deflation, as seen during the Great Depression.  As more fully discussed in Chapter 7—Federal Reserve, Systemic Solvency and Inflation versus Deflation, those risks are being fought, and will be fought, at any cost that can be covered by the unlimited creation of new money, including whatever spending, lending or guarantees are needed.  It was a devil’s choice, but the choice has been made.  Extreme systemic interventions, and formal measures to debase the U.S. dollar through the effective unlimited creation of money to cover systemic needs and the government’s obligations, pushed the timing of a systemic collapse—threatened in September 2008—several years into the future.  The cost of instant, as well as ongoing, systemic salvation, though, is inflation. 

Current efforts at systemic salvation eventually will pummel the U.S. dollar against other currencies and likely will evolve into the proximal trigger for hyperinflation.  Systemic collapse is unavoidable at this point, but it will be in a hyperinflationary great depression, instead of a deflationary one.  A direct result of Fed and U.S. government efforts to delay systemic collapse, as long as possible, the hyperinflation will have been born beyond the reach of official containment, the child of last-ditch efforts to salvage a system that had been methodically pushed to long-range insolvency by decades of federal political malfeasance.

Putting the current environment in historical perspective, the following two graphs measure the level of consumer prices since 1665 in the American Colonies and later the United States.  The first, Graph 30, shows what appears to be a fairly stable level of prices up to the founding of the Federal Reserve in 1913 (began activity in 1914) and to Franklin Roosevelt’s abandoning of the gold standard in 1933.  Then, inflation takes off in a manner not seen in the prior 250 years, and at an exponential rate when viewed using the SGS-Alternate Measure of Consumer Prices in the last several decades.  The price levels shown prior to 1913 were constructed by Robert Sahr of Oregon State University.  Price levels since 1913 either are Bureau of Labor Statistics (BLS) or SGS-based, as indicated.

Graph 30: Consumer Inflation 1665 to 2011

The magnitude of the increase in price levels in the last 50 years or so, however, visually masks the inflation volatility of the earlier years.  That early volatility becomes evident in the next graph, where the CPI history is plotted using a logarithmic scale.  Seeing such detail is a particular benefit of using such a plot, although the full scope of what is happening may be lost to those not used to thinking log-based.  The pattern of the rising CPI level, however, still looks rather frightening even in the modified form.  Nonetheless, since inflation ideally is something that is flat over time—not compounding like the population and related series that grow with it—I do not have any issue with using a non-log scale for the visual impact of what is happening. 

Persistent year-to-year inflation (and the related compounding effect) did not take hold until post-Franklin D. Roosevelt.  Additionally, the CPI level reflects purchasing power lost over time for those holding dollars, which is cumulative, and which has reached extremes (as will be discussed shortly) due to the late-era compounding effect.  If my assessment is correct on where this is headed, the log-based graph shortly will look like the arithmetic-based graph, as was seen the latter months of the Weimar circumstance and as shown in the Weimar Republic section.

Indicated by the visible detail in the second graph, Graph 31, are the regular periods of inflation—usually seen around wars—offset by periods of deflation, up through the Great Depression.  Particular inflation spikes can be seen at the time of the American Revolution, the War of 1812, the Civil War, World War I and World War II (which lacked an ensuing, offsetting deflation).  As a result, consumer prices at the time of the Fed’s founding in 1913 were about the same as they had been in New Amsterdam (today’s New York City) in 1665. 

Graph 31: Log-Scale Consumer Inflation 1665 to 2011

 

The inflation peaks and the ensuing post-war depressions and deflationary periods, tied to the War of 1812, the Civil War and World War I, show close to 60-year cycles, which is part of the reason some economists and analysts have been expecting a deflationary depression in the current period.  There is some reason behind 30- and 60-year financial and business cycles, as the average difference in generations in the United States is 30 years, going back to the 1600s.  Accordingly, it seems to take two generations to forget and repeat the mistakes of one’s grandparents.  Similar reasoning accounts for other cycles that tend to run in multiples of 30 years.

Allowing for minor, average-annual price-level declines in 1949, 1955 and 2009, the United States has not seen a major deflationary period in consumer prices since before World War II.  The reason for this is the same as to why there has not been a formal depression since before World War II: the abandonment of the gold standard and recognition by the Federal Reserve of the impact of monetary policy—free of gold-standard system restraints—on the economy.

The gold standard was a system that automatically imposed and maintained monetary discipline. Excesses in one period would be followed by a flight of gold from the system and a resulting contraction in the money supply, economic activity and prices.

Faced with the Great Depression, and unable to stimulate the economy, partially due to the monetary discipline imposed by the gold standard, Franklin Roosevelt used those issues as an excuse to abandon gold and to adopt close to a fully-fiat currency under the auspices of what I call the debt standard, where the government effectively could print and spend whatever money it wanted to create.

Roosevelt’s actions were against the backdrop of the banking system being in a state of collapse.  The Fed stood by twiddling its thumbs as banks failed and the money supply imploded.  A depression collapsed into the Great Depression, with intensified price deflation.  Importantly, a sharp decline in broad money supply is a prerequisite to significant goods and services price deflation.  Messrs Greenspan and Bernanke are students of the Great Depression period.  As did Mr. Greenspan before him, "Helicopter Ben" has vowed not to allow a repeat of the 1930s money supply collapse and a resulting severe deflation.

Where the Franklin Roosevelt Administration abandoned the gold standard and its financial discipline for the debt standard, twelve successive administrations have pushed the debt standard to the limits of its viability, as seen now in the continuing threat of systemic collapse.  At present, it is the Obama Administration that has to look at abandoning the debt standard (hyperinflation) and starting fresh.  Yet, the Administration and many in Congress have taken recent actions showing the lack of political will to address the nation’s long-range insolvency, hoping to push off the day of reckoning for the economic and systemic solvency crises until after the 2012 presidential election.  They likely do not have that much time.

The effect of the post-Roosevelt policies has been a slow-motion destruction of the U.S. dollar’s purchasing power, per the accompanying table, since the gold standard was abandoned in 1933.  With the dollar’s purchasing power down by 95.6% (based on the CPI) and by 98.4% (based on the SGS-Alternate) since 1933, equivalent or greater purchasing power loss was seen against the precious metals, down by 98.8% versus gold, and down 98.6% versus silver.  That means that money invested in the precious metals, since 1933 (in 1933 it became illegal to own gold privately in the United States, but it became legal again in the early 1970s after Nixon closed the gold window; holding silver was legal throughout the full period), more than preserved the purchasing power against the losses from CPI inflation, and fully preserved the purchasing power against the losses from SGS inflation.

 

Table I: Loss of U.S. Dollar Purchasing Power

 

Please note in the above table that gold and the Swiss franc were held constant by the gold standard versus coins in 1914 and 1933.  The data are from the Federal Reserve Board, the Bureau of Labor Statistics, Kitco and from SGS data and calculations.  The magnitude of the loss in the U.S. dollar’s purchasing in the span of almost one century could be repeated in the span of less than 12 months starting in the next year or so.  Again, fiscal and monetary malfeasance by the federal government and the Federal Reserve are to blame.

 

The table showing the loss of purchasing power of the U.S. dollar against various inflation measures and assets has been expanded to include silver in the assets, as well as to include January 2002 as a base, showing the loss of purchasing power in just the last ten years.  With most of the CPI reporting gimmicks in place by 2001, the differential between the CPI and SGS is close to maximum.

 

 

Chapter 7—Federal Reserve, Systemic Solvency and Inflation versus Deflation

Preventing Systemic Collapse at All Costs

In an ongoing effort to prevent a collapse of the banking and financial system, Federal Reserve Chairman Ben Bernanke has taken extreme efforts to liquefy the system.  The pending systemic collapse in September 2008 was real, and that forced the Fed and the U.S. government to act to save the domestic financial system at any cost.  Whatever was needed to back-up or bailout the system in terms of lending, spending and financial guarantees was supported by the Fed’s ability to create any amount of money that was needed.  The actions of the time brought short-lived stability to the system, but they did nothing fundamentally to remedy the systemic-solvency issues. 

The housing industry had begun to collapse in 2006, which pulled the broad economy into recession and helped to create a crisis with mortgage backed securities.  The ensuing financial crisis and related panics exacerbated the economic downturn but did not start the recession.  None of the actions taken by the Fed and/or the federal government have had significant impact on the worst economic downturn since the Great Depression.  As discussed in Chapter 4—Current Economic and Inflation Conditions in the United States and in Chapter 5—Key Economic Reporting Varies by Inflation Assumptions, a severe structural downturn collapsed the broad economy from late-2007 into 2009, and the economy basically has not recovered, bottom-bouncing for the two-to-three years since with no recovery in sight.

There is nothing the Fed can do to have meaningful positive impact on the economy.  There is nothing the Fed can do to make the U.S. banking system healthy.  What Mr. Bernanke has done has been little more than trying to delay a day-of-reckoning for the banks and the financial system.  Keeping the banking system sound is the Fed’s primary responsibility; fostering sustainable economic growth and contained inflation are secondary considerations.  The quantitative easings were an effort to provide the banking system with adequate liquidity, but the related actions were sold to the public and the media as an effort to boost economic activity.  Future Fed “stimulus” actions should be of a similar nature.

By preventing systemic collapse at all costs, the Fed is preventing a 1930s-style deflation.  As banks failed in the 1930s and depositors lost their funds, the money supply collapsed, as did consumer prices in the Great Depression.  In the current circumstance, so long as the bank failures are controlled and those with money in the system are made whole, that type of money supply collapse is not in the works.  The debt collapse of the current crisis did not collapse the money supply.  Instead, it impaired banks’ balance sheets, restricting lending ability.  That, in turn, slowed broad money supply growth—even fostered a period of minor contraction in money growth—but it did not created a significant deflationary environment for consumer prices, as was seen in the 1930s.

Despite the Fed’s extreme efforts at liquefying the system in the last four or five years, growth in broad liquidity (i.e., money supply M3) generally has been inadequate to support normal economic activity, although there currently are tentative signs of some pick-up in M3.  Where the Fed’s “easing” actions have generated temporary, apparent systemic stability, ongoing efforts—or jawboning of same—for still further systemic liquefaction, suggest that the systemic-solvency crisis is far from over. 

Nonetheless, formal efforts by the Federal Reserve in the last couple of years to debase the U.S. dollar have met with early “success” in exacerbating selling pressures on the U.S. dollar, and in boosting oil and gasoline prices as part of the plan to increase the pace of consumer inflation.  The misguided inflation results do not reflect increased economic activity, only rising commodity prices from monetary policies aimed at debasing the dollar.  The event of the Fed actually pushing these policies into full force would be an indication of panic on the part of the U.S. central bank and likely a measure of how close Mr. Bernanke believes the United States is to a systemic collapse.

Indeed, threats to the system remain in place, including global systemic-solvency issues tied to the euro area.  With significant time to prepare for threats to the U.S. banking or financial system from the euro-area crises, the Fed (and presumably the U.S. Treasury) again can be counted on to create whatever money, or to take whatever short-term action is needed to forestall systemic collapse in the United States.  The next round of easing or emergency actions, however, also runs a high risk of being the proximal trigger of a collapse in the value of the highly-vulnerable U.S. dollar in the global markets, and of the onset of a domestic hyperinflation.

“Helicopter Ben” on Preventing Deflation

Federal Reserve Chairman Ben Bernanke picked up his various helicopter nicknames and references as the result of a November 21, 2002 speech he gave as a Fed Governor to the National Economists Club entitled Deflation: Making Sure ‘It’ Doesn’t Happen Here.  The phrase that the now-Fed Chairman Bernanke likely wishes he had not used was a reference to “Milton Friedman’s famous ‘helicopter drop’ of money.”

Attempting to counter concerns of another Great Depression-style deflation, Bernanke explained in his remarks: “I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States …” 

As expounded upon by Bernanke, “Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.”

“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply.  But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.  By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.  We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” 

The full text of then-Fed Governor Bernanke’s remarks can be found at: http://federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm.

Faced with extreme risk of systemic collapse in the wake of the Lehman failure, Bernanke launched his first round of anti-deflation actions back in 2008, but they did not work fully as advertised.  While the systemic solvency crisis had been contained at least temporarily in key areas, and depositor funds did not suffer heavy losses, the broad money supply began to decline month-to-month in June of 2009 and turned down year-to-year in December 2009.  The deepest annual decline in the SGS-Ongoing M3 Measure in the crisis has been 6.1% in June 2010.  Although that was the worst annual decline in broad money growth since the Great Depression, as discussed earlier, that was not significant  enough to generate a 1930s-style great deflation.  In contrast, the great deflation reflected roughly a one-third contraction in money supply from bank failures and loss of depositor money.  Year-to-year change in M3 turned to the plus-side in April 2011.  As of December 2011, annual growth was at 3.2% and beginning to accelerate to the upside.

Monetary Base and Money Supply Growth

Back in September 2008, the Fed started dropping cash from helicopters, as shown in the graphs of the monetary base.  The process was repeated with the introduction of QE2 in November 2010, with the Fed monetizing Treasury debt (see the graphic in Chapter 1—Overview and Executive Summary).

As shown in the two graphs of level and year-to-year change (Graphs 32 and 33), Bernanke’s spiking of the monetary base has been extraordinary and without precedent.  The Fed’s renewed panic with QE2 provided a second spike in the monetary base.  Again, though, despite the active fleet of choppers, systemic liquidity and solvency remain in deep trouble.

The monetary base remains the Federal Reserve’s primary tool for impacting money supply growth.  As has been the case for the bulk of the extraordinary expansion of the monetary base since late-August 2008—an increase of 204%—the monetary base growth has not been reflected meaningfully in money supply growth, unless it has been holding off an even greater money contraction. 

 

Graph 32: Monetary Base, Level

Graph 33: Monetary Base, Year-to-Year Change

Fundamentally, banks are placing high levels of excess reserves with the Fed, instead of lending the funds into the normal flow of commerce.  As a result, bank lending is down, and small businesses and consumers are experiencing a horrific liquidity squeeze.  This pattern continues despite the Fed’s QE2 buying of Treasury securities.

The monetary base is not part of the money supply.  It consists of currency (which is in M1 money supply) plus bank reserves.  If the banks were lending normally, M1 and the broader measures would be growing.  The ratio of M1 to the monetary base, the monetary base multiplier simply is not a meaningful measure under this circumstance. 

As discussed earlier and as shown in Graphs 34 and 35, year-to-year change in the SGS-Ongoing M3 Measure (the Fed abandoned reporting its broadest money supply measure, M3, back in March 2006) went through a period of contraction from December 2009 through April 2011, with annual growth showing tentative signs of acceleration as of December 2011.

Recent high growth seen in M1 and M2 (M3 includes M2, which includes M1) reflected nothing more than funds shifting from M3 accounts such as institutional money funds and large time deposits into “safer” M1 and M2 accounts.

Inflation-adjusted annual M3 growth also turned negative year-to-year in December 2009, a leading indicator to an economic downturn in normal times, and a signal of deteriorating conditions in an existing economic contraction, discussed in Already in Depression, Economy Continues to Bottom Bounce.

Graph 34: M3, Monthly Year-to-Year Change

Graph 35: Year-to-Year U.S. Money Supply Growth with SGS M3 Continuation

 

Banks Not Increasing Lending into the Regular Flow of Commerce

As discussed previously in Structural Consumer Liquidity Problems, consumer credit outstanding has been in historic contraction, with recently reported growth in the series due solely to federal lending on student loans, not to traditional bank lending to consumers.  The lack of growth in bank lending to consumers has intensified liquidity constraints there, and has exacerbated the structural problems with inflation-adjusted household income.

The following two graphs show the historical levels of commercial and industrial (C&I) loans by commercial banks and commercial paper outstanding.  The first, Graph 36, shows the history of C&I lending since 2000.  While the downturn in lending in the current economic cycle has been the deepest of the post-World War II era, the upturn in the last year has been offset largely by reduced bank lending in other areas, and in reduced levels of commercial paper outstanding (see Graph 37).

As of December 2011, C&I loans were higher by 10.2% year-to-year, but total loans and leases in bank lending by commercial banks was up by just 2.1%, with C&I gains offset by consumer lending (non-mortgage) down by 1.9%, and by real estate lending down by 3.6%.  On the residential lending front, revolving home equity loans were down by 33.8% for the year, closed-end residential lending was down by 0.8%, and commercial real estate lending was down by 5.7%

 

Graph 36: Commercial and Industrial Loans

Graph 37: Commercial Paper Outstanding

 

Graph 37 of commercial paper outstanding includes both financial and nonfinancial firms, with both sub series currently in decline.

Per the Federal Reserve’s third-quarter 2011 flow-of-funds accounting, total U.S. credit market debt outstanding stood at $53.8 trillion, up by 1.7% from third-quarter 2010.  The annual increase, however, was more than accounted for by the 12.3% growth in U.S. government debt.  The balance of the system saw an outright annual contraction of 0.5% in total credit.

Unlike the initial stages of quantitative easing that focused on the Fed buying up troubled mortgage-backed securities, the QE2 round of buying Treasuries—effectively monetizing fully net Treasury issuance—should have had some positive effect on the money supply.  Funds paid out by the Treasury usually end up in private checking accounts, which are part of the money supply, and M3 recently has begun to show some upside momentum.  Banks need to increase lending, though, in order for the money supply to pick up its full and excessive potential.

Some banks are not lending, because they claim there is a lack of credit-worthy borrowers.  Anecdotal evidence and still-soft money supply growth suggest that the biggest issue remains still-impaired bank balance sheets.  The systemic-solvency crisis has constrained many banks’ ability to increase lending.

Inflation and Money Growth

The Fed’s efforts at currency debasement were reflected in a weakening of the U.S. dollar’s value in foreign exchange markets.  In theory, though, slowing or outright contraction in broad money supply growth should be reflected in slower inflation or outright deflation.  As with most economic theories, however, there often are simplifying assumptions that may not be appropriate under certain circumstances, and there often are unusual circumstances.  Money supply, for example, works best as a predictor of inflation in a closed system, as was seen with Zimbabwe.  Also, perversely, contracting money supply can spur inflation when the economy is declining faster than the money supply.

Money Supply outside the United States.  Unlike Zimbabwe, the United States has a significant amount of dollars (currency and near-cash) held outside the country, where shifting dynamics may have significant impact on U.S. inflation. To the extent that aggregate foreign holdings of U.S. dollars are static, with demand and supply in balance, then the circumstances of the simplified money supply model tend to work.  The dollar’s global position, though, is not in balance, particularly with the Fed generally working to debase the U.S. currency and to create inflation.

One distortion up front is in the U.S. currency in circulation, as reported in the narrowest money supply measure, M1.  More than half of the $1.0 trillion reflected in recent M1 (and monetary base) reporting is physically outside the United States in “dollarized” countries and elsewhere. 

Separately, as reported by the Fed in its third-quarter 2011 flow-of-funds analysis, foreign holders of U.S. assets have something in excess of $12 trillion in liquid, dollar-denominated assets that could be dumped at will into the global and U.S. markets.  In perspective, U.S. M3 is somewhat above $14 trillion.

As excess dollars get dumped into the global markets, a shift in the tide against the U.S. dollar gets reflected in a weakening exchange rate, which in turn spikes dollar-denominated commodity prices, such as oil. Increasingly, that effect has been in response to intensifying dollar-debasement efforts by the Fed.  The result is that U.S. consumer inflation has been increasing during the last year, once again, not from strong economic demand and a surging domestic money supply, but from distended monetary policies and a global glut of dollars that has been encouraged by the U.S. central bank.

Demand and supply affect the U.S. dollar.  Supply soars and demand shrinks with the increasing unwillingness of major dollar holders to continue holding the existing volume of U.S. currency and dollar-denominated assets, let alone to absorb new exposure.

Therein lies a significant threat to near-term U.S. inflation.  Heavy dumping of the U.S. dollar and dollar-denominated assets would be highly inflationary to U.S. consumer prices.  It also likely would activate heavy Fed intervention in buying unwanted U.S. Treasuries.  When the Fed moves to buy Treasuries as the lender of last resort—to monetize U.S. debt still well beyond anything seen to date—that also would tend to trigger renewed growth in the otherwise flagging broad money growth.  

In order to get the broad money supply to grow, the federal government has to spend and borrow more money, where the Fed will have to buy large quantities of the Treasury’s securities, monetizing the federal debt.  The liquidity action pre-QE2 was primarily in buying otherwise illiquid mortgage-backed securities off the balance sheets of troubled banks.  The domestic banks in turn have leant substantial excess reserves back to the Fed, rather than lending into the normal stream of commerce, which would spike the money supply and otherwise be something of an economic positive.

The Fed remains the U.S. Treasury’s lender of last resort.  Panicked dollar selling and dumping of dollar-denominated paper assets—particularly U.S. Treasuries—likely would force the Fed’s hand in an increasingly rapid monetizing of Treasury debt.

Economy Growing Slower or Shrinking Faster Than Money Supply?  As noted in the Money Supply Special Report, inflation discussed in the financial markets, financial media and SGS Commentaries, usually centers on price changes in goods and services as traditionally measured by the CPI survey.  Such, however, is not the same measure of price changes as encompassed in general monetary theory (it also is far removed from being a measure of asset inflation or deflation), where the relationship between money supply and inflation commonly is expressed as:

M x V = P x Q

In the preceding equation, M is the money supply.  V is the velocity of money, as measured by the number of times the money supply turns over in a year, relative to the economy as reflected in nominal (not-adjusted for inflation) gross national product (GNP), where V = GNP/M.  GNP is the broadest measure of U.S. economic activity and encompasses the more popularly reported gross domestic product (GDP).

In turn, nominal GNP = P x Q, where P is some measure of GNP deflator (prices/inflation) and Q represents some measure of physical quantity/volume, or a real (inflation-adjusted) GNP, as a measure of economic output.

So, the P, or inflation measure here, effectively is the GNP deflator.  The change in P is a broader inflation measure than the consumers’ CPI, since it also covers costs of consumption for businesses, government and net exports, in addition to the costs of consumer spending on goods and services.  In terms of the other variables, the price equation is:

P = (M x V) / Q,

where price level (P) equals money supply times velocity (M x V), divided by real GNP (Q).  Typically, increases in the combination of money supply and velocity, relative to Q (real GNP) result in higher prices.  A drop in Q (real GNP), as seen in recessions, also would be inflationary, in theory, if money supply times velocity increased or otherwise did not drop as quickly as real GNP.

The latter case may be happening.  Although none of the equation components can be measured accurately, the theoretical relationships can be useful.  As discussed in Chapter 5—Key Economic Reporting Varies by Inflation Assumptions, based on key underlying economic series, the inflation-adjusted broad economy does appear to be declining faster than has been suggested by official GDP reporting.  If the pace of decline in the economy is faster (or weak growth slower) than the pace of decline (or weak growth) in the money supply times velocity, then that circumstance is inflationary, even with the declining or low money growth.

Nonetheless, I expect that money supply growth and velocity will pick up at excessive rates with the hyperinflation.

Consider, too, the following variation on the monetary equation:

Q = (M/P) x V

Activity, the inflation-adjusted economy (Q), is the same thing as inflation-adjusted money supply (M/P) times velocity (V).  Such is the theoretical basis as to why a decline in year-to-year inflation-adjusted M3 signals an economic downturn, as graphed at the beginning of Already in Depression, Economy Continues to Bottom Bounce.

Money Growth and Velocity Will Increase.  The U.S. hyperinflation very much will reflect a complete loss of confidence in the U.S. dollar.  The Fed has primed the system for explosive money supply growth; all that is needed is a pickup in bank lending.

The Fed’s initial moves to debase the U.S. dollar worked, impairing the U.S. currency’s exchange rate value and triggering commodity inflation fueled by the weak-dollar policy.  This also has helped to set the stage for a global dumping of the dollar and dollar-denominated paper assets, a rapid influx of unwanted dollars from abroad that either would collapse the financial markets or would force the Fed to flood the system with the incoming liquidity, monetizing dumped U.S. Treasury securities among other assets.

As dollar selling intensifies anew and debased-dollar inflation mounts, people in the United States are going to need higher earnings to buy necessities such as gasoline and food.  Even with a weak economy and high unemployment, wages will increase.  Companies paying higher costs for labor and goods increasingly will raise their prices, and their borrowing needs will increase.  Holders of dollars increasingly will not want to hold them long, in turn, raising the velocity of money, and so the cycle of inflation will begin to accelerate, all with still-impaired economic activity.  

 

 

Chapter 8—U.S. Government Cannot Cover Existing Obligations

 

Annual GAAP-Based Federal Deficits at $5 Trillion

The continuing $5 trillion GAAP-based federal deficit remains unsustainable, uncontainable and is unstable.  Against a headline, official quasi-cash-basis and gimmicked reporting of a $1.3 trillion federal budget deficit in 2011, GAAP-based accounting (using generally accepted accounting principles) indicated that the actual 2011 deficit ran somewhat in excess of $5 trillion for the year.  The largest difference between these estimates was that the GAAP-based number includes the widening shortfall of unfunded liabilities for social insurance programs, such as Social Security and Medicare.

As shown in the accompanying table of “U.S. Government – Alternative Fiscal Deficit and Debt Numbers” (SGS Table), the various 2011 deficit estimates remained close to the same horrendous levels as estimated for 2010.  Based on the 2011 Financial Report of the United States Government the 2011 cash-based federal deficit at $1.299 trillion was little changed against the $1.294 trillion estimate for 2010.  The limited GAAP-based deficit (before consideration of changes in social insurance unfunded liabilities), narrowed to $1.313 trillion in 2011, from $2.080 trillion in 2010, but that was due almost entirely to one-time reporting/assumption changes in Veterans Benefits and U.S. government liabilities tied to Fannie Mae and Freddie Mac.  Accordingly, the operating deficits effectively were about the same level in both 2010 and 2011. 

In like manner, the indicated full GAAP-based deficits (including annual change in the net present value of social insurance programs) of $4.6 trillion in 2011 and $5.3 trillion in 2010, effectively were about $5 trillion in each of 2011 and 2010, adjusted for one-time reporting changes.

Federal Debt and Net Present Value of Unfunded Liabilities Exceed $80 Trillion

The numbers discussed in the text here are those from the GAO-Based Alternative version of the 2011 numbers as shown in the SGS Table.  Unfortunately, the government’s financial reporting has become nearly as heavily politicized as some of its economic reporting.  Unlike the economic numbers, though, the financial data are audited (where possible) by the GAO (Government Accountability Office, formerly the General Accounting Office).

In the 2010 statement, consistent year-to-year accounting was not shown, with a large, one-time reduction in reported Medicare liabilities being based on overly optimistic assumptions of the impact from the then recently enacted healthcare legislation.  Referred to in the government’s statements as the Affordable Care Act (ACA), the full GAAP-based results from the ACA accounting showed an annual surplus of $7.0 trillion in 2010, but again, that was not in terms of consistent reporting, which would have been along the lines of a $5 trillion annual deficit.

The new health-care enhanced Medicare results used in the government’s statements were prepared under the auspices of the Obama Administration, but the GAO did not fully buy into the happy numbers in 2010 or again in 2011, with disclaimers of opinion.  The GAO went so far as to run an “Illustrative Alternative Scenario” (pages 130 and 134, respectively of the 2010 and 2011 statements) to the government’s overly optimistic Medicare adjustments.  The “Alternative” versions appear to have more realistic assumptions than the politicized data used in official ACA-based data.   Unfortunately, under present accounting conditions there simply is no way of coming up with truly meaningful hard number, in terms of total government obligations.

Where the “Alternative” data used here show $80.9 trillion of U.S. government debt, obligations and the net present value of the unfunded social security liabilities, as of September 30, 2011, that likely is shy of reality.  Adding estimates of government liabilities in, and exposures to Fannie Mae, Freddie Mac, the PBGC and FDIC easily could take that total into the $100 trillion range.  Publicized estimates of U.S. government exposure beyond the $100 trillion mark usually included gross unfunded liabilities, which are not adjusted for net present value (NPV).  NPV reflects the amount of cash needed in hand today to be able to cover a future obligation.  In any event, $80.9 trillion in U.S. government obligations in excess of five-times U.S. GDP.

Graph 38: Total Federal Obligations as Percent of GDP 

Annual Deficits of $5 Trillion Are Not Sustainable 

Those looking at the current $80 trillion of government debt and obligations, who think such is stable, need to consider that the circumstance is not static, but rather it is getting worse each year by at least $5 trillion.  Taxes cannot be raised enough to bring the system into balance for one year, let alone for the ongoing future.  Every penny of government spending—except for Social Security and Medicare—could be cut and the system still would be in annual deficit.  Massive cuts would have to be put in place now (an absolute necessity with the social insurance), if there were to be any hope of restoring long-term solvency for the United States government.  (Continued following table.)

 

Table II: U.S. Government GAAP Accounting, Deficits and Obligations

 

U.S. Government - Alternative Fiscal Deficit and Debt Numbers Reported by U.S. Treasury
Sources: U.S. Treasury, Shadow Government Statistics.
(I) Fiscal Year(1)	(II) Formal Cash-Based Deficit ($Billions)	(III) GAAP Ex-SS Etc. Deficit ($Billions)	(IV) GAAP With SS Etc. Deficit ($Trillions)	(V) GAAP  Federal  Negative Net Worth ($Trillions)	(VI) Gross Federal Debt ($Trillions)	(VII) Total(2) Federal Obligations (GAAP) ($Trillions)
GAO- Alternative Based(3)
2011	$1,298.6	$1,312.6	$4.6(5)	$73.5	$14.9	$80.9
2010	1,294.1	2,080.3	5.3(3)	68.9(3)	13.6	$76.3(3)
Official ACA- Assumption Based(3)
2011	$1,298.6	$1,312.6	$4.5(5)	$61.1	$14.9	$68.5
2010	1,294.1	2,080.3	(7.0)(3)	56.5(3)	13.6	64.0(3)
Pre-ACA Distortions(3)
2009(4)	1,417.1	1,253.7	4.3	63.6	11.9	70.5
2008	454.8	1,009.1	5.1	59.3	10.0	65.6
2007	162.8	275.5	1.2(5)	54.3	9.0	59.8
2006	248.2	449.5	4.6	53.1	8.5	58.2
2005	318.5	760.2	3.5	48.5	7.9	53.3
2004	412.3	615.6	11.0(6)	45.0	7.4	49.5
2003	374.8	667.6	3.0	34.0	6.8	39.1
2002	157.8	364.5	1.5	31.0	6.2	35.4
(1) Fiscal year ended September 30th; the numbers are subject to rounding differences.  (2) Includes gross federal debt, not just “public” debt.  While the non-public debt is debt the government owes to itself for Social Security, etc., the obligations there are counted as “funded” and as such are part of total government obligations.  (3) Fiscal years 2011 and 2010 are broken out into “Alternative” and “Official” measures necessitated by “Official” 2010 reporting including a large, one-time reduction in the estimated net present value of unfunded Medicare liabilities, due to unrealistically favorable assumptions tied to the passage of the Affordable Care Act (ACA) healthcare legislation.  With consistent accounting, SGS estimates the GAAP shortfall with Social Security and Medicare for 2010 to be roughly $5 trillion.  The “GAO-Alternative” numbers here are being used as a placeholder until such time as better accounting estimates are available, and reflect results using the “Illustrative Alternative Scenario” on Medicare costs shown on page 130 of the 2010 report and on page 134 of the 2011 report.  (4) The 2009 data predate December 2009 guarantees of Fannie Mae and Freddie Mac (GSEs) and do not reflect PBGC or FDIC liabilities.  Even so, accounting for neither 2010 nor 2011 reflected what might be considered direct, full faith and credit guarantees of the U.S. government in those areas.  Please note that mid-year 2009 accounting redefinitions for TARP knocked off roughly $500 billion from the reported formal cash-based estimate and contributed to a TARP “profit” in the GAAP numbers.  Accordingly, post-2008 reporting may understate annual operating shortfalls and federal debt obligations by significant amounts.  (5) On a consistent reporting basis, net of one-time changes in assumptions (actuarial and otherwise) and accounting, SGS estimates that the GAAP-based deficit for 2011 topped $5 trillion.  In like manner, SGS estimates that the GAAP-based deficit for 2007 topped $4 trillion, with negative net worth of $57.1 trillion and total obligations of $59.8.  So as to maintain consistency with the official GAAP statements, the “official” numbers are shown.  (6) SGS estimates a $3.4 trillion 2004 deficit, excluding one-time unfunded setup costs of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (enacted December 2003).  Again, in order to maintain consistency with the official GAAP statements, the “official” numbers are shown in the table for 2004.  The 2011 GAAP statements were released on December 26, 2011: http://fms.treas.gov/fr/index.html.  Sources for the SGS Table Data Fiscal Year (Column I) – All numbers are for the indicated fiscal-year (ended September 30th), in either billions or trillions of dollars as shown. Formal Cash-Based Deficit (Column II) – headline deficit number from Table 3 on page 7 of the 2011 report, “Management’s Discussion and Analysis” (hereinafter referred to as MDA).  Please note that the latest (November 2011) monthly statements from the U.S. Treasury show a 2011 deficit of $1,296.8 billion and a 2010 deficit of $1,294.2 billion. GAAP ex-SS Etc. Deficit (Column III) – euphemistically referred to as “Net Operating Cost” in MDA (Table 3 on page 7).  It excludes annual change social insurance unfunded liabilities. GAAP with SS Etc. Deficit (Column IV) – previous number (Column III) plus year-to-year change in the net present value (NPV) of social insurance unfunded liabilities, which comes from MDA (Table 8 on page 21) line “Closed Group” under “Statement of Social Insurance,” 2011 minus 2010 (for the 2011 “Official” number).  The “Closed Group” is used here for consistency, as it has been the preferred measure used by the U.S. government in its earlier statements.  The “Official” closed group NPV for fiscal 2011 and 2010 respectively are $46,273 and $43,057 billion. The “Alternative” accounting adds in the differential to the MDA line “Closed Group” and the $12.4 trillion additional net present value of excess expenditures over income for Medicare shown in the “Illustrative Alternative Scenario,” shown in the table on page 130 of the 2010 report (for the 2010 “Alternative” estimate), and the differential between the 2011 “Illustrative Alternative Scenario,” data on page 134 of the 2011 Report, and the 2010 data, to estimate the 2011 number.  The resulting “Alternative” closed group NPV estimates for fiscal 2011 and 2010 respectively are $58,707 and $55,410 billion. GAAP Federal Negative Net Worth (Column V) – “Net Position” from MDA Table 5 on page 11, plus the 2011 “Closed Group” “Official” and “Alternative” total net present value unfunded liabilities of social insurance as indicated and adjusted in Column IV. Gross Federal Debt (Column VI) – from “Note 14. Federal Debt …” pages 90 to 92 of the 2011 report.  Total held by public (p. 90) plus Total intragovernmental (p. 92). Total Federal Obligations (Column VII) – “Total Liabilities” from the MDA Table 5 on page 11, in the 2011 report, plus the 2011 “Closed Group” “Official” and “Alternative” total net present value unfunded liabilities of social insurance as indicated and adjusted in Column IV, plus total intragovernmental debt of $4,710.9 billion from (p. 92) of the 201 report.
___________________

(Continued from before the table.)  As seen in the debt limit and deficit negotiations of the least year, there is no political will apparent among those currently controlling the White House and Congress to restore solvency.  Accordingly, the U.S. will be doomed to an eventual hyperinflation, following the course taken by most sovereign states who have spent beyond their ability to raise money, eventually printing the money it needs to meet its obligations.  As noted earlier, that process already has started.  There is little time.  The next Fed action to help the economy (a.k.a. prop-up banking system liquidity), easily could be the one that pushes the U.S. dollar into the abyss.

 

 Chapter 9—Hyperinflationary Great Depression

MoveTowards Hyperinflation Accelerated by Current Fed and Government Actions

Even with the government’s spending, debt and obligations running far beyond the ability of the government to cover with taxes or the political willingness of the government to cut entitlement spending, the inevitable inflationary collapse, based solely on these funding needs, possibly could have been pushed well towards the end of the current decade.  Yet, the effects of various systemic crises, the extraordinary economic downturn, and the government’s responses to same, have advanced the turning of Social Security funding from being in net surplus, to net deficit, by several years, to the present day. 

Federal Reserve and government responses to those crises also have destroyed global confidence in the U.S. dollar and otherwise have rapidly accelerated the pace of movement towards a hyperinflation crisis in the United States. 

Conceivably, massive and fiscally painful action now by the federal government to restore and maintain long-range U.S. government solvency still could avoid the looming dollar collapse, but the political will to do so does not exist among those who control the federal government, at present.  That has been evident in actions by both the White House and Congress in the last six months.  

The printing presses already are running, and the Fed has been working actively to debase the U.S. dollar, effectively funding fully net U.S. Treasury debt issuance to the public during QE2.  Global rejection of the U.S. dollar and criticism of U.S. government fiscal actions and Federal Reserve monetary policy generally have been accelerating, along with calls for a new world reserve currency.  Heavy selling pressure against the U.S. dollar has been relieved at key times by the markets turning their focus to the euro.  As discussed in Chapter 1—Overview and Executive Summary, though, I contend the euro has been targeted artificially, in an effort to distract global markets from the elephant in the bathtub of sovereign-solvency concerns: the U.S. dollar.  Interventions, jawboning and manipulations of the markets tend to be short-lived in their impact.

Beyond the various actions that have failed to contain the systemic-solvency crisis or to stimulate the economy; the devastating impact of the unexpected continuation of economic weakness on tax revenues and Treasury funding needs; and some form of renewed stimulus package by the Fed aimed at helping banking-system solvency; all have helped set the stage for the ultimate dollar crisis well before the end of this decade.  Risks remain high for the prerequisites for and early stages of the hyperinflation to continue breaking in the months ahead.  The hyperinflation crisis likely cannot be avoided beyond 2014; it already may be beginning to unfold.

It is in this environment of rapid fiscal deterioration and related massive funding needs that the U.S. dollar remains open to a rapid and massive decline, along with a dumping of domestic- and foreign-held U.S. Treasuries.  The Federal Reserve would be forced to monetize further significant sums of Treasury debt, triggering the early phases of a monetary inflation.  Under such circumstances, current multi-trillion dollar deficits would feed rapidly into a vicious, self-feeding cycle of currency debasement and hyperinflation.

With the economy already in depression, hyperinflation kicking in quickly would push the economy into a great depression, since disruptions from uncontained inflation are likely to bring normal commercial activity to a halt.

What happens next is anyone’s speculation.  How long would a hyperinflation last before the government brought its fiscal house into order and established a sound currency?  I would be surprised if the hyperinflation crisis lasted beyond a year or two, since the system is not positioned to handle the crisis well and pressures for rapid resolution would be extremely strong.  All that depends, however, on what evolves out of what otherwise would be highly unstable political, economic, financial and social environments.  Accordingly, the best individuals can do is to take actions to protect themselves and their families, through the worst of foreseeable circumstances, both in terms of personal safety and in terms of the purchasing power of pre-crisis assets. 

The following is an exploration of certain problems that likely would have to be handled in a hyperinflation.

Lack of Physical Cash

The United States, in a hyperinflation, likely would experience the quick disappearance of cash as we know it.  In Zimbabwe, there was the back-up of a well-functioning black market in U.S. dollars, but no such back-up exists in the United States. 

In the last year, Congressman Ron Paul introduced legislation that would make gold a legal currency, directly convertible and exchangeable at market rates with Federal Reserve notes, and with no tax consequences.  If such a system were in place, that would provide a back-up system that conceivably would do much to mitigate the severe economic damage that otherwise would occur in the early stages of a U.S. hyperinflation.

Shy of a back-up system, and shy of the rapid introduction of a new currency and/or the highly problematic adaptation of the current electronic commerce system to new pricing realities, a barter system is the most likely circumstance to evolve for regular commerce.  Such would make much of the current electronic commerce system useless and add to what would become an ongoing economic implosion.  It also could take a number of months to become reasonably functional.

Some years back, I happened to be in San Francisco, having dinner with a former regional Federal Reserve Bank president and the chief economist for a large Midwestern bank.  Market rumors that day had been that there was a run on a major bank in the City by the Bay.  So I queried the regional Fed president as to what would be happening if the rumors were true.

He had had some personal experience with a run on banks in his region and explained how the Fed had a special team designed to handle such a crisis.  The biggest problem he had had was getting adequate cash to the troubled banks to cover depositors, having to fly cash in by helicopters to meet the local cash-flow needs.

The troubled bank in San Francisco, however, was much larger than the example cited, and the former Fed bank president speculated that there was not enough cash in the vaults of the regional Federal Reserve Bank, let alone the entire Federal Reserve System, to cover a true run on deposits at the major bank.

Therein lies an early problem for a system headed into hyperinflation: adequate currency.  Where the Fed may hold roughly $185 billion in currency outside of roughly $60 billion in commercial bank vault cash, the bulk of roughly $1.0 trillion in currency outside the banks is not in the United States.  Back in 2000, the Fed estimated that 50% to 70% of U.S. dollar cash was outside the system.  That number probably is higher today, with perhaps as less than $300 billion in physical cash in circulation in the United States, or roughly 2% of M3.  The rest of the dollars are used elsewhere in the world as a store of wealth, or as an alternate currency, free of the woes of unstable domestic financial conditions.  Those conditions would change severely in the event of a U.S. hyperinflation.

Given the extremely rapid debasement of the larger denomination notes, with limited physical cash in the system, existing currency would become worth more as kindling for a fire than as currency, and would disappear quickly as a hyperinflation broke.

For the system to continue functioning in anything close to a normal manner, the government would have to produce quickly an extraordinary amount of new cash, and electronic commerce would have to be able to adjust to rapidly changing prices.

In terms of cash, new bills of much higher denominations would be needed, but production lead time is a problem.  Conspiracy theories of recent years have suggested the U.S. Government already has printed a new currency of red-colored bills, intended for some dual internal and external U.S. dollar system.  If something like that indeed were the case, then there might be a store of “new dollars” that could be released at a 1-to-1,000,000 ratio, or whatever ratio was needed to make the new currency meaningful, but such would not resolve any long-term problems—as seen in the multiple Zimbabwe devaluations—unless it was part of an overall restructuring of the global currency system, and unless the U.S. government first put its fiscal house in order.

From a practical standpoint, however, currency would disappear, at least for a period of time in the early period of a hyperinflation.

Possible Short-Term Electronic Relief for Individuals

For those who have foreign-currency denominated bank accounts outside the United States, something along the lines of a debit or credit card against that account—let’s say a Swiss franc account—could help, in theory.  In the U.S., one could buy $100,000 worth of groceries with the credit card, and 50 Swiss francs would be deducted overnight from the account in Zurich, based on the then-current exchange rate.  Such presumes, though, the ongoing functioning of a system in the U.S. that could handle the transaction.

Where the vast bulk of today’s money is not physical, but electronic, however, chances of the system adapting there are virtually nil.  Think of the time, work and effort that went into preparing computer systems for Y2K, or even problems with the recent early shift to daylight savings time.  Systems would have to be adjusted for variable, rather than fixed pricing, credit card lines would need to be expanded daily, the number of digits used in tallying dollar-denominated transactions would need to be expanded sharply.  I have had assurances from some in the computer field, though, that a number of businesses have accounting software that can handle any number of digits.

From a practical standpoint, however, the electronic quasi-cashless society of today likely also would shut down early in a hyperinflation.  Unfortunately, this circumstance rapidly would exacerbate an ongoing economic collapse.  

Barter System

With standard currency and electronic payment systems non-functional, commerce quickly would devolve into black markets for goods and services and a barter system.  Gold and silver both are likely to retain real value and would be exchangeable for goods and services.  Silver would help provide smaller change for less costly transactions.  One individual indicated to me that he had found airline bottles of high-quality scotch to be ideal small change in a hyperinflationary environment.

Other items that would be highly barterable would include full bottles of liquor or wine, or canned goods, for example.  Similar items that have a long shelf life can be stocked in advance of the problem, and otherwise would be consumable if the terrible inflation never came.  Separately, individuals, such as doctors and carpenters, who provide broadly useable services, already have services to barter.

A note of caution was raised once by one of my old economics professors, who had spent part of his childhood living in a barter economy.  He told a story of how his father had traded a shirt for a can of sardines.  The father decided to open the can and eat the sardines, but he found the sardines had gone bad.  Nonetheless, the canned sardines had taken on a monetary value.

Howard J. Ruff, who has been writing about these problems and issues since Nixon closed the gold window, rightly argued that it would take some time for a barter system to be established, and suggests that individuals should build up a six-month store of goods to cover themselves and their families in the difficult times.  Such is within the scope of normal disaster planning in some areas of the country (for example, I sit almost on top of the Hayward Fault).  Stories out of the great Japanese earthquake just reinforce those common-sense principles.

Financial Hedges and Investments

During these times, safety and liquidity remain key concerns for investments, as investors look to preserve their assets and wealth through what likely are going to be the most difficult of times.  Those who can preserve their wealth and maintain liquidity will have the ability to take advantage of extraordinary investment opportunities during and after the crises.

The nature of what lies beyond the onset of the hyperinflation cannot be predicted by anyone with much confidence, given the extreme systemic and economic disorder and political instability that likely would follow.  Any number of outcomes is possible, and the following comments reflect concepts that should offer some asset protection given the reality of a hyperinflation, or where certain behavior can be anticipated.  Beyond that point, whether there are functioning stock markets or financial institutions, or how society, the economy and government would function are open questions.  I’m an economist, not an investment advisor.  Individuals simply have to use their own common sense in preparing for and handling whatever may arise. 

Gold and Silver.  In a hyperinflation, holding physical gold and silver would be primary hedges for maintaining the purchasing power of assets.  The precious metals would retain real value and also be portable in the event of possible civil turmoil.  Sovereign coins have the greatest liquidity.  At some point, the failure of the world’s primary reserve currency will lead to the structuring of a new global currency system.  I would not be surprised to find gold or silver as part of the new system, structured in there in an effort to help sell a new non-fiat currency system to the public.

Real Estate.  Real estate also would provide a basic long-range inflation hedge, but it lacks the portability and liquidity of gold.  That could become an issue if the political environment shifted so radically that ownership of private property became impossible.

Allowing for periods of possible illiquidity, over the long-term, real estate in general should tend to retain much of the purchasing of the dollars invested into it.  Depending on location and function, agricultural, residential and commercial real estate could appreciate relative to each other in that sequence through a hyperinflation, but nothing is set.  As before, individual common sense has to be applied to particular circumstances.

Currencies.  Having some funds invested offshore—outside of the U.S. dollar—would be a plus in circumstances where the government might impose currency or capital controls.  I still look at the Swiss franc, the Canadian dollar and the Australian dollar as currencies likely to maintain their purchasing power against the U.S. dollar.  Any suggestions here in terms of currencies, gold and silver, etc. are for holding same over the long term.  Extreme near-term price volatility remains a risk in most markets.  The current intervention by the Swiss National Bank to provide a quasi-fixed exchange rate versus the euro, effectively propping both the euro and the U.S. dollar, should prove to be short-lived.

Taking on Debt.  Inflation is supposed to be the debtor’s friend, where debtors, like the U.S. government, end up paying off their obligations in cheap dollars.  A note of caution is offered here.  The current circumstances are extraordinary.  Borrowers should consider their ability to carry debt through extremely difficult economic times, including possible loss of employment, etc., before high inflation might kick in.  Consider, too, the U.S. government recently has intervened in altering terms and conditions of mortgages.  Could a radical political change end up recasting the terms of personal obligations?

Bonds.  If inflation increases, so too should bond yields.  Yields would continue to rise in a situation with rising inflation.  That would reduce the value of bonds already held at lower yields.

TIPS.  The U.S. Treasury offers securities where yields and principal get adjusted regularly for the rate of inflation.  In a hyperinflation, price changes can be so rapid that the principal and/or yield adjustment would lag enough so as to make the adjustments worthless.  The reporting lag in calculating the adjusting CPI index—if it even could be calculated—still would wipe out investors, unless the Treasury became particularly creative and began benchmarking to spot gold or such, but nothing like that is in place.

As to the potential rapidity of price change, consider some anecdotal evidence.  One story out of Weimar Germany involved buying an expensive bottle of wine for dinner.  The empty bottle was worth more as scrap glass the next morning than it had been worth as a full bottle of wine the night before.  Another story involved negotiating the price and paying for a meal, before sitting down, as the price of the meal would be higher by the time it was finished.

 

Graph 39: Year-End DJIA, Current versus Constant Dollar

Graph 40: Log-Based, Year-End DJIA, Current versus Constant Dollar

Equities.  While equities do provide something of a traditional inflation hedge—revenues and profits get expressed in current dollars—they also tend to reflect underlying economic and political fundamentals.  I still look for U.S. stocks to take an ultimate 90% hit, peak-to-trough, net of inflation, during this period.  Where all stocks are tied to a certain extent to the broad market—to the way investors are valuing equities—such a large hit on the broad market would tend to have a dampening effect on nearly all equity prices, irrespective of the quality of a given company or a given industry.

The preceding graphs show the year-end Dow Jones Industrial Average (DJIA) in current terms, as well as adjusted for the CPI-U and the SGS-Alternate Consumer Inflation.  While stocks may rally based on high inflation, in inflation-adjusted terms, a bear market remains a good shot.  An early-hyperinflation DJIA at 100,000 could be worth 1,500 in today’s terms.

Possible Official Actions and Responses/External Risks

As consumer prices begin to spike, as the Fed moves to accommodate funding needs for ever-exploding federal fiscal shortfalls, and as the U.S. dollar comes under ever-heavier global selling pressures—all at high risk in the coming months—the federal government and the Federal Reserve could react with a variety of measures that could delay the hyperinflation’s onset for brief periods.  Those possible actions, though, would not alter the hyperinflation outlook fundamentally or meaningfully.  Potential official responses or external events include, but are not limited to:

Currency and Other Market Interventions.  The U.S. Treasury can have the New York Federal Reserve Bank intervene in the currency markets in support of the dollar.  Even when coordinated with other central banks, intervention usually is counter to fundamental pressures, and does nothing to turn a currency beyond the period of intervention.  Intervention becomes expensive and usually fails in a short period of time.  Unless underlying fundamentals are changed at the same time (i.e. interest rates are raised against the rest of the world), supportive intervention provides a selling opportunity for those looking to dump dollars.  At present, the Swiss National Bank has been intervening and artificially propping both the euro and U.S. dollar.

Intervention often is preceded by jawboning, which usually fails even faster than the intervention.

Then there is the President’s Working Group on Financial Markets (aka the “Plunge Protection Team”), which has been directed to do what it has to do in order to keep financial markets orderly.  Actions here, however, usually have been worked through what formerly were investment banks, and are short-lived in impact, as with the currency interventions.  Action here appears to have been taken in advance of S&P’s downgrade of U.S. Treasuries. 

Also, as argued earlier, someone has been focusing market concerns on the euro as a foil for distracting from U.S. dollar problems.

Wage and Price Controls.  The federal government can freeze wages and prices or limit the pace of increase in same, but such tends to distort economic activity, creating product shortages and black markets.  Fundamental inflation pressures are not relieved.

Nationalization of the Banking System.  One “solution” to ongoing and likely deepening systemic insolvency within the banking system would be a nationalization of the banks by the U.S. government.  Such likely would accelerate dollar debasement and the onset of the hyperinflation, but it most certainly would be fought by the banking system and the Federal Reserve.

Restricted Capital Flows.  The federal government can impose restrictions on capital outflows from the United States, impairing the ability of those in the United States to seek financial safe-haven elsewhere.  This likely would exacerbate a global dollar panic. 

Release of Strategic Petroleum Reserves.  Administrations irregularly have tapped U.S. strategic oil reserves in order to help provide relief from rising oil or gasoline prices.  Effects from those actions usually have been temporary, and usually have been short-sighted from a supply standpoint, given the political problems still festering in the Middle East and North Africa.  Oil price problems increasingly will be difficult to contain when they are driven by weakness in the U.S. dollar

Balanced-Budget Effort.  The government could move to balance its fiscal condition, to restore long-range fiscal solvency.  With those currently controlling the U.S. government demonstrating a lack of political will to address the serious issues, any budget deals in the near-term likely would be dominated by accounting gimmicks stretched over many years.  With limited actual impact on both near- and long-term fiscal solvency, such deals likely would do more damage than good to global confidence in the U.S. dollar.

Return to Gold Standard.  Suggestions have been floated as to returning the U.S. dollar to full gold backing.  While something like that is likely—probably a necessity—in the aftermath of the hyperinflation ahead, the problem (perhaps the desired effect) is that the gold standard would restrict the government’s deficit spending.  As such, in order for the new system to work, the government first would have to balance its GAAP-based spending—which I contend is not politically feasible at present.  Unless fiscal circumstances are in balance, a new gold-based system would see continuous devaluations of the dollar against gold, as unsupportable money was created.  On the other hand, if fiscal conditions were in balance, returning to a gold standard likely would not be under serious consideration at present. 

Government Seizure of Privately Held Gold.  A question commonly raised by subscribers is the potential for the federal government to seize privately held gold, today, as it did back in 1933, when President Franklin Roosevelt abandoned the domestic gold standard.  While there is little the federal government might do that would be too surprising in the current environment, seizure of privately-held gold most likely would be tied to some reform of the monetary system, not just as an action aimed at punishing gold investors.

Back in 1933, the use of gold continued for the settlement of international accounts between sovereign states, and the U.S. government’s needs under that circumstance were used as an excuse for the seizure of the public’s gold holdings.  While there were some exceptions to the seizure, such as coin collections and jewelry, U.S. investors ended up shifting funds into gold stocks as surrogates for the precious metal.

Private U.S. ownership of physical gold became legal, again, after President Richard Nixon closed the gold window on international settlements in 1971.  The shift in private-gold-ownership policy, then, also was tied to the international monetary system’s backing, or lack of same, in gold. 

Meaningful reform of the global monetary system and creation of a new U.S. currency, of whatever form, most likely would be post-hyperinflation events. 

Major Natural Disasters.  The catastrophic earthquake in Japan is a reminder of unpredictably of the natural disasters that can befall a nation.  Physical damages are not adjusted in GDP, although insurance payments can have positive impact when the payments are made by a foreign-based insurer or reinsurer.  Disruptions in normal commerce are a GDP negative, but rebuilding activity is a positive.  To the extent the federal government funds rebuilding efforts with deficit spending or pays out unfunded government insurance, such actions add to the deficit and inflation issues.

Military Action.  Beyond their horrors, wars historically have roots in economic problems, and they usually have the effect of spiking economic activity and inflation, as well as distracting public attention from other concerns.  Orders for military goods at the outbreak of World War II in Europe, for example, helped to pull the United States out of the Great Depression.  

Today, defense accounts for just six-percent of durable goods orders in the consumer-driven U.S. economy.  A major new military conflict—beyond conflicts already impacting U.S. economic activity and fiscal planning—might provide the economy with some boost, but that would be at the expense of an offsetting further sharp deterioration in fiscal conditions and inflation prospects. 

Some production gains also might be problematic, where the United States has lost significant manufacturing capacity to offshore competition.  When the big gun on the U.S.S. Iowa exploded in 1989, the machine tools needed to manufacture a replacement gun no longer were available in the United States.  They were available, however, in China.  At the extreme, the outbreak of a global conflict of the magnitude of World War II, today, would be at the horrific risk of becoming nuclear. 

Back to the Fed: A New Round of Easing and Other Non-Effective Policies.  The Federal Reserve fairly easily can have negative impact on the economy and inflation, but positive results are not so simple.  The Fed can kill economic activity by shrinking systemic liquidity, and it can increase inflation by “printing” money.  Efforts to stimulate economic growth or to reduce inflation, however, historically have been much more difficult to accomplish.  At present, though, Fed policies perversely have been creating new inflation at the same time that an ongoing systemic liquidity squeeze is intensifying the economic downturn.  Continued efforts to debase the dollar should be successful, but not in stimulating economic activity, only in triggering an accelerating pace of inflation.

Significant efforts to cut back on, or to reverse, the so-called quantitative easing actions are not likely.  The liquidity that the Fed has put into the system has been deemed necessary by the Fed, likely more from the standpoint of helping banking-system liquidity than really expecting the measures would boost economic activity.  As discussed throughout this report, the economic and systemic-solvency crises appear to be worsening, not improving, suggesting more, not less, quantitative easing is likely.

Volcker-Like Inflation Containment.  Back in the oil-based inflation of the late-1970s, early-1980s, Federal Reserve Chairman Paul Volcker earned a reputation as an effective inflation fighter.  What he did was to raise interest rates so high as to drive the economy into the ground, creating one of the worst (double-dip) recessions of the post-World War II era.  He killed economic demand enough so as to offset oil-price distortions, at least partially.  With current economic activity already in severe contraction—even more severe than that of the early-1980s—chances of such a policy being pursued or even having the potential of working, at present, are slim.  

Restraining the Federal Reserve.  Efforts in Congress to restrain government spending could contain federal spending activity when the system next moves to the brink of collapse.  As long as the Federal Reserve remains independent, however, it still likely would do whatever it had to in order to prevent systemic collapse into a deflationary great depression.  If the Fed were reined-in, then whether the system ended in fire or ice, or somehow bought new life with a miraculous political shift that allowed for fiscal balance, would be in the hands of the President and Congress.

Closing Comments—Other Issues

Political Considerations

What lies ahead for the economy and inflation will have significant impact on the U.S. political process, as economic woes did on the 2010 mid-term election.  Historically, the concerns of the electorate have been dominated by pocketbook issues.  Prior to gimmicked methodologies making the reporting of disposable personal income largely meaningless, that measure was an excellent predictor of presidential elections.

In every presidential race since 1908, in which consistent, real (inflation-adjusted) annual disposable income growth was above 3.3%, the incumbent party holding the White House won every time. When income growth was below 3.3%, the incumbent party lost every time.  Again, with redefinitions to the national income accounts in the last two decades, a consistent measure of disposable income as reported by the government has disappeared.  Yet, even with the upside biases in official reporting, third-quarter 2011 annual growth in real disposable income was 0.1%, well below the traditional 3.3% limit.  This cannot be a happy prospect for the incumbent party holding the White House in 2012.

As was suggested would be the case in the 2008 hyperinflation report, the economy contributed to the Republicans losing the White House in 2008.  In the 2010 report, it was suggested that, “Present economic conditions are bleak enough to impair re-election prospects severely for incumbents in the 2010 mid-term election.”

As noted in the 2011 report, “A wide variety of possibilities would follow or coincide politically with a hyperinflationary great depression, but the political status quo likely would not continue.  Times would be financially painful enough to encourage the development of a third party that could move the Republicans or Democrats to third-party status in the 2012 presidential and congressional elections.”

That circumstance remains true, given current and likely deteriorating economic conditions, irrespective of the hyperinflation’s timing. 

Where I always endeavor to keep my political persuasions separate from my analyses, for purposes of full disclosure, my background is as a conservative Republican with a libertarian bent.

Common Sense

A U.S. hyperinflationary great depression would be extremely disruptive to the lives, businesses and economic welfare of most individuals.  Such severe economic pain could lead to extreme political change and/or civil unrest. 

What has been discussed here remains well shy of a comprehensive overview of all possible issues, but rather at least has raised some questions and touched upon some likely consequences.  No one can figure out better than you the peculiarities of this circumstance and how you, your family and/or your business might be affected and best be protected.  Using common sense remains the best advice I can give.

These matters will continue to be expanded upon in the SGS regular Commentaries and Special Commentaries, as circumstances and subscriber interests dictate.  As always, I extend by deep thanks to the various readers who have raised questions and provided ideas, comments and material.  Please feel free to offer your thoughts or raise your questions by e-mail to johnwilliams@shadowstats.com. 

Recommended Further Reading

As mentioned elsewhere in the text, and as recommended to subscribers for years, there is:

Fiat Paper Money, The History and Evolution of Our Currency
by Ralph T. Foster (Privately Published)
2189 Bancroft Way, Berkeley, CA 94704
E-mail: tfdf@pacbell.net

To my knowledge, Ralph Foster’s extraordinary volume is the most comprehensive and informative analysis available on the history of fiat currencies.  Continually updated and expanded, the privately printed book is offered with a novel binding that incorporates authentic worthless fiat currency notes.

 

COMMENTARY NUMBER 399
October Retail Sales, PPI

November 15, 2011

__________

 

Retail Sales Gain Not Statistically Meaningful

PPI Inflation Showed High Oil Price Effects
Still Spreading in Broad Economy

 

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for tomorrow, Wednesday, November 16th, covering October CPI and industrial production.  That will be followed by a Commentary on the 17th covering October housing starts.  The November 16th and 17th issues also will include Special Commentaries, discussing respectively the actual U.S. budget deficit and underlying U.S. economic reality.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  With two pending Special Commentaries, tomorrow (November 16th) on U.S. budget deficit reality, and November 17th on underlying economic reality, today’s comments are limited.   The general outlooks for the economy, inflation and for systemic solvency are 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 the November 17th Special Commentary.

October Retail Sales.  The 0.5% headline monthly gain in October retail sales was not statistically meaningful, as has been the case in five of the last six months.  Seasonal-adjustment distortions also continue, with the severe downturn having warped regular patterns of seasonal activity.  There have been no indications of an improvement in consumer liquidity conditions that could support a sustainable rebound in consumer spending.  That said, monthly retail sales likely will remain in positive territory, when deflated by the October CPI-U (due for releases tomorrow, November 17th). 

October Producer Price Index (PPI).  Headline October PPI inflation declined by 0.3% for the month, reflecting a short-lived monthly decline in oil prices.  Having jumped by 0.8% for the month in September, this series tends to be highly volatile.

Unadjusted annual inflation in finished goods declined from 6.9% in September to 5.9% in October.  Yet, reflecting the continued spread of the effects of higher oil prices into the broad economy, annual “core” inflation—net of food and energy—rose from 2.5% in September to 2.8% in October.

 

__________

 

REPORTING DETAIL

 

 

 

Week Ahead.  Although still not widely recognized, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

Consumer Price Index—CPI (October 2011).  The October CPI is scheduled for release on Wednesday, November 16th.  Whatever increase is seen in month-to-month October consumer inflation likely will be from areas other than energy.  Gasoline prices still get something of a seasonal-adjustment boost in October, but not enough to turn the unadjusted 4.4% decline in October’s monthly gasoline prices (per Department of Energy) to the plus side in the CPI.  Nonetheless, spreading systemic inflation should add upside risk to this month’s reporting versus what generally have been published as flat consensus estimates.

Year-to-year total CPI-U inflation would increase or decrease in October’s reporting, dependent on the seasonally-adjusted monthly change, versus the 0.25% gain in the adjusted monthly level reported for October 2010.  I use the adjusted change here, since that is how consensus expectations are expressed.  To approximate the annual unadjusted inflation rate for October 2011, the difference in October’s headline monthly change (or forecast of same) versus the year-ago monthly change should be added to or subtracted directly from September 2011’s reported annual inflation rate of 3.87%.  For example, if the monthly October CPI-U were unchanged, the annual inflation rate would ease back to roughly 3.6%.

Industrial Production (October 2011).  The release of October industrial production is scheduled for Wednesday, November 16th, and should be flat-to-minus.  That would be weaker than published consensus estimates of the headline number at around a 0.4% monthly gain.

Residential Construction (October 2011).  The release of October housing starts on Thursday, November 17th, should show a continued downside bottom-bouncing trend.  Any upside surprise likely would not be statistically meaningful.

 

__________

 

COMMENTARY NUMBER 398
September Trade Deficit

November 10, 2011

__________

 

September Trade Data Suggest
Minimal Upside Contribution to Pending GDP Revision

U.S. Fiscal Disaster Surpasses Any Problems Seen With Major Trading Partners

Pending Special Commentaries

 

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Tuesday, November 15th, covering October retail sales and PPI.  That will be followed by Commentaries on the 16th and 17th covering, respectively, October CPI and industrial production, and October housing starts.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  Wild market gyrations around the latest news out of the euro-area simply highlight extreme instability and danger present in the current global and domestic financial systems and the rapid explosion of systemic solvency issues.  The continued faltering of broad U.S. economic activity is in the process of intensifying.  These factors, in combination, promise continued market instabilities, and likely extraordinary financial and fiscal measures by central banks and governments.  New action most likely will be forthcoming from the Federal Reserve and even from the extremely-politicized Congress and White House, if the politicians get scared enough.  The general outlook is not changed from what has been discussed in the Hyperinflation Special Report (2011) and in recent and the current Hyperinflation Watch section, but a number of issues are likely to come to a head in the next several months, not the least of which is what will come out of the Congressional Super Committee that is in the process purportedly of making minimal cuts to the federal budget deficit.

Special Commentaries—Revisiting and Reviewing the Systemic Solvency and Economic Crises. Today’s Commentary is relatively brief, as result of a week light in major economic releases.  In contrast, next week’s calendar provides for five major October economic releases in three Commentaries, including what are planned as two Special Commentaries, one on Wednesday, November 16th, that will address the current GAAP-deficit of the United States and ways it could be addressed; and one on Thursday, November 17th, addressing underlying U.S. economic reality and what would have to happen to return to economic growth.  The story has not changed, but the issues and systemic limitations are worth revisiting.

Subsequent to next week’s Special Commentaries, and following the release of the federal government’s GAAP-based (using generally accepted accounting principles) financial statements for fiscal 2011 (scheduled for publication on December 15th), I plan to publish a fully revamped Hyperinflation Report.

September Trade Deficit.  The shortfall in September U.S. trade narrowed from August’s estimate, which was reduced in revision.  With three months of reporting now in hand, the third-quarter trade deficit is improved slightly from what had been estimated by the Bureau of Economic Analysis for the initial third-quarter GDP reporting.  Accordingly, the net export account could offer a small, positive contribution to the pending November 22nd first revision of third-quarter GDP.

 

Hyperinflation Watch—U.S. Issues Should Trump Euro Concerns.  As will be discussed in next week’s Special Commentaries, the 2011 GAAP-based U.S. deficit likely fell in the $5-trillion to $7-trillion range, a circumstance that is beyond control and appears to be uncontainable in the current political circumstance.  With the economy in ongoing crisis, with no prospect of a turnaround in the foreseeable future, the implications for the federal budget deficit, U.S. Treasury funding needs and prospective banking-system stability, in the year and years ahead, are horrendous.  The current, relatively happy forecasts for each of those areas are based on assumptions of solid economic growth going forward.  That growth simply will not be forthcoming. 

The sovereign solvency crisis in the United States easily could move to the center of global financial-market attention in the weeks ahead, depending on how the federal deficit reduction negotiations evolve.   The systemic solvency crisis that continues to unfold in the U.S. is of a relative magnitude that eclipses the rolling financial crises in the euro area.

Repeated from the prior Commentaries, there are no happy solutions available here to remedy the crises, only tools—devil’s choices—for the Fed and the U.S. government to buy a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any overt change in policy.  The ultimate cost in propping the system, however, remains inflation.  The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and in recent Commentaries, continue to unfold with outlooks that remain unchanged.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent crises in the euro-area from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The financial markets still are roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political instability.  For those living in a U.S. dollar-denominated world, regardless of any ongoing near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets may start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print, spend, loan or guarantee whatever money is needed; with the U.S. dollar at increasing risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

__________

 

REPORTING DETAIL

 

 

Week Ahead.  Although still not widely recognized, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

Retail Sales (October 2011).  October retail sales are scheduled for release on Tuesday, November 15th, with inflation-adjusted details available on November 16th, in conjunction with November’s consumer inflation data.  Given the underlying broad weakness in consumer financial conditions and confidence, and the unstable nature of concurrent seasonal-factor adjustments for this series, a downside surprise is a fair bet against what likely will be a relatively soft consensus estimate.  Increasingly, reported retail sales gains will reflect nothing more than rising prices, with declining sales volume as measured by physical consumption of goods and services.

Producer Price Index—PPI (October 2011).  The October PPI is scheduled for release on Tuesday, November 15th.  Seasonal adjustments should keep the impact of October oil prices in positive territory (monthly average for Brent down 2.7%, West Texas Intermediate up 0.9%, based on St. Louis Fed data).  With the continued spread of the impact of higher oil costs throughout the U.S. economy, there is some risk of an upside surprise to a likely flat consensus estimate of the otherwise highly volatile series.

Consumer Price Index—CPI (October 2011).  The October CPI is scheduled for release on Wednesday, November 16th.  Whatever increase is seen in month-to-month October consumer inflation likely will be from areas other than energy.  Gasoline prices still get something of a seasonal-adjustment boost in October, but not enough to turn the unadjusted 4.4% decline in monthly gasoline prices in October (per Department of Energy) to the plus side in the CPI.  Nonetheless, spreading systemic inflation should add upside risk to this month’s reporting versus what likely will be a flat-to-minus consensus outlook.

Year-to-year total CPI-U inflation would increase or decrease in October’s reporting, dependent on the seasonally-adjusted monthly change, versus the 0.25% gain in the adjusted monthly level reported for October 2010.  I use the adjusted change here, since that is how consensus expectations are expressed.  To approximate the annual unadjusted inflation rate for October 2011, the difference in October’s headline monthly change (or forecast of same) versus the year-ago monthly change should be added to or subtracted directly from September 2011’s reported annual inflation rate of 3.87%.  For example, if the monthly October CPI-U were unchanged, the annual inflation rate would ease back to roughly 3.6%.

Industrial Production (October 2011).  The release of October industrial production is scheduled for Wednesday, November 16th, and should be flat-to-minus, net of revisions.  That likely will be weaker than consensus.

Residential Construction (October 2011).  The release of October housing starts on Thursday, November 17th, should show a continued downside bottom-bouncing trend.  Any upside surprise likely would not be statistically meaningful.

 

__________

 

COMMENTARY NUMBER 397
October Employment and Unemployment

November 4, 2011

__________

 

Monthly Payroll and Unemployment Changes Were Not Statistically Meaningful

October Payroll Employment Not Only Was 6.5 Million Below the Pre-2007 Recession High, But Also Was 1.0 Million Below the Pre-2001 Recession High

October Unemployment: 9.0% (U.3), 16.2% (U.6), 22.9% (SGS)

Annual Growth in October Money Supply M3 Held at About 2.6%

 

__________

PLEASE NOTE: The next regular Commentary is scheduled for Thursday, November 10th.  It will cover reporting of the September 2011 trade balance.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  The U.S. economy remains deep in a severe contraction, experiencing a protracted period of bottom-bouncing that followed the sharpest decline in business activity seen since the Great Depression.  Economic series that have shown any marked upside bounce reflect little more than understated inflation used in deflating such series (use of understated inflation results in overstated inflation-adjusted growth) and/or the transient effects of government stimulus efforts.  As discussed in the prior Commentary No. 396, rather than using the heavily biased and politicized GDP numbers for guidance on broad economic activity, series such as payroll employment give a much more stable and meaningful picture of general business activity.  This is despite numerous problems with payroll employment reporting, which are discussed in the appropriate sections.  How can the economy be healthy and expanding when current payrolls are below where they were coming into the 2001 recession?

Contrary to popular hype, employment is a coincident, not a lagging, economic indicator.  Traditionally, it was deemed coincident in the government’s leading, coincident and lagging indicator series, and it is used by the National Bureau of Economic Research (NBER) to time the monthly onset of a recession.  Employment has been mislabeled as a lagging indicator in the last decade or two, because the NBER called ends to the last two recessions well before those downturns ended.  Those miscalls resulted from evolving methodological understatement of inflation and resulting reporting distortions in various series.

That said, consider that on a seasonally-adjusted basis, nonfarm payrolls for October 2011 stood at 131.516 million.  That was 6.5 million below the pre-2007 recession high of 137.996 million (January 2008).  It also was 1.0 million below the pre-2001 recession high of 132.530 million (February 2001).  The series shows the economic plunge in 2008 and 2009 and the ongoing bottom-bouncing thereafter.  Despite the 192,000 upside benchmark estimated by the Bureau of Labor Statistics (BLS) for March 2011, later revisions likely will eliminate the gentle upside slope seen in current reporting.  The small spike in 2010 was due to temporary hiring (and reversal of same) related to conducting the 2010 census.

 

 

Employment and Unemployment (October 2011).  Neither October’s headline 80,000 monthly jobs gain, nor the headline decline in unemployment to 9.0% from September’s 9.1%, were statistically meaningful.  The reported 80,000 employment increase also is more than accounted for by what appears to have be an upside shift in the monthly Birth-Death Model add-factors of 50,000 jobs per month, on top of major job shifting between periods due to the ongoing concurrent seasonal factor distortions.

The headline seasonally-adjusted October U.3 unemployment rate of 9.0% was against 9.1% in September, and U.6 was 16.2% in October versus 16.5% in September.  The SGS-Alternate Unemployment Measure was 22.9% in October versus 23.1% in September, declining less than U.6, as more unemployed continued rolling out of the short-term discouraged worker status in U.6 into the long-term discouraged worker status in the SGS estimate.

 

Hyperinflation Watch—Economic Woes Threaten Systemic Stability.  With the economy in ongoing crisis and with no prospects of a turnaround in the foreseeable future, the implications for the federal budget deficit, U.S. Treasury funding needs and prospective banking-system stability, in the year and years ahead, are horrendous.  The current, relatively happy forecasts for each of those areas are based on assumptions of solid economic growth going forward.  That growth simply will not be forthcoming.

Money Supply M3 (October 2011).  Bank lending remains impaired and broad money growth is not picking up as it would with a healthy banking system.  Based on roughly three weeks of data, the preliminary estimate of the SGS Ongoing-M3 Estimate for October 2011 will be published in the Alternate Data section on November 5th.  October M3 is on track to show year-to-year growth of about 2.6%, the same level as in September and still below the official rate of CPI inflation.  These numbers reflect the latest benchmark revisions by the Fed to its money and banking data.  The seasonally-adjusted, month-to-month change estimate for M3 likely will be on the minus-side of unchanged, which would be the first monthly decline since January 2011.  The estimated month-to-month M3 changes, however, remain less reliable than the estimates of annual growth.

A flattening in the relative monthly estimates of annual growth, and slowing month-to month gains, also are likely for the narrower M1 and M2 measures (M2 includes M1, M3 includes M2).  M2 for October is on track to show year-to-year growth of about 9.9%, versus 10.0% in September, with month-to-month growth estimated at roughly 0.3% in October versus 0.5% in September.  The early estimate on M1 for October shows year-to-year growth of roughly 20.6%, the same level as in September, with month-to-month growth estimated at roughly 0.5% in October, versus 1.2% in September.  The relatively stronger annual growth rates in M1 and M2 still reflect the recent shifting of funds out of M3 accounts into M1 and M2 accounts.

Broad Systemic, Economic and Inflation Outlooks Are Unchanged.  The markets remain unstable and highly volatile, with the financial system still vulnerable to potential negative surprises in areas ranging from economic data to domestic and global political instabilities. 

Repeated from the prior Commentaries, there are no happy solutions available here to remedy the crises, only tools—devil’s choices—for the Fed and the U.S. government to buy a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any overt change in policy.  The ultimate cost in propping the system, however, remains inflation.  The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and in recent Commentaries, continue to unfold with outlooks that remain unchanged.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent crises in the euro-area from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The financial markets still are roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political instability.  For those living in a U.S. dollar-denominated world, regardless of any ongoing near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets may start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print, spend, loan or guarantee whatever money is needed; with the U.S. dollar at increasing risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

__________

 

REPORTING DETAIL

 

 

Week Ahead.  Although still not fully acknowledged, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

U.S. Trade Balance (September).  The September monthly trade deficit is due for release on Thursday, November 10th.  The general trend here should remain one of deterioration, with reporting risk favoring greater trade deficit widening than likely will be estimated by consensus forecasters.  A significant variation against consensus expectation would have implications for the first-revision to third-quarter GDP (due for release on November 22nd), since the September numbers will complete the otherwise guesstimated third-quarter trade data currently used in the GDP estimate.  A much worse-than-expected deterioration in the deficit, for example would be indicative of a downward revision to estimated third-quarter GDP growth, and vice versa.

 

__________

 

COMMENTARY NUMBER 396
3rd-Quarter GDP, October Confidence, September Durables Orders and Home Sales

October 27, 2011

__________

 

Consumer Confidence and Sentiment Sink to Levels Never Seen Outside of the Worst Recessions

No Economic Recovery Is in Place or in the Works

Third-Quarter GDP Gain Not Statistically Meaningful

GDP Nonsense:  Consumption Surged 1.7% While Disposable Income Collapsed 1.7%?

 

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Friday, November 4th.  It will cover October 2011 unemployment and payroll employment reporting.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  The U.S. economy is sinking anew, not rebounding.  Such is contrary to the media hype around this morning’s (October 27th) headline 2.5% second-quarter GDP growth, which was up from the 1.3% growth estimate of the first-quarter.  Officially the broadest measure of U.S. economic activity published by the U.S. government, the widely-followed gross domestic product (GDP) nonetheless remains the most-heavily-biased, the most-heavily-guessed-at, the most-heavily politicized and the most-worthless major indicator of domestic business activity.  Today’s numbers out of the Bureau of Economic Analysis are outright nonsense.

Consider that latest numbers showed that the level of inflation-adjusted third-quarter 2011 GDP broke above the pre-recession high of fourth-quarter 2007: a full recovery.  That is absurd.  No other major economic indicator, including payrolls, real (inflation-adjusted) retail sales, industrial production, trade deficit or housing starts is showing that.  The GDP previously had been reported as breaking above its pre-recession high in fourth-quarter 2010, but that happy news revised away with July 2011’s benchmark revisions to the GDP series.  Downside revisions also should erase today’s nonsensical news, eventually.

Consider that personal consumption contributed 1.72%, or 70%, of the annualized real 2.46% quarterly growth rate attributed to third-quarter GDP.  Yet, consumer liquidity problems intensified in the third-quarter, with real disposable income (effectively inflation-adjusted take-home pay) falling at an annualized pace of 1.73%.  Year-to-date, since fourth-quarter 2010, real disposable income has been flat (up 0.02%), while real personal consumption has gained 1.3%, which accounted for more than the total 1.0% growth in real GDP in the same period.

As discussed in recent Commentaries (see the Hyperinflation Special Report (2011) and Commentary No. 394 for example), sustained positive real growth in consumption is not possible without sustained positive real growth in income.  Where short-term growth can be borrowed from the future with debt expansion or liquidation of savings, those options, at present, however, are constrained at their practical limits.

More-Reliable Indicators of Economic Activity.  Among some of the more-reliable economic indicators of business activity, payroll employment shows no sign of economic recovery and the consumer confidence measures have fallen to levels never seen outside of the worst recessions and indicate an unfolding a double-dip downturn.

Despite the seasonal-factor and monthly-upside-reporting-bias issues with the birth-death model, the nonfarm payroll employment series probably is the best-quality government series published as an indicator of broad economic activity.  It is a coincident indicator of business activity.  Its pattern in the current economic downturn has been one of initial collapse and then bottom-bouncing, while recent monthly “gains” have lacked statistical significance.  Payrolls as of September 2011 still were 4.8% shy of topping the pre-2007 recession peak.  What is more, the current payroll employment is 0.9% below the payroll levels of December 2000, the pre-2001 recession peak!  With employment below where it was a decade ago, there is no economic recovery in the works here.  The payroll circumstance will be updated in next week’s Commentary

Consumer confidence and sentiment also tend to be coincident indicators of economic activity that tie to the consumer (some will contend these series lead retail sales, etc., reflecting consumer willingness to purchase goods and services).  As shown in the following graphs, both the University of Michigan sentiment series, which is not seasonally adjusted, and the Conference Board confidence series, which is seasonally adjusted (the unadjusted series is not made available), are suggesting double-dips in business activity.

In the case of Consumer Sentiment, the sentiment level historically has dropped to the current level only three times since the series was established in 1952.  Those periods were during the worst economic downturns of the post-World War II era: the 1973-1975 recession, the double-dip recession in the early-1980s, and in the 2007 recession, when the risk of systemic failure came to a head in 2008 and 2009.  The current level now has fallen back to that 2008 level.

Consumer Confidence hit the lowest levels ever recorded in 2008 and 2009, and although not quite back to the trough of the current cycle, the latest reading on consumer confidence still is below anything ever seen outside of the current economic collapse.

No Surprises in Durable Goods Orders or Home Sales.  New orders for durable goods (not adjusted for inflation) fell by 0.8% in September, but that was well within the normal volatility of the series.  The small 3.0% decline in existing home sales and the 5.7% gain in new home sales also were within the ranges of normal monthly volatility, as home sales continued a protracted period of bottom-bouncing.  One developing trend worth watching, though, is that year-to-year change has started to slow markedly in both the durable goods orders and home sales series.

 

Hyperinflation Watch—As Circumstances Unfold, the Outlook Remains the Same.  As discussed frequently in this section, the euro crisis has appeared frequently as a likely foil, distracting global market attention from the potential financial-system-busting crises unfolding with the U.S. dollar and the related, effective long-term U.S. government insolvency.  As we go to press, the markets are hyperventilating over the latest solution to the Greek crisis—at least temporarily—with U.S. equities soaring.  Those equity gains, however, largely are being offset for those outside the U.S. dollar by renewed heavy selling of the U.S. dollar against the other major Western currencies.  U.S. economic activity continues to falter, with increasingly negative implications for financial-market stability and systemic solvency.  The financial system remains highly vulnerable to potential negative surprises. 

Repeated from the prior Commentaries, there are no happy solutions available here to remedy the crises, only tools—devil’s choices—for the Fed and the U.S. government to buy a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any overt change in policy.  The ultimate cost in propping the system, however, remains inflation.  The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and in recent Commentaries, continue to unfold with outlooks that remain unchanged.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent a euro-area crisis from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The financial markets still are roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of any further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets may start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

 

 

Week Ahead.  Although still not fully acknowledged, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

Unemployment Rate and Payroll Employment (October 2011).  Nonfarm payrolls and the unemployment rate for October 2011 are due for release on Friday, November 4th.  This first major indicator of October economic activity likely will confirm ongoing deterioration in broad economic conditions.  A pattern of weaker-than-expected reporting, against likely somewhat stronger consensus expectations for the labor market, is a fair bet for October reporting.

Payrolls remain at risk of showing an outright monthly contraction, with the unemployment rate notching higher.  Yet, as seen with last month’s change in headline payrolls and unemployment rate, whatever is reported likely will include a payroll contraction and higher unemployment rate within the 95% statistical reporting confidence intervals (+/- 129,000 for payroll change, +/- 0.2% for the unemployment rate).   As has been the case for some time, unstable seasonal adjustments can distort the reported monthly changes in these series meaningfully.

 

__________

 

COMMENTARY NUMBER 395
September CPI, PPI, Real Retail Sales, Housing Starts, Industrial Production

October 19, 2011

__________

 

Consumer and Wholesale Inflation Jumped in September

September’s Annual Inflation: 3.9% (CPI-U), 4.4% (CPI-W), 11.5% (SGS)

Annual PPI Inflation Hits 6.9% in September

Third-Quarter Real Retail Sales, Production and Housing Starts Outpaced
Second-Quarter Activity, but Economy Remains in Severe Downturn

 

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Thursday, October 27th.  It will cover the “advance” estimate of third-quarter 2011 GDP and September new orders for durable goods.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  The pace of annual inflation rose in September at both the consumer and wholesale levels.  Also holding up is the pace of annual inflation in the so-called “core” measure, net of food and energy prices.  Rising prices continue to be boosted by the effects of the Federal Reserve’s efforts at dollar-debasement, not by strong economic activity.  At the same time, the economy remains in severe contraction, despite some upside monthly reporting in recent economic series.

CPI and PPI.  The September producer price index jumped by 0.8% for the month and 6.9% for the year, versus August’s unchanged monthly reading and 6.5% annual inflation.

Annual inflation in the September consumer price index again hit the highest level for the CPI-U series since September 2008.  The CPI-U gained 0.3% for the month and 3.9% for the year, while the narrower CPI-W gained 0.4% for the month and 4.4% for the year.

The chained-CPI-U (C-CPI) showed annual growth of 3.8%.  The miscreants in Washington, D.C., would like to change CPI reporting, once again, so as to cut cost-of-living adjustments artificially.  By shifting COLA adjustments from a CPI-W base to the C-CPI base, the politicians can cut the federal deficit without anyone having to vote formally to cut Social Security costs. 

If the C-CPI were in place now for such purposes, it would have lowered the coming Social Security COLA adjustment by 0.6 percentage point.  It would be better for the general public if the government just came out and said it could not afford to pay a full COLA, rather than put out an understated inflation rate that neither reflects the costs of maintaining a constant standard of living, nor reflects actual out-of-pocket expenses.  As a result of the deception, the general public often ends up using understated inflation numbers for purposes such as wage and salary adjustments and for targeting investment returns.

The SGS-Alternate-CPI measures reflected annual inflation for September at 7.2% (1990-based) and at 11.5% (1980-based)

Although at slower pace of increase in September, the CPI-U’s annual “core” inflation rate has risen now for 11 straight months, since the Fed introduced QE2.  As shown in the following graph, the annual core rate rose to 1.97% in September versus 1.95% in August, and was up from 0.61% in October 2010.

 

Real Retail Sales, Industrial Production and Housing Starts.  Monthly gains reported in September for real retail sales, industrial production and housing starts, which have helped to boost the third-quarter outlook a little, generally appeared to be tied to seasonal-adjustment problems that should reverse out in the month ahead (see the discussion on seasonal-adjustment reporting quality in the Hyperinflation Special Report (2011)).  With extraordinarily negative underlying fundamentals still in play, there is no shift in economic outlook and no chance of a near-term economic recovery

Given relatively better current quarterly reporting, versus the second-quarter, for the trade deficit, real retail sales, industrial production and housing starts, however, next week’s (October 27th) initial estimate of third-quarter GDP growth likely will be somewhat above that of the 1.3% last estimated for annualized, real (inflation-adjusted) quarterly growth in the second-quarter.  Nonetheless, as with the second-quarter, the initial third-quarter headline GDP estimate likely will not be statistically meaningful, encompassing both a potential contraction as well as expansion within its 95% confidence interval of plus-or-minus three percentage points. 

Also, where the Bureau of Economic Analysis’s (BEA) “advance” estimate tends to target the consensus forecast, weaker than widely recognized underlying fundamentals tend to favor a downside surprise for the initial GDP reporting.  As discussed in the prior Commentary No. 394, the underlying structural issues impairing consumer activity are getting worse, not better. 

Indeed, the fundamental factors that drive U.S. consumption show the broad economy still to be in decline, with the lack of real consumer income growth and restricted credit availability at the core of U.S. the economic problems.

 

Hyperinflation Watch—Outlook Remains the Same.  The U.S. economic and systemic-solvency crises are ongoing.  The systemic-solvency crisis reflects both domestic and global banking-system and sovereign solvency issues, as well as related extreme instability in the domestic and global financial markets and financial and economic systems.  The systemic problems are exacerbated by the still-faltering economy, in something of a self-feeding cycle.

Repeated from the prior Commentaries, there are no happy solutions available here to remedy the crises, only tools—devil’s choices—for the Fed and the U.S. government to buy a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any overt change in policy.  The ultimate cost in propping the system, however, remains inflation.  The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and in recent Commentaries, continue to unfold with outlooks that remain unchanged.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent a euro-area crisis from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The financial markets still are roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of any further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

The impact of recent extreme market turmoil and volatility is evident in the usual gold graphs that follow.  Again, the precious metals and stronger currencies remain the best long-term hedges against the extreme decline ahead in the purchasing power of the U.S. dollar.

 

__________

 

REPORTING DETAIL

 

CONSUMER PRICE INDEX—CPI (September 2011)

Higher Oil Prices Continue Permeating Broad Economic Activity.  Once again, despite a seasonally-adjusted boost to otherwise weak gasoline prices, September CPI reporting showed the continued spread of inflationary pressures well beyond the energy and food sectors, with the annual “core” inflation rate still on the rise.  Topping August’s numbers, full September CPI-U reporting showed the highest level of annual consumer inflation since September 2008.

 

CPI-U.  The BLS reported today (October 19th) that the seasonally-adjusted September 2011 CPI-U rose by 0.30% (up by 0.15%, unadjusted) for the month.  That followed a gain of 0.37% (up by 0.28%, unadjusted) in August.  The September reporting reflected an unadjusted 0.7% drop in monthly average gasoline prices (the Department of Energy reported an unadjusted 0.8% decline), but the unadjusted BLS estimate was turned into a seasonally-adjusted monthly gain of 2.9%.  Gasoline-price seasonal-adjustments still are in a price-boosting mode, catching up on depressed adjusted gasoline inflation as reported in the first half of the year. 

September’s unadjusted year-to-year CPI-U inflation rose to 3.87%, from August’s 3.77%, the strongest pace of annual inflation since September 2008.

The annualized quarterly gain in seasonally-adjusted CPI-U inflation was 3.07% for third-quarter 2011, versus 4.09% in the second quarter.  Unadjusted year-to-year inflation rose to 3.76% in the third-quarter versus from 3.43% in the second-quarter.

The September report also showed still-greater inflationary pressures from the spread of higher energy prices into the broad economy (see the graph and comments in Opening Comments and Executive Summary).  On an annual basis, “core” CPI-U inflation moved higher, albeit marginally, for the 11th straight month, up to 1.97% in September, versus 1.95% in August.  When Fed Chairman Bernanke used his jawboning in an effort to debase the U.S. dollar in the global markets, in advance of announcing QE2 in November 2010, annual “core” inflation was at 0.61%.

Year-to-year total CPI-U inflation would increase or decrease in next month’s October 2011 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.25% gain in the adjusted monthly level reported for October 2010.  I use the adjusted change here, since that is how consensus expectations are expressed.  To approximate the annual unadjusted inflation rate for October 2011, the difference in October’s headline monthly change (or forecast of same) versus the year-ago monthly change should be added to or subtracted directly from September 2011’s reported annual inflation rate of 3.87%.

CPI-W.  The narrower, seasonally-adjusted CPI-W, which has greater weighting for gasoline than does the CPI-U, rose by 0.37% (up by 0.16% unadjusted) in September, following August’s gain of 0.42% (up by 0.29% unadjusted). 

Unadjusted, September 2011’s year-to-year CPI-W inflation was 4.38%, against a 4.26% annual increase in August.

The annualized quarterly gain in seasonally-adjusted CPI-W inflation was 3.31% for third-quarter 2011, versus 4.55% in the second quarter.  Unadjusted year-to-year inflation rose to 4.25% in the third-quarter from 3.94 % in the second-quarter.

C-CPI-U.  The Chain-Weighted CPI-U—the fully substitution-based series that gets touted by CPI opponents and inflation apologists, including the recent presidential deficit commission and some members of Congress, as the replacement for the CPI in COLA adjustments—is reported only on an unadjusted basis.  Year-to-year inflation increased to 3.71% in September, up from 3.61% in August.

Unadjusted C-CPI-U year-to-year inflation for the third-quarter was 3.86%.   If this gimmicked measure were utilized for this year’s Social Security cost of living adjustment (COLA), instead of the CPI-W, the adjustment would be lowered by 0.39%.  Therein is the political motivation for changing the COLA-adjustment mechanism to the C-CPI-U, as a deficit-reduction tool. 

Alternate Consumer Inflation Measures. Adjusted to pre-Clinton (1990) methodology, annual CPI inflation was roughly 7.2% in September 2011, up from 7.1% in August, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to about 11.5% (11.45% for those using the extra digit) in September, up from about 11.4% in August. 

The SGS-Alternate Consumer Inflation Measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS (the series is not recalculated).  Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept.  Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the annual impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact not otherwise published by the BLS.

Gold and Silver Highs Adjusted for CPI-U/SGS Inflation.  Despite the September 5th historic-high gold price of $1,895.00 per troy ounce (London afternoon fix), and despite the multi-decade high silver price of $48.70 per troy ounce (London fix of April 28th), gold and silver prices have yet to re-hit their 1980 historic levels, adjusted for inflation.  The earlier all-time high of $850.00 (London afternoon fix, per Kitco.com) of January 21, 1980 would be $2,479 per troy ounce, based on September 2011 CPI-U-adjusted dollars, $8,677 per troy ounce based on SGS-Alternate-CPI-adjusted dollars (all series not seasonally adjusted). 

In like manner, the all-time high price for silver in January 1980 of $49.45 per troy ounce (London afternoon fix, per silverinstitute.org), although approached earlier this year, still has not been hit since 1980, including in terms of inflation-adjusted dollars.  Based on September 2011 CPI-U inflation, the 1980 silver price peak would be $144 per troy ounce and would be $505 per troy ounce in terms of SGS-Alternate-CPI-adjusted dollars (again, all series not seasonally adjusted).

As shown on page 43 of the Hyperinflation Special Report (2011), over the decades, the price of gold has compensated for more than the loss of the purchasing power of the U.S. dollar as reflected by CPI inflation, while it has effectively fully compensated for the loss of purchasing power of the dollar based on the SGS-Alternate Consumer Price Measure (1980 Methodologies Base).

Real (Inflation-Adjusted) Retail Sales.   Based on the September 2011 CPI-U reporting, inflation- and seasonally-adjusted September 2011 retail sales rose by 0.81% for the month, where, before inflation adjustment, the current number was up by 1.13% (see Commentary No. 394 for details of the nominal reporting).  Real August retail sales revised to a monthly decline of 0.09% (previously down by 0.33%), where nominal (not-adjusted for inflation) sales in August revised to a gain of 0.28% (previously up by 0.04%). 

Real retail sales in third-quarter 2011 were up by a 0.34% from the second-quarter, which, in turn, was up by 0.14% from the first-quarter.

September’s real retail sales rose at a year-to-year pace of 3.87%, versus a revised 3.63% (previously 3.28%) annual gain reported for August. 

The ongoing “recovery” in real retail sales is reflected in the following graphs, which show the latest monthly levels of inflation- and seasonally-adjusted activity.  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.

 

As noted in earlier writings, using the SGS Alternate-CPI Inflation estimates for deflation of the retail series would not have shown an ongoing rise in activity for the last year or so.  It is my preference here, and wherever otherwise possible, to use the official estimates (the series here is as calculated by the St. Louis Fed), since that eliminates a level of argument over what is being reported.  As official consumer inflation picks up, and as overall retail sales suffer from the ongoing consumer liquidity squeeze, these data should turn down meaningfully in what eventually will become a formal double-dip recession. 

There has been no change in underlying fundamentals that would support a sustainable turnaround in personal consumption or in general economic activity—no recovery—just general bottom-bouncing.  Accordingly, real retail sales levels in the months ahead should become increasingly negative (see the household income comments in Commentary No. 394).

 

 

Real Money Supply M3.  The signal of the unfolding double-dip recession, based on annual contraction in the real (inflation-adjusted) broad money supply (M3), discussed in the Hyperinflation Special Report (2011), continues and is graphed above.  Based on the September CPI-U report and the latest September SGS-Ongoing M3 Estimate, the annual contraction in real M3 for September 2011 was 1.2%, somewhat shallower than the revised 1.3% (1.5%) annual contraction in August.  The August revision was in the context of benchmark revisions to underlying data published by the Fed.

The signal for a downturn or an intensified downturn is generated when annual growth in real M3 first turns negative in a given cycle; the signal is not dependent on the depth of the downturn or its duration.  The current downturn signal was generated in December 2009.  The broad economy tends to follow in downturn or renewed deterioration roughly six-to-nine months after the signal, as has appeared to have started in recent months.  Weakness in a number of series have surfaced in recent months, and the downturn likely will accelerate in the months ahead, eventually leading to recognition of a double-dip recession.

 

PRODUCER PRICE INDEX—PPI (September 2011)

Monthly Wholesale Inflation Jumped to 0.8% for September, Up 6.9% Year-to-Year.  As reported yesterday, October 18th, by the Bureau of Labor Statistics (BLS), the regularly-volatile, seasonally-adjusted finished-goods producer price index (PPI) for September up by 0.8% (up by 0.5% unadjusted) month-to-month, following an unchanged month-to-month reading (down by 0.4% before seasonal adjustment) in August.

Unadjusted and year-to-year, September 2011’s PPI inflation rose to 6.9% from 6.5% in August.  The recent run-up in annual PPI inflation generally has reflected ongoing impact of the Fed’s dollar-debasement policies, not surging economic demand. 

Separately, on a monthly basis, seasonally-adjusted September 2011 intermediate goods prices rose by 0.6%, versus a decline of 0.5% in August, with September crude goods prices up by 2.8%, following a 0.2% gain in August.  Year-to-year inflation in September intermediate goods was 10.5%, versus a 10.3% level in August, with September’s annual inflation in crude goods at 20.9%, versus August’s 18.4% pace.

 

RESIDENTIAL CONSTRUCTION—HOUSING STARTS (September 2011)

Housing Starts Bottom-Bounced in September.  The regularly volatile housing starts series continued its bottom-bouncing in September, having seen nearly three years of activity at 75% below 2006’s record construction level, and no relief in sight.  The Census Bureau reported this morning (October 19th) a marginally-statistically-significant monthly gain in seasonally-adjusted September 2011 housing starts of 15.0% (a gain of 15.2% before prior-period revisions) +/- 14.9% (all confidence intervals are at the 95% level).  August starts were revised to a 7.0% (previously a 5.0%) monthly decline.  The bulk of September’s monthly gain was due to a 52.4% jump in the highly volatile apartment units component, with single unit starts up by 1.7% for the month.

As a result of the September reading, housing starts in the third quarter were 7.5% ahead of the second-quarter, which, in turn was 1.7% below first-quarter activity.

The year-to-year change in September starts was a statistically-insignificant increase of 10.2% +/- 15.5%, following a revised annual 5.6% (previously 5.8%) decline in August.  The recent swings in the direction of annual change reflect comparisons with volatile year-ago monthly activity that was exaggerated in both directions by stimulus and post-stimulus effects.

With housing starts well into their third year of post-housing-market-crash bottom-bouncing, there remain no indications of a reprieve for the industry or the otherwise deteriorating broader economy.  Indeed, the pattern of housing starts has remained one of stagnation at an historically low-level plateau of activity, over the last 34 months.  Since December 2008, housing starts have averaged a seasonally-adjusted annual rate of 575,000.  In that period, all monthly readings have been within the normal range of monthly volatility for the aggregate series around that average, with the 658,000 September 2011 monthly reading at 14.4% above average.  Again, such is within the normal reporting range of this extremely volatile series.

As shown in the following graphs, current monthly housing starts activity remains near the record monthly low seen for the present series in April 2009.  The current number also is well below any level reported in the predecessor nonfarm housing starts series, which was introduced in 1946.  The first graph shows recent detail for current housing starts activity, the second graph shows the same data within the historical context of the post-World War II period.

 

 

INDEX OF INDUSTRIAL PRODUCTION (September 2011)

Third-Quarter Industrial Production Had a 1.3% Quarterly Gain.  Monday’s (October 17th) Federal Reserve Board release of seasonally-adjusted September 2011 industrial production showed a monthly gain of 0.19% (0.15% net of prior-period revisions) versus August.  In turn, the monthly change in August production was flat (a 0.0045% gain), revised lower from initial reporting of a 0.18% monthly gain. 

Third-quarter industrial production gained 1.26% versus the second-quarter, which in turn was up by a revised 0.11% (0.13%) from the first-quarter.  The relatively stronger third-quarter growth would suggest stronger third-quarter GDP growth in the second-quarter.  For some reason, though, where a quarterly gain in industrial production often follows through to GDP reporting, a quarterly decline in production often does not.

Year-to-year growth in September 2011 production was 3.22%, down from a revised 3.32% (previously 3.35%) August 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.

 

 

Week Ahead.  Although still not fully acknowledged, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

Existing and New Home Sales (September 2011).  September existing home sales (National Association of Realtors) are due for release tomorrow, Thursday, October 20th, while September new home sales (Census Bureau) are due for release on Wednesday, October 26th.  Once again, as with the ongoing bottom-bouncing seen in today’s housing starts release, both home sales series should remain extremely weak, with any positive monthly change lacking statistical significance (especially for the highly volatile new home sales series).  Also, as usual, given the extreme volatility, reporting error and revisions in both these series, given the poor-quality seasonal adjustments, given continuing negative anecdotal evidence, and given ongoing massive distortions from irregularly volatile foreclosure activity, the reported monthly movements in these numbers (particularly to the upside) generally are meaningless.

New Orders for Durable Goods (September 2011).  Due for release on Wednesday, October 26th, the highly volatile new orders for durable goods likely will not show a meaningful monthly change in September, with odds slightly favoring a monthly decline in new orders.

Gross Domestic Product—GDP (Third-Quarter 2011, First Estimate).  The “first” or “advance” estimate of third-quarter GDP is due for release from the Bureau of Economic Analysis (BEA) on Thursday, October 27th.  With the existing trade, production, retail sales and housing starts data suggestive of a somewhat relatively stronger quarter-to-quarter GDP performance than in the second-quarter, the headline, annualized inflation-adjusted third-quarter GDP growth rate likely will be above the last-estimate of 1.3% for the second-quarter.  Yet, given widely weaker-than-recognized underlying economic fundamentals, reporting risk is to the downside of whatever consensus forecasters are likely to estimate.

 

__________

 

COMMENTARY NUMBER 394
September Retail Sales, August Trade Deficit

October 14, 2011

__________

 

The Great Downturn Deepens as Household Incomes Collapse

September Retail Sales Gain Exaggerated by Poor-Quality Seasonal Adjustments

Trade Deficit Still Suggests A Positive Contribution to Third-Quarter GDP

 

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Wednesday, October 19th.  It will cover September CPI, PPI, housing starts, real retail sales and industrial production.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  Fundamental factors that drive U.S. consumption show the broad economy still to be in decline, with no near-term chance of the prospective economic recovery that regularly gets hyped by Wall Street.  Structural problems tied to the lack of real (inflation-adjusted) consumer income growth, and to restricted credit availability, remain at the core of the economic problems, as discussed in the Hyperinflation Special Report (2011).

Household Income Collapse.  On the consumer income front, household income is continuing to collapse, per a just-released private study by Gordon Green and John Coder.  Green and Coder, respectively, were the former Chiefs of the Governments Division and of the Income Statistics Branch at the U.S. Census Bureau, and, at one time, produced the government’s annual poverty survey, from which I pull details on annual household income (see Commentary No. 389).  The new study was publicized in an October 9th New York Times story: “Recession Officially Over, U.S. Incomes Kept Falling.”

Using raw data available from the Census Bureau’s Current Population Survey (the unemployment survey used by the Bureau of Labor Statistics), Green and Croder concluded that monthly median household income, adjusted for CPI-U inflation, fell by 9.8% from the official beginning of the recession in December 2007 through June 2011.  This is near-depression territory (see the definitions section of the Hyperinflation Special Report (2011)).  Further, the collapse in household income accelerated after the purported end of the recession in June 2009, suggesting that the recession never really ended.

Per Green and Croder, “Real [adjusted for inflation] median annual household income has fallen significantly more during the economic recovery period from June 2009 to June 2011 than during the recession lasting from December 2007 to June 2009.  During the recession, real median annual household income fell by 3.2 percent, from $55,309 in December 2007 to $53,518 in June 2009.  During the economic recovery, real median annual household income fell by an additional 6.7 percent, from $53,518 in June 2009 to $49,909 in June 2011.”

The declines in real median household income in all mentioned periods were greater than the appropriate CPI inflation, which means that the median household incomes also declined in nominal terms (not adjusted for inflation).  The latest reading on real median household income appears to be at the low of the cycle, and, as deflated by the CPI-U, should be at the lowest level seen since before 1970, based on the Census Bureau’s historical annual series.

Growth in real consumption and real GDP cannot be sustained without sustained growth in real income.  Short-term consumption growth, however, can be borrowed from the future—through debt expansion—assuming consumers have the ability and willingness to take on new debt.

Credit and Confidence.  On the consumer credit front, the Fed’s reporting of August 2011 consumer credit outstanding showed a 1.9% increase versus the third-quarter 2010 level.  That also is less than the official annual increase in consumer inflation of 3.8% (CPI-U) to 4.3% (CPI-W) in August.  Net of consumer debt held by the federal government, however, nominal August consumer credit was down by 3.1% over the same period.  The banks still are not lending, and without credit expansion available to the consumer to make up for the shortfall in his or her living standards, real consumption and GDP again have no prospects for sustainable expansion.

As to consumer confidence, both the Conference Board’s confidence measure and the University of Michigan’s sentiment measure remain deep in territory usually not seen outside of historical recessions (except for the current period, where, again, the 2007 recession really never ended).

Retail Sales.  Despite all the factors hampering consumer activity, headline September retail sales rose by 1.1% in the month.  Even after inflation adjustment, that should remain in positive territory.  The monthly changes here are warped by poor-quality seasonal adjustments.  The sales gain here would have been roughly 0.5%, based on 2010 adjustments.  The underlying fundamentals, as discussed above, do not support any form of near-term consumer recovery, and real contractions in monthly retail sales should be common in the key holiday-shopping-season months ahead.

Trade Deficit.  The August trade deficit was unchanged versus July, but with July now showing a wider deficit in revision.  The net narrowing in the quarterly deficit initially suggested by the July report now is smaller, but the effect still should be the same.  The net export account likely will make a positive contribution to the “advance” third-quarter GDP estimate due for release on October 27th.

An update on the broad outlook for inflation and the economy will be included in the Commentary scheduled for October 19th.

 

Hyperinflation Watch—Outlook Unchanged.  The U.S. economy continues to falter.  With the added pressures of systemic-solvency stresses, the domestic and global financial markets and financial system remain extremely unstable.

Repeated from the prior Commentaries, there are no happy solutions available here to remedy the economic and systemic-solvency crises, only tools—devil’s choices—for the Fed and the U.S. government to buy a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any overt change in policy.  The ultimate cost in propping the system, however, remains inflation.  The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and in recent Commentaries, continue to unfold with outlooks that remain unchanged.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent a euro-area crisis from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The financial markets still are roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of any further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

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REPORTING DETAIL

 

RETAIL SALES (September 2011)

September Retail Sales Boosted by Poor-Quality Seasonal Factors.  With anything close to stable monthly seasonal adjustments relative to last year, September’s 1.1% adjusted monthly sales gain would have been around 0.5%.  The concurrent seasonal factor issues, and broader distortions seen otherwise in current seasonal factors, as discussed in Commentary No. 393 and in the Hyperinflation Special Report (2011), continue.  The stability of the seasonal-adjustment process has been disrupted by the unprecedented depth and length of the current economic downturn in the post-World War II era (the period of modern economic reporting).

As a result, monthly changes being reported in series such as payroll employment and new orders for durable goods—in addition to the retail sales series—remain within the realm of statistical meaninglessness.  Distorted monthly reporting in these and other key series, leave the markets effectively flying blind as to actual underlying economic activity.  In such circumstances, looking at broad underlying fundamentals may be useful.  As discussed in the Opening Comments and Executive Summary, the underlying consumer fundamentals continue to signal economic deterioration, not recovery.  The broad economy remains in serious trouble.

Nominal (Not-Adjusted-for-Inflation) Retail Sales.  Today’s (October 14th) report on September 2011 retail sales—issued by the Census Bureau—indicated a statistically-significant, seasonally-adjusted monthly gain of 1.13% (up by 1.53% before prior-period revisions) +/- 0.6% (95% confidence interval).  September’s jump was against a revised 0.28% (previously 0.04%) monthly increase in August.  The July monthly gain also was revised higher, to 0.42% from 0.27% in last month’s reporting.

On a year-to-year basis, September 2011 retail sales were reported up by 7.94%, versus the revised year-to-year August 2011 gain of 7.53% (previously 7.16%).    

Real (Inflation-Adjusted) Retail Sales.  Details on real retail sales for September will be published in the October 19th Commentary, along with details on the September 2011 CPI-U release.  While September CPI-U inflation likely increased (see Week Ahead), the gain should be well below 1.1%.  As a result, real retail sales for September most likely will show a month-to-month gain.  Despite the upside revisions to August and July’s nominal monthly gains, though, both months continue to show monthly real contractions, with August now down by 0.09% (previously down by 0.33%) and July down by 0.07% (previously down by 0.23%).

Core Retail Sales.  Assuming that the bulk of non-seasonal variability in food and gasoline sales is in pricing, instead of demand, “core” retail sales—consistent with the Federal Reserve’s preference for ignoring food and energy prices when “core” inflation is lower than full inflation—are estimated using two approaches:

Version I: September 2011 versus August 2011 seasonally-adjusted retail sales—net of total grocery store and gasoline station revenues—was up by 1.3%, versus an official gain of 1.1%.

Version II: September 2011 versus August 2011 seasonally-adjusted retail sales—net of the monthly change in revenues for grocery stores and gas stations—was up by 1.0%, versus an official gain of 1.1%.

 

TRADE BALANCE (August 2011)

August Trade Data Still Suggest A Positive Contribution to Third-Quarter GDP.  The July trade deficit widened in revision, with the August number then reported as unchanged.  These two months of reporting, which will be used to estimate the net-export contribution in the initial third-quarter GDP report (due for release October 27th), appear to have narrowed against first-quarter reporting, suggesting a positive contribution to the quarterly GDP number.  Going forward, though, look for ongoing monthly trade deterioration.

Nominal (Not-Adjusted-for-Inflation) Trade Deficit.  The Bureau of Economic Analysis (BEA) and the Census Bureau reported yesterday (October 13th) that the nominal, seasonally-adjusted monthly trade deficit in goods and services for August 2011 held at $45.6 billion, the same level as the revised July deficit, which widened from the initial reporting of $44.8 billion.

Against the revised July data, the August trade balance showed offsetting minimal $0.1 billion monthly declines in both exports and imports.  The import numbers reflected a decline in oil prices, but also a surge in physical oil import volume.  Specifically, for the month of August 2011, the not-seasonally-adjusted average price of imported oil was $102.62 per barrel, down from $104.27 in July 2011, but up from $73.47 in August 2010.  In terms of not-seasonally-adjusted physical oil imports, August 2011 volume averaged 9.757 million barrels per day, up from 9.067 million in July 2011, but down from 9.905 million in August 2010.

Real (Inflation-Adjusted) Trade Deficit.  Adjusted for seasonal factors and net of oil price swings and other inflation (2005 chain-weighted dollars as used in reporting real GDP), the reported August merchandise trade deficit came in at $47.0 billion, up from a revised $46.0 (previously $45.3) billion in July.

Based on the two months of reporting that will be used in estimating the net export component of third-quarter GDP, the annualized deficit for the third-quarter would be $557.6 billion (previously estimated at $543.3 billion from the initial one month’s reporting).  Although widened from the initial estimate, it still is narrower than the full reporting of an annualized real second-quarter 2011 merchandise deficit of $567.4 billion.  The likely estimate of a quarterly narrowing of the trade deficit would be a positive for the GDP’s net export account and, accordingly, a positive contribution to the initial estimate of third-quarter GDP growth.

 

Week Ahead.  Although still not fully acknowledged, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

Industrial Production (September 2011).  The September 2011 industrial production release is scheduled for Monday, October 17th.  The consensus estimate for the headline monthly change in September production likely will be for modest growth, above the 0.2% increase initially reported for August.  Reporting risk, however, generally will be to the downside of consensus, with a flat-to-minus result, as a formal double-dip recession begins to unfold in the numbers.

Producer Price Index—PPI (September 2011).  The release of the September 2011 PPI is scheduled for Tuesday, October 18th.  Finished goods inflation should top a likely flat-to-minus consensus outlook, due to the effects of still-spreading broader inflationary pressures from earlier higher oil prices.

Consumer Price Index—CPI (September 2011).  The release of the September 2011 CPI is scheduled for Wednesday, October 19th.  Headline consumer inflation, once again, is at fair risk of topping a likely relatively soft consensus.  At work here remains the continued boost to gasoline prices from seasonal adjustments (catch-up from depressed reporting of gasoline prices from earlier in the year), while further inflationary pressures from the recent Fed-induced jump in oil prices continue spreading beyond direct energy cost measures in the general, broad economy.

Specifically, in terms of retail gasoline, unadjusted prices fell on average by 0.8% in September 2011 per the Department of Energy.  Suggestive of the likely seasonal-adjustment impact on 2011 reporting, an unadjusted 1.4% monthly decline in September 2010 gasoline prices was boosted to a 1.6% increase, after seasonal adjustments.

Year-to-year total CPI-U inflation would increase or decrease in September 2011 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.16% gain in the adjusted monthly level reported for September 2010.  I use the adjusted change here, since that is how consensus expectations are expressed.  To approximate the annual unadjusted inflation rate for September 2011, the difference in September’s headline monthly change (or forecast of same) versus the year-ago monthly headline change should be added to or subtracted directly from August 2011’s reported annual inflation rate of 3.77%.  For example, if the headline CPI-U gained 0.3% in September, annual CPI-U inflation should move to about 3.9%.

Housing Starts (September 2011).  September residential construction data are due for release on Wednesday, October 19th.  The historic weakness in housing starts should continue, again, with an intensifying downtrend.  As seen generally in the last several years, any upside movement likely will not be statistically meaningful.

 

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COMMENTARY NUMBER 393
September Employment, Unemployment, M3, Special Commentary

October 7, 2011

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September Payroll Gain Was Statistically Meaningless

Broadest Government Unemployment Rate Jumped by 0.3% to 16.5%

September Unemployment: 9.1% (U.3), 16.5% (U.6), 23.1% (SGS)

Annual Money Supply M3 Growth Inched Higher in September

Economic and Systemic-Solvency Crises Intensify

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PLEASE NOTE: The next regular Commentary is scheduled for Friday, October 14th.  It will cover September retail sales and the August trade deficit.

—Best wishes to all, John Williams

 

SPECIAL COMMENTARY

Do Not Blame Europe.  Broad systemic and economic instabilities have been ongoing in the United States for more than three years, and the crises appear headed for a near-term crescendo.  All the extreme monetary and fiscal measures taken by the Federal Reserve and the U.S. government in 2008, and later, aimed at preventing a collapse of the U.S. financial system, and ostensibly intended to stimulate the economy, have done little to fix either the banking system or the economy.  Sovereign and systemic issues in the euro area, however, are receiving heavy blame from the Obama administration and some market analysts both for mounting questions on systemic problems and for concerns of an intensifying U.S. economic downturn.  The problems, however, always have been primarily U.S.-based and due to domestic economic, monetary and regulatory policies.  Blaming the euro area for U.S. problems is little more than a foil aimed at distracting attention from the catastrophic fiscal and Fed-policy issues threatening long-term U.S. solvency and the U.S. dollar.

The U.S. markets have been extraordinarily violent and unstable since the U.S. government demonstrated its inability and unwillingness to control its sovereign finances in early-August 2011.  As the dollar entered a tailspin, various actions by governments and financial regulators were undertaken, aimed at quelling the instabilities.  The euro crisis suddenly intensified anew (distracting the markets from the great overhanging crisis with the U.S. dollar).  Yet, the underlying negative U.S. dollar fundamentals persist and cannot be altered easily.  Accordingly, near-term relative U.S. dollar strength against gold, silver and the stronger currencies should prove to be short-lived.

As was established with the 2008 crisis, central banks (primarily the Fed) and various governments (primarily the U.S. government—even though more politically splintered at present) will do whatever is necessary to prevent a collapse of the banking and financial systems.  The Fed and the U.S. government still will provide whatever guarantees are needed, whatever money has to be created, spent or loaned out, in order to prevent systemic failure.  This includes any sovereign or non-U.S.-bank bailouts required to prevent systemic collapse.  The costs of such actions remain inflation or U.S. dollar debasement.  They can continue only so long as the global markets allow them, until the U.S. dollar comes under massive, sustained selling pressure.

SYSTEMIC ISSUES.  When the Treasury Secretary has to deny vehemently (in response to Congressional questioning) that any major U.S. banks are at risk of failure, systemic instability is beginning to break into the light of day.   Per Dow Jones of October 6th:  “When asked at a Senate Banking Committee whether the euro-zone sovereign debt crisis could bring down Morgan Stanley or another major financial institution, Geithner said, ‘Absolutely not.’”

Banks generally are not increasing lending.  Per the Fed’s recent second-quarter Flow of Funds report, total bank credit issued by U.S chartered banks, seasonally-adjusted for second-quarter 2001, was down by 0.8% quarter-quarter, unchanged on an unadjusted basis, and down by 0.4% year-to-year.  While there certainly are issues as to credit-worthy borrowers, I contend that the weakness in lending is due more to still-impaired bank balance sheets than to any other factor.  As a result, broad money growth remains tepid.

Money Supply M3 (September 2011).  Based on roughly three weeks of data, the preliminary estimate of the SGS Ongoing-M3 Estimate for September 2011 will be published in the Alternate Data section on October 8th.  September M3 is on track to show year-to-year growth of about 2.6%, up from 2.4% in August and 2.5% in July.  These numbers reflect the latest regular benchmark revisions by the Fed to its money and banking data.  The seasonally-adjusted, month-to-month change estimate for M3 likely will be on the plus-side of unchanged, as it was in August and July.   The estimated month-to-month M3 changes, however, remain less reliable than the estimates of annual growth.

Similar flattening in the relative monthly estimates of annual growth, as well as in month-to month changes, also is likely for the narrower M1 and M2 measures (M2 includes M1, M3 includes M2). M2 for September is on track to show year-to-year growth of about 10.1%, versus 10.3% in August, with month-to-month growth estimated at roughly 0.3% in September versus 2.5% in August.  The early estimate on M1 for September shows year-to-year growth of roughly 20.0% versus 20.8% in August, with month-to-month growth estimated at roughly 0.6% in September, versus 5.1% in August.  The relatively stronger annual growth rates in M1 and M2 reflect the recent shifting of funds out of M3 accounts into M1 and M2 accounts.

Fed Easing Remains Likely.  With ongoing economic and systemic-solvency crises, the Fed remains likely to institute some new form of liquidity injection for the banking system, soon, despite protestations to the contrary.  That action, though, should continue under the guise of trying to stimulate the economy.  Neither the Fed nor the Administration is in a position to put forth meaningful economic stimulation, although action by both entities remains expected or hoped for by the markets and/or the electorate.  As a point of clarification, I am not advocating any specific actions, only offering my opinion as to what likely will unfold.

U.S. ECONOMY: Employment and Unemployment (September 2011).  The stronger-than-expected 103,000 gain reported in September payrolls was, as usual, statistically meaningless.  Even with a 45,000 one-time boost from Verizon strikers returning, the 95% statistical confidence interval around the monthly jobs increase allowed for an outright monthly payroll contraction, as well as for monthly growth.  Also, as commonly has been the case, changes in seasonal factors, which are recalculated each month, have shifted growth into the current period from revised prior reporting.  Those revisions, however, are not published.  The overall patterns in payroll employment were little changed, with current payroll levels below where they were 10 years ago. 

Also, as usual, the unchanged 9.1% headline U.3 unemployment rate could have reflected a 0.2% increase or decrease, within the official statistical confidence interval.  The government’s broader U.6 rate, however, jumped to 16.5% in September from 16.3% in August, and the SGS Alternate Unemployment rate rose in tandem to 23.1% from 20.8%.  The unemployment rates are heavily skewed by seasonal-adjustment issues, with the resulting adjusted data currently of little meaning.

As can be seen with the U.S. payroll employment data, shown below, the U.S. economy entered a free-fall in late-2007 and then began to flatten-out—bottom-bounce—by late-2009, early-2010.  The plot of seasonally-adjusted payroll levels shows a recent slowing of growth and certainly no recovery to pre-recession highs.  The data continue to bottom-bounce along a plateau of low-level activity, with the latest payroll level still well below where it was a decade ago, even though the U.S. population has increased by more than 10% in the same period. 

The economic downturn is worsening, fueled as it was in 2007 by structural problems in consumer income, where the average household could not keep its income growing fast enough to cover inflation, and where consumer credit quickly dried up, preventing the use of debt expansion to cover the shortfall in income (see the Hyperinflation Special Report (2011) and Commentary No. 389 for greater detail).

 

 

Hyperinflation Watch—Economic and Systemic Solvency Crises Continue to Unfold. Repeated from the prior Commentaries, there are no happy solutions available here, only tools—devil’s choices—for the Fed and the U.S. government buying a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any overt change in policy.  The ultimate cost in propping the system, however, remains inflation.  The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and in recent Commentaries, continue to unfold with outlooks that remain unchanged.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent a euro-area crisis from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The financial markets still are roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

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REPORTING DETAIL

 

EMPLOYMENT AND UNEMPLOYMENT (SEPTEMBER 2011)

Constant Recalculation of Payroll Seasonal Factors Boosted September Payrolls.  The BLS practice of using “concurrent” seasonal-factor adjustments artificially shifted previously reported jobs growth into September 2011, and that resulted in boosting the reported September monthly gain.  Also the revised July month-to-month payroll gain was inflated to 107,000, from the 99,000 that would have been seen with consistent reporting.

As discussed in prior writings (see the Hyperinflation Special Report (2011), for example), seasonal-factor estimation for most economic series has been distorted severely by the extreme depth and duration of the economic contraction.  These distortions are exacerbated for payroll employment data based on the BLS’s monthly seasonal-factor re-estimations and lack of full reporting.

While the BLS recalculates the monthly seasonal factors each month for payroll employment, going back a number of years, it only publishes revised data for the last two months of reporting (July and August 2011 with the September 2011 report).  Shown in the following graph, the latest “concurrent” seasonal factor changes upped September 2010 (with implied stronger seasonals and a boost for the September 2011 reporting).  With just two months of prior reporting shown as revised, the changes pre-July 2011 were not published by the BLS, so as to avoid “confusing” people who use the data.  

As discussed repeatedly in recent employment Commentaries, meaningful seasonal-adjustments tend to be stable over time, without wild fluctuations every time the seasonals are re-estimated.  This is true particularly for series like payroll employment and retail sales, where the seasonal factors are concurrent—recalculated each month for the current month’s raw data.  If the payroll seasonals were stable, the lines in the graph would be flat and coincident.  Instead, the variations intensify with each successive month.  The monthly recalculations of seasonally-adjusted payroll levels show irregular revisions, with monthly swings now of plus or minus 90,000 jobs shifting over time.  To the extent the numbers affect current reporting, the differences are enough potentially to alter financial-market perceptions and reactions. 

The big issue remains that the month-to-month seasonally-adjusted payroll data have become increasingly worthless, with reporting errors likely now well beyond the official 95% confidence interval of +/- 129,000 jobs in the reported monthly payroll change.  Yet the media and the markets tout the data as meaningful, usually without question or qualification.

 

 

The inconsistency differences in the graph were calculated based on the raw unadjusted data and the seasonal-adjustment program available to the public on the BLS Web site.  Using the BLS data, we have calculated the seasonally-adjusted numbers as the BLS should be showing them, as of the current reporting, and the differences between official reporting and the consistent seasonally-adjusted series.

Payroll Survey Detail.  The Bureau of Labor Statistics (BLS) reported today (October 7th) a statistically-insignificant, seasonally-adjusted September 2011 month-to-month jobs gain of 103,000 (a gain of 202,000 jobs before prior-period revisions) +/- 129,000 (95% confidence interval).  August payrolls showed a revised 57,000 gain (previously unchanged), while July’s monthly gain also increased in revision, to 107,000, versus last month’s estimate of an 85,000 gain.  As noted in the comments on concurrent seasonal adjustment, the revised monthly gain for July really was 99,000, based on the BLS seasonal-factor detail, but revisions for June 2011 and before are not reported by the BLS.  Accordingly, the revised “official” July monthly gain was against an unrevised and inconsistent June number.

September’s monthly gain of 103,000 reflected the return to work of 45,000 striking Verizon workers, reversing downside pressures of same on prior reporting.  The estimated level of September’s payroll employment still was below the level reported 10 years ago.

In terms of year-to-year change, the unadjusted September 2011 growth rate was at 1.12%, versus the revised 1.09% (previously 0.99%) reported in August, and against 0.97% (previously 0.94%) annual growth reported for July.  Although the graphs of long-term year-to-year unadjusted payroll change had shown a rising trend in annual growth, which primarily reflected the still-protracted bottom-bouncing in the payroll series, that pattern has flattened out in recent months, as shown in the first graph following of the near-term detail in year-to-year change.  These numbers still reflect some short-lived year-to-year distortions as a result of the year-ago hiring surge and full layoffs of temporary census workers.

 

 

 

As shown in the next, longer-term graph (historical detail back to World War II), with the bottom-bouncing of recent years, current annual growth has recovered from the post-World War II record 5.06% decline in August 2009, which was the most severe annual contraction seen since the production shutdown at the end of World War II (a trough of a 7.59% annual contraction in September 1945).  Disallowing the post-war shutdown as a normal business cycle, the August 2009 annual decline remains the worst since the Great Depression, yet the current level of employment is far from any recovery.

 

 

 

The regular graph of seasonally-adjusted payroll levels is shown in the Special Commentary section.

Payroll Benchmark Revision.  On September 29th, the BLS published a preliminary upside benchmark revision to March 2011 unadjusted nonfarm payrolls.  The estimated 192,000 positive revision suggests there was a monthly-average understatement of 16,000 jobs in the period from April 2010 to March 2011.  Reporting history will not be revised until the February 2012 release of the January 2012 payrolls. The relatively small preliminary upside revision follows three consecutive larger downside annual revisions, and it should not affect current reporting.  In the final accounting, the BLS will distribute the revision going back a year from the March 2011, as well as carrying forward a relatively more positive monthly reporting through January 2012.

Birth-Death/Bias Factor Adjustment.  Despite the ongoing and regular overstatement of monthly payroll employment—as evidenced usually by regular and massive, annual downward benchmark revisions—the BLS generally has upped its monthly biases in post-benchmark reporting.  Reversing patterns, in the wake of the upside benchmark preliminary revision for March 2011 (see previous section), however, the monthly bias used in September 2011 was a more-negative subtraction of 43,000 jobs, versus a 25,000 subtraction in September 2010.  That followed an add factor for August 2011 of 87,000 jobs, somewhat less positive than the 91,000 monthly upside bias used in August 2010.   The net aggregate annual upside biases used at present, however, still well exceed the 192,000 tentative upside benchmark revision and remain suggestive of ongoing in stabilities in the Birth-Death Model.

The aggregated upside annual bias reflects an ongoing assumption of a net positive jobs creation by new companies versus those going out business.  Such becomes a self-fulfilling system, as the upside biases boost reporting for financial-market and political needs, with relatively good headline data, while often also setting downside benchmark revisions for the next year, which traditionally are ignored by the media and the politicians.  Where the BLS cannot measure the impact of jobs loss and jobs creation from employers starting up or going out of business, on a timely basis (within at least five years, if ever), such information is estimated by the addition of a bias-factor generated by the Birth-Death Model (a model of the effects of new business creation and old business bankruptcies).  The fundamental defects of the Birth-Death Model are discussed as usual in the ensuing paragraphs.

Positive assumptions—commonly built into government statistical reporting and modeling—can become self-fulfilling prophesies, with “stronger” economic data being reported as a result of happy guesstimates, or underlying assumptions of ongoing economic recovery.  Indeed, historically, the Birth-Death Model biases have tended to overstate payroll employment levels—to understate employment declines—during recessions.   There is a faulty underlying premise here that jobs created by start-up companies in this downturn have more than offset jobs lost by companies going out of business.  So, if a company fails to report its payrolls because it has gone out of business, the BLS assumes it still has its previously-reported employees and adjusts those numbers for the trend in the company’s industry. 

Further, the presumed net additional “surplus” jobs created by start-up firms, get added on to the payroll estimates each month as a special add-factor.  These add-factors have averaged 40,000 jobs per month over the last 12 months.  I still estimate this monthly bias should be significantly on the negative side, on average, but I am re-assessing the 200,000 negative bias estimate based on updated survey information.  I do not expect a significant change in the estimate and will update it in a future Commentary.  I do expect a significant downside benchmark revision for next year (March 2012), given current details of the BLS’s happy estimates.

Household Survey.  The usually statistically-sounder household survey, which counts the number of people with jobs, as opposed to the payroll survey that counts the number of jobs (counting multiple job holders more than once), showed a September 2011 employment gain of 398,000 versus a 331,000 gain in August and a 38,000 decline in July.  Issues with seasonal factors still meaningfully cloud the significance of the reported monthly levels in the adjusted headline U.3 unemployment rate and other adjusted household-survey numbers.  Again, adjusted data have been shifted by highly unstable seasonal factors that are artifacts of the severe and extraordinarily protracted downturn in U.S. economic activity (as well as distortions created by last year’s census hiring and firing effects), not by the regular and stable seasonal patterns that were in place before the current economic crisis.

The September 2011 seasonally-adjusted headline (U.3) unemployment rate was virtually unchanged for a second month, with a statistically-insignificant 0.01 percentage point decline to 9.08% +/- 0.23% (95% confidence interval), versus 9.09% both August and July.  Not-seasonally-adjusted, September’s U.3 unemployment rate was 8.8%, down from 9.1% in August and 9.3% in July.

The September U.6 unemployment rate jumped to a seasonally-adjusted 16.5%, from 16.2% in August and 16.1% in July.  The unadjusted U.6 rate eased to 15.7% in September, down from 16.1% in August and 16.3% in July.  The broadest unemployment rate published by the BLS, U.6 includes accounting for those marginally attached to the labor force (including short-term discouraged workers) and those who are employed part-time for economic reasons (they cannot find a full-time job).

In 1994, during the Clinton Administration, “discouraged workers”—those who had given up looking for a job because there were no jobs to be had—were redefined so as to be counted only if they had been “discouraged” for less than a year.  This time qualification defined away the long-term discouraged workers.  The remaining short-term discouraged workers (less than one year) are included in U.6. 

Adding the SGS estimate of excluded long-term discouraged workers back into the total unemployed and labor force, unemployment—more in line with common experience as estimated by the SGS-Alternate Unemployment Measure—rose to 23.1% in September, up from 22.8% in August and 22.7% in July.  The SGS estimate generally is built on top of the official U.6 reporting, and tends to follow its relative monthly movements. Accordingly, it will suffer some of the current seasonal-adjustment woes afflicting the base series.  See the Alternate Data tab for more detail.

 

 

As discussed in previous writings, an unemployment rate near 23% might raise questions in terms of a comparison with the purported peak unemployment in the Great Depression (1933) of 25%.  The SGS level likely is about as bad as the peak unemployment seen in the 1973 to 1975 recession.  The Great Depression unemployment rate was estimated well after the fact, with 27% of those employed working on farms.  Today, less that 2% work on farms.  Accordingly, for purposes of Great Depression comparison, I would look at the estimated peak nonfarm unemployment rate in 1933 of 34% to 35%.

 

Week Ahead.  Although still not fully acknowledged, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

U.S. Trade Balance (August).  The August trade deficit is due for release on Thursday, October 13th.  The general trend here should remain one of general deterioration against recent month-to-month volatility, with reporting risk favoring greater trade deficit widening than likely will be estimated by consensus.  The August report will be the last one available to the Bureau of Economic Analysis (BEA) for its first guess at third-quarter GDP.  Accordingly, a much worse-than-expected deterioration in the deficit would be suggestive of weaker third-quarter growth than had been suggested by initial improved July trade reporting, and vice versa.

Retail Sales (September).  The first estimate of September retail is scheduled for Friday, October 14th.  Risk remains to the downside of a likely positive consensus outlook.  As generally has been the case year-to-date, any reported monthly growth likely will be flat-to-negative after accounting for September’s consumer price inflation.

 

__________

 

COMMENTARY NUMBER 392
Benchmark Payroll and GDP Revisions, August Durable Goods and Home Sales

September 29, 2011

__________

 

GDP Revised Higher, GDI Revised Lower,
Growth Remained Statistically Indistinguishable from a Contraction

Average Monthly Understatement of 16,000 Jobs for
Year-Ended March 2011 (per BLS)

Home Sales Keep Bottom-Bouncing
Despite Having Covered Sales Lost to Stimulus Efforts

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Friday, October 7th.  It will cover the September employment and unemployment data. A Special Commentary likely will be included, if it has not been published earlier in response to escalating systemic instability.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  Economic reporting of the last week held few surprises with no change in the general economic outlook.  As discussed in recent Commentaries and the Hyperinflation Special Report (2011), the U.S. economy remains in its deepest and most-protracted downturn since the Great Depression, and chances for any meaningful improvement in broad economic activity remain nil for the foreseeable future.  The systemic solvency crisis and the structural issues with consumer income and liquidity continue to constrain broad consumption patterns as well as the demand for housing.

Payroll Benchmark Revision.  One surprise this week was today’s (September 29th) Bureau of Labor Statistics’ (BLS) preliminary upside benchmark revision to March 2011 unadjusted nonfarm payrolls.  The estimated 192,000 positive revision means a monthly-average understatement of 16,000 jobs since the March 2010 count.  I had expected a downside revision and will discuss that further in the Commentary of October 7th, which will cover the September 2011 payroll release.  The final benchmark will be published in February 2012.  The relatively small preliminary upside revision follows three consecutive larger downside annual revisions, and it should not affect current reporting (see Week Ahead section).

Online Help-Wanted Advertising.  Sending out negative signals on the labor market is the Conference Board’s online help-wanted advertising measure.  The no-longer-published newspaper help-wanted advertising index was one of the best leading indicators to employment and general economic activity.  The online measure still has a limited track record (since 2005) and may have some upside bias built into it from still-growing usage of the online medium for help-wanted ads.

That said, seasonally-adjusted total online help-wanted advertising fell for the fourth consecutive month in September, down by 11.2% or 524,000 job offerings since May.  September’s new ads, contracting in two of the last four months, were down 6.1% from May.  While I consider the new ads to be the better economic indicator, the pattern here is a negative one, in any event, for upcoming payroll reporting.

Initial Claims for Unemployment Insurance.  Despite repeated writings on the worthlessness of the individual weekly claims numbers (except for creating stock-market gyrations and financial-media frenzies), I constantly get queries as to what a big gain or loss in weekly jobless claims means.  Big weekly movements usually have no significance, because they most often are tied to the Department of Labor’s inability to make meaningful weekly seasonal adjustments, particularly around holidays, etc.

To make sense of the numbers, one has to look at some type of smoothing, such as a moving average, and the four-week moving average is the popular measure.  Based on today’s reporting (with a market-spiking sharp weekly decline), the four-week moving average was 417,000.  Going back to the beginning of the year, the first weekly reporting of January 2011 showed the four-week moving average at 418,000.

Further, in a depressed labor market, where payrolls stand below where they were 10 years ago, one cannot expect “benchmarks” from less-severe economic circumstances to be meaningful in the current environment.  Some analysts, for example, tout as a “rule of thumb” that weekly new claims below 400,000 signal growing employment.  That is simplistic at best, given the extraordinary magnitude of jobs already lost and in the context of underlying labor conditions such demand for new hires.

One needs to consider the balancing factor to new claims for unemployment insurance (basically layoffs): hiring.  The best indicator of current demand for labor is help-wanted advertising (see previous section), which has been in contraction for the last four months.

GDP.  With second-quarter growth still statistically indistinguishable from a quarterly contraction, the latest revision to second-quarter gross domestic product (GDP) took the headline growth rate back to the initial reporting of 1.3%, versus 1.0% in the first revision.  That was against 0.4% growth in the first-quarter.  Year-to-year growth slowed in the second-quarter to 1.6% from 2.2% in the first-quarter.

At the same time, gross domestic income (GDI)—the GDP’s theoretical equivalent—was revised lower.  The boost in GDP came from an upward revision estimated for vacation spending.  Only in the national income accounts (GDP, GDI, etc.) is that likely to happen alongside a downward revision in income.

New Orders for Durable Goods.  The 0.1% decline reported for August new orders for durable goods was no more than statistical noise, well within the scope of regular volatility for this series.

New Home Sales.  Enough time has passed for the short-lived gains from the housing stimulus measures—home sales borrowed from future activity—to have run their course, and the cost to future activity appears largely to have been paid.  Although such should be relatively positive for home sales, sales numbers continued bottom-bouncing in August, with new home sales in a new downtrend.  The housing issues remain tied to the systemic solvency crisis and to the structural liquidity issues hampering consumers and homeowners.

Combined existing and new home sales in August 2011 are now basically at the same level they were in August 2008 (the first month following the initial housing-stimulus enactment), and also as averaged over the intervening period.  The ensuing stimulated sales boosts and countervailing stimulus-expiration losses have averaged out to what otherwise would have been three-years of bottom bouncing (as seen in housing starts, Commentary No. 391). 

In August 2008, the first full month following enactment of the initial stimulus, total monthly (not the annualized pace used in the headline data), seasonally-adjusted home sales were 447.1 thousand (410.8 thousand existing homes, 36.3 thousand new homes).   The August 2011 number was 443.8 thousand (419.2 thousand existing homes, 24.6 thousand new homes), while the intervening average through all the sales gyrations was 444.9 thousand (416.1 thousand existing homes, 28.8 thousand new homes).  The greater relative weakness has been with the new home sales and related construction, which impact GDP directly.

As was widely recognized at the time, stimulus efforts to encourage home buying through tax breaks did little more than borrow activity from the future, moving it into the period of the stimulus.  Since August of 2008, following enactment of the first new homebuyer tax credit, home sales repeatedly surged and sank along with various stimulus efforts and expirations of same.  That volatility, perhaps, is most visible in the existing home sales graph among the three charts that follow.

Note in the two graphs of home sales that the downturns start in 2005, while the downturn in housing starts began to reflect the underlying market in early-2006, nearly two years before the official onset of the recession.  It is this weakness that led to the debt crisis in 2007, which, in turn, exacerbated the downturn.  It was not the debt crisis that triggered the recession.

 

 

Hyperinflation Watch—Financial System Instabilities Continue.  The financial markets and systemic conditions remain in turmoil and are extremely dangerous.  Various heads of state, finance ministers, central bankers, Treasury Secretary Geithner and Fed Chairman Bernanke continue to behave and talk as though the system is at risk.  It well may be, although Mr. Bernanke took no meaningful overt action last week to create new systemic liquidity.  A Special Commentary on the systemic liquidity crisis will be published before or with the October 7th Commentary on September labor conditions.

Repeated from the prior Commentary, there are no happy solutions available here, only tools—devil’s choices—for buying a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any overt change in policy.  The ultimate cost in propping the system, however, remains inflation.  The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and recent Commentaries, continue to unfold with outlooks that remain unchanged.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent a euro-area crisis from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The financial markets still are roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

__________

 

REPORTING DETAIL

 

NONFARM PAYROLLS (March 2011 Benchmark Revision, Preliminary Estimate)

BLS Estimated Average Understatement of 16,000 Jobs per Month for Year-Ended March 2011. The Bureau of Labor Statistics (BLS) published its preliminary estimate of the 2011 nonfarm payroll benchmark revision this morning (September 29th).  The initial not-seasonally-adjusted benchmarking for March 2011 indicated that payrolls had been understated by 192,000 (an average of 16,000 per month) since the prior benchmarking of March 2010.  The latest revision follows three years of larger downside benchmark revisions.

Final benchmarking detail will be published on February 3, 2012 (the January 2012 employment release).  The benchmarking should have no impact on monthly payroll reporting, prior to the January 2012 release, assuming traditional reporting patterns are followed.

 

GROSS DOMESTIC PRODUCT—GDP (Second-Quarter 2011, Third Estimate, Second Revision)

Reported GDP Growth Still Is Statistically Indistinguishable from Contraction.  As discussed in the Opening Comments and Executive Summary, the revised second-quarter GDP growth estimate remained statistically insignificant, while the revision itself was little more than statistical noise.  The consumption-side GDP revised higher by 0.3%, thanks largely to stronger personal consumption (recreation services—vacations), but the income-side-equivalent GDI revised lower by 0.2%.  Revisions at the same time for stronger consumption and weaker income are suggestive of possible internal discrepancies in the GDP model.

GDP.  Published today, September 29th, by the Bureau of Economic Analysis (BEA), the third-estimate or second-revision of second-quarter 2011 gross domestic product (GDP) showed annualized real quarterly growth of 1.33% (versus the second estimate of 0.99% and initial reporting of 1.28%) +/- 3% (95% confidence interval), versus an estimated annualized gain of 0.36% for first-quarter 2011.  Not annualized, second-quarter GDP growth revised to 0.33%, against a second estimate of 0.25% and initial reporting of 0.32%, and up from 0.09% in the first-quarter.  In this most worthless of major economic series, the reported annualized growth rates for the last two quarters are little more than statistical noise around the unchanged level.  They possibly have been massaged to keep the quarterly growth rates in minimally-positive as opposed to minimally-negative territory.

Year-to-year real change in second-quarter 2011 GDP retained its slowing trend, up by a revised 1.63%, versus a second estimate of 1.55% (that rounds to 1.5%) and initial reporting of 1.62%, and versus 2.24% in the first-quarter.  Such remained well off the near-term peak in reported growth of 3.51% in third-quarter 2010.

The estimate of the second-quarter GDP implicit price deflator (IPD) was revised to 2.59%, up from the second-estimate of 2.50% and initial reporting of 2.39%, versus 2.73% in the first-quarter.  In contrast, annualized seasonally-adjusted quarterly inflation for the CPI-U in the second-quarter eased to 4.09% from a seasonally-adjusted 5.22% in the first-quarter.  On a year-to-year basis, the second-quarter IPD was up by 0.64%, versus 0.67% in the first-quarter.  In contrast, second-quarter CPI-U surged to 3.43%, versus 2.14% in the first-quarter.

The lower the inflation rate that is used in deflating the GDP, the stronger is the resulting inflation-adjusted number and vice versa.  A slightly more realistic inflation number would have pushed the second-quarter GDP quarterly growth rate into negative territory.

The SGS Alternate-GDP estimate for second-quarter 2011 remains an approximate annual contraction of 2.8% versus the official revised estimate of a 1.6% gain.  Such is more negative than the alternate 2.6% annual contraction (2.2% official gain) in the first-quarter (see the Alternate Data tab).  While annualized real quarterly growth is not estimated formally on an alternative basis, a meaningful quarter-to-quarter contraction appears to have been realistic for the second-quarter, in what generally has been a protracted period of business bottom-bouncing.

GNP.  GDP is Gross national product (GNP) net of international flows in factor income (dividend and interest payments).  Although boosted by money-flow distortions from the ongoing systemic-solvency crisis, GNP growth still is statistically insignificant, with annualized real quarterly growth reported at a revised 2.16% (initially 1.70%) in the second-quarter, versus 1.45% in the first-quarter (0.54% [initially 0.42%] versus 0.36%, not annualized).   Year-to-year growth revised to 2.01% (initially 1.89%), versus 2.59% in the first-quarter.

GDI.  Gross domestic income (GDI) is the theoretical income-side equivalent to the GDP’s consumption-side.  Reflecting revised income reporting, the statistically-insignificant, annualized real quarterly growth in GDI revised lower to 1.34% (initially 1.55%) in the second-quarter, versus 2.45% in the first.  Year-to-year change revised to 1.94% (initially 2.00%) in the second-quarter, versus 2.55% in the first-quarter.

 

NEW ORDERS FOR DURABLE GOODS (August 2011)

August Durable Goods Orders Decline Still Included Strong Airplane Orders.  The Census Bureau reported September 28th that the regularly-volatile, seasonally-adjusted new orders for durable goods fell for the month by 0.1% (rose by 0.2% before prior-period revisions) in August 2011, following a revised 4.1% (previously 4.0%) gain reported for July.  August’s monthly contraction was despite a 23.5% jump in irregular, long-term nondefense aircraft orders, a category that showed a revised 49.9% (previously 43.4%) surge in July.  Airplane orders usually are placed years in advance of delivery and rarely impact near-term economic activity.

Unadjusted, year-to-year growth in total August 2011 new orders was 14.1%, versus a revised 9.5% (previously 9.2%) annual gain in July.  Current durable goods reporting remains subject to many of the same sampling and seasonal-adjustment problems that are seen with retail sales and payroll reporting.

The widely followed nondefense capital goods orders increased in August by 5.2% (up by 7.4% before prior-period revisions), versus a revised monthly 4.3% (previously 2.4%) increase in July.  For August, the unadjusted year-to-year growth in the series was 25.4%, up from July’s revised 13.8% (previously 12.5%) annual growth estimate.

 

EXISTING AND NEW HOME SALES (August 2011)

Three Years Later, All Housing Stimulus Gains Having Evaporated in Offsets.  Combined existing and new home sales in August 2011 are basically the same level they were in August 2008 (first month following the initial housing-stimulus enactment), and also as averaged over the intervening period.  The ensuing stimulated sales boosts and countervailing stimulus-expiration losses have averaged out to what otherwise would have been three-years of bottom bouncing.  Enough time has passed that paying for the “borrowed” sales has run its course.  While that could be a positive for home sales, ongoing weakness continues, reflecting the residential market still taking a full hit from the fundamental and ongoing consumer structural income problems and illiquidity (see discussion and graphs in Opening Comments and Executive Summary.

Existing Home Sales Bounce A Little Higher.  The September 21st release of August existing-home sales (counted based on actual closings, National Association of Realtors [NAR]) showed a seasonally-adjusted monthly gain of 7.7%, versus July’s unrevised decline of 3.5%.  On a year-to-year basis, August sales jumped by 18.6%, versus an unrevised 21.0% in July.  The relatively strong annual growth still reflects the lapsing of year-ago end-of-stimulus effects.

Foreclosure activity remained a major distorting factor for home sales, with "distressed" activity accounting for an estimated 31% of existing sales in the NAR’s August’s reporting, up from the 29% estimated for July.

August New Home Sales Showed a Further, Downtrending Bottom-Bounce. Consistent with the long-term negative trends in housing starts (see the prior Commentary No. 391 for August details), the September 26th release of August new-home sales (counted based on contract signings, Census Bureau) showed an ongoing pattern of a bottom-bounce at a slowing pace, nearing last year’s historic low.  August’s decline of 2.3% (down 1.0% before prior-period revisions) +/- 16.2% (95% confidence interval) from July was statistically insignificant.  In turn, July’s decline was revised to a 0.3% drop (previously down by 0.7%) versus June.  The year-to-year gain in August 2011 new-home sales was a statistically-insignificant 6.1% +/- 22.0% (95% confidence interval).  July’s annual gain was revised to 8.2% (previously 6.8%). 

As with existing homes sales, the positive annual change is due to the effects of the lapsing of housing stimulus efforts a year ago.  Also, part of the new sales volume is due to foreclosure activity, but the Census Bureau does not provide an estimate of foreclosure volume. 

The following graphs reflect a level of finer monthly detail than seen in the charts of the Opening Comments and Executive Summary.

 

Week Ahead.  Although still not fully acknowledged, there is both an intensifying double-dip recession and an escalating inflation problem.  Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Increasingly, previously unreported economic weakness should show up in prior-period revisions. 

Unemployment Rate and Payroll Employment (September 2011).  Nonfarm payrolls and the unemployment rate for September 2011 are due for release on Friday, October 7th.  This first major indicator of September economic activity likely will show continued deterioration in broad economic conditions.  A pattern of weaker-than-expected reporting, against likely soft consensus expectations for the labor market, is a fair bet to be seen with the September numbers.

Payrolls remain at risk of showing an outright monthly contraction, with the unemployment rate notching higher.  Yet, as seen with last month’s (August) zero monthly change in headline payrolls and unemployment rate, whatever is reported likely will include a payroll contraction and higher unemployment rate within the 95% statistical reporting confidence intervals (+/- 129,000 for payroll change, +/- 0.2% for the unemployment rate).   As has been the case for some time, unstable seasonal adjustments can distort the reported monthly changes in these series meaningfully.

The preliminary estimate of the 2011 payroll benchmark revision should have no bearing on near-term reporting.  The weakness in online help-wanted advertising (see Opening Comments and Executive Summary), though, is suggestive of outright monthly payroll contractions in near-term payroll reporting.

 

__________

 

COMMENTARY NUMBER 391
August Housing Starts

September 20, 2011

__________

Following a 75% Crash in Housing Industry,
Housing Starts Near Three-Years of Bottom-Bouncing

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Thursday, September 29th.  It will cover August home sales, new orders for durable goods and the second revision to second-quarter GDP.  A Special Commentary would be published, as appropriate, in response to any unusual market or economic developments.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  The U.S. economy remains in its deepest and most-protracted downturn since the Great Depression, and chances for any meaningful improvement in broad economic activity remain nil for the foreseeable future.  Constraining activity are the systemic solvency crisis and, most fundamentally, the structural problems with consumer income, where household income cannot keep up with inflation (see the Hyperinflation Special Report (2011) and Commentary No. 389).

One of the more heavily hit industries has been housing, where residential activity is a major driver behind such economic and financial elements as consumer and banking-system liquidity; retail sales ranging from home-decorating and yard-work needs to durable goods production and sales (washers, dryers, dishwashers, furniture, etc.); sales of lumber, wiring, concrete, construction equipment, etc.; and the full range of employment tied to those industries and of course to construction, real estate, banking, etc.  The economy, in turn, has taken secondary and tertiary hits on consumption and production from reduced spending by those whose financial circumstances have been impaired by housing industry woes.

As reflected by housing starts, industry activity peaked in 2005/early-2006 and then crashed by 75% through the end of 2008.  For nearly three years since December 2008—thirty-three months—industry activity has been bottom-bouncing, and the recent trend has been towards a renewed period of decline.

In a week light in major economic releases, this morning’s publication of the August 2011 housing starts data showed a statistically-insignificant, seasonally-adjusted monthly decline of 5.0% (down 5.8% year-to-year), to an annualized level of 571,000 starts.  The monthly average around which activity has been fluctuating since December 2008 is 572,000.  The monthly historical high for the series was 2,273,000 starts in January 2006, with the levels of the industry average since December 2008 and in August 2011 both down by 75% from that peak activity.

As shown in the following graphs, current monthly housing starts activity remains near the record monthly low seen for the present series in April 2009.  The current number also is well below any level reported in the predecessor nonfarm housing starts series, which was introduced in 1946.  The first graph shows recent detail for current housing starts activity, the second graph shows the same data within the historical context of the post-World War II period.

 

 

Hyperinflation Watch—No Way Out.  In efforts to forestall systemic collapse, central bankers, finance ministers and the U.S. Treasury Secretary openly have been discussing, proposing and announcing emergency funding/liquidity measures.  The U.S. Federal Reserve will make some form of policy-change announcement tomorrow, if market expectations are to be met, and Mr. Bernanke does his best not to disappoint the markets.  As discussed in the Hyperinflation Special Report (2011), there are no happy solutions available here, only tools—devil’s choices—for buying a little extra time.  From the Fed’s standpoint, keeping the banking system afloat remains its primary concern, although needs for economic growth and contained inflation will be given as the rationale behind any change in policy.  The ultimate cost in propping the system, however, remains inflation.

The root source of current global systemic instabilities largely has been the financially-dominant United States, and it is against the U.S. dollar that the global markets ultimately should turn, massively.  The Fed and the U.S. Treasury likely will do whatever has to be done to prevent a euro-area crisis from triggering a systemic collapse in the United States.  Accordingly, it is not from a euro-related crisis, but rather from within the U.S. financial system and financial-authority actions that an eventual U.S. systemic failure likely will be triggered, seen initially in a rapidly accelerating pace of domestic inflation—ultimately hyperinflation.

The economic and systemic-solvency crises and the broad inflation and economic issues detailed in the Hyperinflation Special Report (2011) and recent Commentaries, continue to unfold with outlooks that remain unchanged.

Repeated from the prior Commentary, the financial markets still are unstable and extremely volatile, roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

__________

 

REPORTING DETAIL

 

RESIDENTIAL CONSTRUCTION—HOUSING STARTS (AUGUST 2011)

Housing Starts Well into Third Year of Bottom-Bouncing.  The regularly volatile housing starts series continued its downside bottom-bouncing in August, having seen nearly three years of activity at 75% below 2006’s record construction level, with no relief in sight.  The Census Bureau reported this morning (September 20th) a statistically-insignificant monthly drop in seasonally-adjusted August 2011 housing starts of 5.0% (a decline of 5.5% before prior-period revisions) +/- 12.5% (all confidence intervals are at the 95% level).  July starts were revised to a 2.3% (previously a 1.5%) monthly decline. 

The year-to-year change in August starts was a statistically-insignificant decrease of 5.8% +/- 14.0%, following a revised annual 9.3% (previously 9.8%) increase in July.  The recent swings in the direction of annual change reflect comparisons with volatile year-ago monthly activity that was exaggerated in both directions by stimulus and post-stimulus effects.

With housing starts well into their third year of post-housing-market-crash bottom-bouncing, there remain no indications of a reprieve for the industry or the otherwise deteriorating broader economy.  Indeed, the pattern of housing starts has remained one of stagnation at an historically low-level plateau of activity, over the last 33 months.  The six-month moving-average of seasonally-adjusted housing starts was 580,000 in July, 10.2% above the historic low six-month moving-average seen in May 2009.  Significantly weaker monthly numbers remain likely in the months ahead.  Since December 2008, housing starts have averaged a seasonally-adjusted annual rate of 572,000.  In that period, all monthly readings have been within the normal range of monthly volatility for the aggregate series around that average, with the 571,000 August 2011 monthly reading at 0.2% below average.  Again, such is within the normal volatility of the series.

The regular graphs for the housing starts survey are included in the Opening Comments and Executive Summary section.

 

Week Ahead.  Though still not widely acknowledged, there is both an intensifying double-dip recession and a rapidly escalating inflation problem.  Until such time as financial-market expectations fully catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Generally, previously unreported economic weakness should show up in prior-period revisions. 

Home Sales (August 2011).  August existing home sales (National Association of Realtors) are due for release tomorrow, Wednesday, September 21st, while August new home sales (Census Bureau) are due for release on Monday September 26th.  As with the ongoing historic weakness seen in today’s housing starts release, both home sales series should remain extremely weak, with any positive monthly change lacking statistical significance (especially for the highly volatile new home sales series).  Also, as usual, given the extreme volatility, reporting error and revisions in both these series, given the poor-quality seasonal adjustments, given continuing negative anecdotal evidence, and given ongoing massive distortions from irregularly volatile foreclosure activity, the reported monthly movements in these numbers (particularly to the upside) generally are meaningless.

New Orders for Durable Goods (August 2011).  Due for release on Wednesday, September 28th, the highly volatile new orders for durable goods likely will not show a meaningful monthly change in August, with odds slightly favoring a renewed monthly decline in new orders.

Gross Domestic Product—GDP (Second-Quarter 2011—“Third” Estimate, Second Revision).  The “third” estimate of second-quarter GDP is due for release from the Bureau of Economic Analysis (BEA) on Thursday, September 29th.  Any revision at this point likely will be little more than statistical noise around the otherwise statistically-insignificant, previous headline estimate of 1.0% annualized real growth.

 

__________

COMMENTARY NUMBER 390
August CPI, Real Retail Sales, Industrial Production

September 15, 2011

__________

 

Consumer Inflation at Three-Year High 

August’s Annual Inflation: 3.8% (CPI-U), 4.3% (CPI-W), 11.4% (SGS)

“Core” Inflation Jumped Again with Some Acceleration

Real Retail Sales Fell 0.3% in August

August’s 0.2% Production Gain Was a 0.1% Loss Against Initial September Reporting

 

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Tuesday, September 20th.  It will cover August housing starts.  A Special Commentary would be published, as appropriate, in response to any unusual market, systemic or economic developments.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.   Inflation continues to increase, while the economy falters.  In today’s (September 15th) reporting, consumer inflation hit a three-year high, while annual “core” inflation—net of food and energy—rose for the 10th straight month and at an accelerating pace.  The inflation problem has been triggered by federal government fiscal malfeasance and Federal Reserve actions, with Fed policies aimed specifically at debasing the U.S. dollar.  The rising pace of inflation is due to perverse monetary policies; it does not reflect strong economic demand.

In current business activity, real (inflation-adjusted) retail sales contracted for August and are on track to contract for third-quarter 2011.  August industrial production slowed markedly, and showed a monthly gain only because of relative downside revisions to prior periods.

August CPI.  The seasonally-adjusted CPI-U rose by 0.37% for the month, up 3.77% year-to-year (versus 3.63% in July), while the seasonally-adjusted CPI-W rose by 0.42% for the month, up 4.26% year-to-year (versus 4.11% in July).  The SGS-Alternate Consumer inflation measures in August were 7.1% (1990-base) and 11.4% (1980-base).

As was seen last month, despite a seasonally-adjusted boost to otherwise weak gasoline prices, August CPI reporting reflected an ongoing spread of inflationary pressures well beyond the energy and food sectors, with the annual “core” inflation rate picking up at an accelerating pace, nearing 2.0%, as shown in the graph that follows.  This circumstance has to be distressing to Fed Chairman Ben Bernanke, who has taken official refuge in the “core” inflation concept, ignoring food and energy inflation.  Keep in mind that rising “core” inflation still reflects upside pricing pressures from the spreading effects of higher oil prices (driven by the Fed’s dollar-debasement policies), not from economic demand.  The Fed’s primary function remains keeping the banking system solvent.  Containing inflation and boosting economic activity are secondary goals.  The Fed, however, has not had much success in any of these areas, recently.

 

 

August Real Retail Sales.  With nominal (not adjusted for inflation) sales basically flat in August, the increase in the CPI-U caused a 0.33% monthly decline in the real retail series.  Annual growth slowed to 3.28% in August from 4.57% in September.  Given the pace of currently reported July and August sales, third-quarter 2011 is on track to show a quarterly decline versus the second-quarter, a pattern that easily could be followed by GDP reporting, as the double-dip becomes formalized.  There effectively has been no growth in retail sales in the last six months, other than what can be accounted for by rising prices, that is no growth in physical economic activity.   Continued weakening in the series is likely

August Industrial Production.  The August production number showed a 0.18% increase, versus a 0.90% increase in September, but the August level of activity was down by 0.12% from the initial reporting of September activity.  Revisions showed lower activity in the period since April 2011.  Continued weakening in this series also is likely in the months ahead.

 

Hyperinflation Watch.  With the still-unfolding economic and systemic solvency crises—as discussed in the recent Commentaries and repeated here—the broad inflation and economic outlooks detailed in the Hyperinflation Special Report (2011) continue to unfold and are unchanged.  To the extent that euro-area problems threaten to trigger a global or U.S. systemic collapse, the Fed—most likely with other parties—will create, spend, loan, or guarantee whatever money is needed to prevent a collapse.  This has been the case for some time, but the cost to the system is inflation, as discussed previously (Hyperinflation Report and Commentary No. 388, for example, links are elsewhere in this section).

The financial markets still are unstable and extremely volatile, roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

The usual graphs of gold versus the Swiss franc, oil and silver follow.  The effects of what likely will be short-lived Swiss National Bank intervention to prop the euro, and effectively the U.S. dollar, are evident in the first graph.  That circumstance is discussed in the Hyperinflation Watch of Commentary No. 388.

 

 

__________

 

REPORTING DETAIL

 

CONSUMER PRICE INDEX—CPI (AUGUST 2011)

Higher Oil Prices Permeating Broad Economic Activity.  Once again, despite a seasonally-adjusted boost to otherwise weak gasoline prices, August CPI reporting showed a continued spread of inflationary pressures well beyond the energy and food sectors, with the annual “core” inflation rate picking up at an accelerating pace.  Full CPI-U reporting in August showed the highest level of annual consumer inflation since September 2008.

CPI-U.  The BLS reported today (September 15th) that the seasonally-adjusted August 2011 CPI-U jumped by 0.37% (up by 0.28%, unadjusted) for the month.  That followed a gain of 0.50% (up by 0.09%, unadjusted) in July.  The August reporting reflected an unadjusted 0.5% drop (the Department of Energy reported an unadjusted 0.2% decline) in monthly average gasoline prices, but the unadjusted BLS estimate was turned into a seasonally-adjusted monthly gain of 1.9%, with gasoline-price seasonal-adjustment factors in a price-boosting mode.

August’s unadjusted year-to-year CPI-U inflation rose to 3.77%, from July’s 3.63%, the strongest pace of annual inflation since September 2008.

The August report also showed accelerating inflationary pressures from higher energy prices spreading further into the broad economy (see the graph and comments in Opening Comments and Executive Summary).  On an annual basis, “core” CPI-U inflation moved higher for the 10th straight month, up to 1.95% in August, versus 1.77% in July and 1.64% in June.  When Fed Chairman Bernanke used his jawboning in an effort to debase the U.S. dollar in the markets, in advance of announcing QE2 in November 2010, annual “core” inflation was at 0.61%.

Year-to-year total CPI-U inflation would increase or decrease in next month’s September 2011 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.16% gain in the adjusted monthly level reported for September 2010.  I use the adjusted change here, since that is how consensus expectations are expressed.  To approximate the annual unadjusted inflation rate for September 2011, the difference in September’s headline monthly change (or forecast of same) versus the year-ago monthly change should be added to or subtracted directly from August 2011’s reported annual inflation rate of 3.77%.  Annual CPI-U inflation should move to top 4% in the next couple of months.  The CPI-W broke that barrier in May and stood at 4.26% for August in today’s reporting.

CPI-W.  The narrower, seasonally-adjusted CPI-W, which has greater weighting for gasoline than does the CPI-U, rose by 0.42% (up by 0.29% unadjusted), following July’s gain of 0.59% (up by 0.07% unadjusted). 

Unadjusted, August 2011’s year-to-year CPI-W inflation was 4.26%, against a 4.11% annual increase in July.  The July and August annual CPI-W are the first two of three months to be averaged into the next Social Security cost of living adjustment (COLA), net of any residual deflation from recent years.

C-CPI-U.  The Chain-Weighted CPI-U—the fully substitution-based series that gets touted by CPI opponents and inflation apologists, including the recent presidential deficit commission and some members of Congress, as the replacement for the CPI in COLA adjustments—is reported only on an unadjusted basis.  Year-to-year inflation increased to 3.61% in August, up from 3.47% in July.

Alternate Consumer Inflation Measures. Adjusted to pre-Clinton (1990) methodology, annual CPI inflation was roughly 7.1% in August 2011, up from 7.0% in July, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to to about 11.4% (11.35% for those using the extra digit) in August, from about 11.2% in July. 

The SGS-Alternate Consumer Inflation Measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS (the series is not recalculated).  Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept.  Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the annual impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact not otherwise published by the BLS.

Gold and Silver Highs Adjusted for CPI-U/SGS Inflation.  Despite the September 5th historic-high gold price of $1,895.00 per troy ounce (London afternoon fix), and despite the multi-decade high silver price of $48.70 per troy ounce (London fix of April 28th), gold and silver prices have yet to re-hit their 1980 historic levels, adjusted for inflation.  The earlier all-time high of $850.00 (London afternoon fix, per Kitco.com) of January 21, 1980 would be $2,475 per troy ounce, based on August 2011 CPI-U-adjusted dollars, $8,639 per troy ounce based on SGS-Alternate-CPI-adjusted dollars (all series not seasonally adjusted). 

In like manner, the all-time high price for silver in January 1980 of $49.45 per troy ounce (London afternoon fix, per silverinstitute.org), although approached recently, still has not been hit since 1980, including in terms of inflation-adjusted dollars.  Based on August 2011 CPI-U inflation, the 1980 silver price peak would be $144 per troy ounce and would be $503 per troy ounce in terms of SGS-Alternate-CPI-adjusted dollars (again, all series not seasonally adjusted).

As shown on page 43 of the Hyperinflation Special Report (2011), over the decades, the price of gold has compensated for more than the loss of the purchasing power of the U.S. dollar as reflected by CPI inflation, while it has effectively fully compensated for the loss of purchasing power of the dollar based on the SGS-Alternate Consumer Price Measure (1980 Methodologies Base).

Real (Inflation-Adjusted) Retail Sales.  Based on the August 2011 CPI-U reporting, inflation- and seasonally-adjusted August 2011 retail sales declined by 0.33% for the month, where, before inflation adjustment, the current number was virtually unchanged, up by 0.04% (see Commentary No. 389).  Real July retail sales revised to a monthly decline of 0.23% (previously down by 0.03%, basically unchanged), where nominal (not-adjusted for inflation) sales in July revised to a gain of 0.27% (previously up by 0.47%). 

The average real retail sales level for July and August (the first two months of the third-quarter) was down by 0.18% (annualized real quarterly decline of 0.73%) versus the average for second-quarter 2011, a negative indicator at this point in time for third-quarter GDP.  Second-quarter real retail sales were up by 0.14% (0.58% annualized) from first-quarter 2011.

August’s real retail sales rose at a year-to-year pace of 3.28%, versus a revised 4.57% (previously 4.77%) annual gain reported for July. 

The ongoing “recovery” in real retail sales is reflected in the following graphs, which show the latest monthly levels of inflation- and seasonally-adjusted activity.  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.

 

 

As noted in earlier writings, using the SGS Alternate-CPI Inflation estimates for deflation of the retail series would not have shown an ongoing rise in activity for the last year or so.  It is my preference here, and wherever otherwise possible, to use the official estimates (the series here is as calculated by the St. Louis Fed), since that eliminates a level of argument over what is being reported.  As official consumer inflation picks up, and as overall retail sales suffer from the ongoing consumer liquidity squeeze, these data have started to turn down in what will become eventually an official and formal double-dip recession. 

There has been no change in underlying fundamentals that would support a sustainable turnaround in personal consumption or in general economic activity—no recovery—just general bottom-bouncing.  Accordingly, real retail sales levels in the months ahead should become increasingly negative.

Real Money Supply M3.  The signal of the still unfolding double-dip recession, based on annual contraction in the real (inflation-adjusted) broad money supply (M3), most recently discussed in the Hyperinflation Special Report (2011), continues and is graphed below.  Based on the August CPI-U report and the latest August SGS-Ongoing M3 Estimate, the annual contraction in real M3 for August 2011 was 1.5%, somewhat deeper than the 1.2% annual contraction in July.

The signal for a downturn or an intensified downturn is generated when annual growth in real M3 first turns negative in a given cycle; the signal is not dependent on the depth of the downturn or its duration.  The current downturn signal was generated in December 2009.  The broad economy tends to follow in downturn or renewed deterioration roughly six-to-nine months after the signal, as has appeared to have started in recent months.  Weakness in a number of series should become increasingly evident in the months ahead, eventually leading to recognition of a double-dip recession.

 

 

INDUSTRIAL PRODUCTION (AUGUST 2011)

August Industrial Production Received a Relative Boost from Earlier Downside Revisions.  Today’s (September 15th) Federal Reserve Board release of seasonally-adjusted August 2011 industrial production showed a monthly gain of 0.18% (a loss of 0.12% net of prior-period revisions) versus July.  In turn, the monthly change in July production was revised to a 0.90% (previously a 0.91%) gain.  The slower growth rate reflected the lack of or reversal of one-time events seen in July (an unusual-heat-induced utility spike and some catch up in auto assembly, as assembly parts from Japan re-entered the system).

Year-to-year growth in August 2011 production was 3.35%, down from a revised 3.39% (previously 3.70%) July 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 preceding 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.

 

Week Ahead.  Though still not widely acknowledged, there is both an intensifying double-dip recession and a rapidly escalating inflation problem.  Until such time as financial-market expectations fully catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Generally, previously unreported economic weakness should show up in prior-period revisions. 

Housing Starts (August 2011).  August residential construction data are due for release on Tuesday, September 20th.  The historic weakness in housing starts should continue, again with an intensifying downtrend.  As seen generally in the last several years, any upside movement likely will not be statistically meaningful.

 

 

__________

COMMENTARY NUMBER 389
August Retail Sales, PPI, 2010 Household Income

September 14, 2011

__________

Flat August Retail Sales Most Likely Were Down Net of Inflation

Real Median Household Income Drops to 15-Year Low (Below 1969 Level, CPI-U Adjusted)

Volatile PPI Reporting Flat for Month, Up 6.5% for Year

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for tomorrow, Thursday, September 15th.  It will cover the August CPI and industrial production.  A Special Commentary would be published, as appropriate, in response to any unusual market or economic developments.

—Best wishes to all, John Williams

 

 

Hyperinflation Watch.  With the still unfolding economic and systemic solvency crises—as discussed in the recent Commentaries and repeated here—the broad inflation and economic outlooks detailed in the Hyperinflation Special Report (2011) continue to unfold and are unchanged.  The general outlook will be reviewed in tomorrow’s September 15th Commentary. 

The financial markets still are unstable and extremely volatile, roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

__________

 

REPORTING DETAIL

 

 

 

HOUSEHOLD INCOME (2010 POVERTY SURVEY)

Household Income and Liquidity Deteriorated Sharply in 2010.  Some of the text that follows is repetitive from prior years; the story varies little.  The U.S. Census Bureau published Income, Poverty, and Health Insurance Coverage in the United States: 2010 (Poverty Report), yesterday, September 13th.  The value of this report is in its estimates of household income and income variance, not in its poverty estimates.  Annual poverty reporting per se is not too meaningful, where the structure of the reporting is highly subjective.  Not too surprisingly, more people were reported in poverty as of 2010 than as of 2009.

Measuring “poverty” is difficult, at best, when few can agree on a definition.  There are many who do not consider themselves to be poor, even though they meet the government’s standards, while others think they are poor but are not so defined.  Separately the whole process has been heavily influenced by politics, with even some short-term efforts at impacting the numbers.  For example, the survey’s inner-city sampling size was reduced (with Congressional oversight) during the Clinton Administration, and then re-expanded at the end of the Clinton era. 

The actual survey usually is piggy-backed on the March household unemployment survey of the year following the reported data.  So the March 2011 survey of 2010 data is what was published yesterday. What follows is brief update of the numbers.

Rising Income Dispersion Usually Foreshadows Economic and Financial Market Turmoil.  Measures of income dispersion, or variance, indicate how income is distributed within a population.  A low level of income dispersion indicates that income tends to be concentrated in the middle, while a high level of dispersion indicates heavier income concentrations in the extremes of low and high income, with less in the middle.  The higher the variance of income is, as shown in the graph, the greater is the income dispersion.

Generally, the more moderate the income variance is, the stronger the middle class is, and the healthier the economy will be.  Conversely, the greater the variance in income is, the more negative are the longer term economic implications.  A person earning $100,000,000 per year is not going to buy proportionately more automobiles than someone earning $100,000 per year.  

 

Conditions surrounding extremes in income variance usually help to fuel financial-market bubbles, followed by financial panics and economic depressions.  The sequence of those factors tends to redistribute income in a manner that usually lowers income variance.   Other than for a brief dip following the 1987 stock-market crash, however, U.S. income variance since 1987 has been higher than has been estimated for the economy going into the 1929 stock-market crash and the Great Depression, and its current reading remains nearly double that of any other "advanced" economy.  Variance increased further in 2010.

Shown in the preceding graph are the Gini Index of Income Inequality and the Mean Logarithmic Deviation of Income (MLD), two of the more popular income dispersion series.  Some of the finer points and mathematics behind several of the income variance measures are covered in the Census Bureau’s article: The Changing Shape of the Nation’s Income Distribution.

The increase of income dispersion in 2010 to record or near-record highs for both series, despite the ongoing economic and systemic liquidity crises, suggests that the greatest negative impact of the systemic turmoil, so far, has been on those in the middle-income area.  It also is suggestive of even greater financial crises still ahead.

Household Income Fell in 2010; Real Household Income Has Fallen Back to 1996/1997 Levels (1969 Level Deflated Using CPI-U).  Consumer liquidity remained in contraction during 2010, with both household income and consumer credit tumbling in nominal and real terms (not adjusted and adjusted for inflation).  Constrained consumer liquidity usually results in restrained personal consumption, as suggested by today’s August 2011 retail sales report.

The next two graphs show inflation-adjusted median and mean levels of household income from 1967 through 2010.  The median measure is the middle measure of the survey and likely is a better reflection of how most households are doing.  When the income dispersion measure is high, the mean, or average, measure tends to be skewed (in this case to the upside).  Nonetheless, both measures showed sharp declines in 2010, adjusted for inflation.  On a real basis, neither series has topped the annual high levels seen before the 2001 recession, with real median and mean household incomes hitting their respective tops in 1999 and 2000.  As discussed in the Opening Comments, on a real basis using the CPI-U, median household income in 2010 was below its level of 1969.

 

 

 

COMMENTARY NUMBER 388
July Trade Deficit, Turmoil in Financial Markets

September 8, 2011

__________

July Trade Deficit Suggests Possible Positive Contribution to Third-Quarter GDP

Swiss Intervention Unlikely to Have Lasting Impact

__________

 

PLEASE NOTE: The next regular Commentary is scheduled for Wednesday, September 14th.  It will cover the release of the 2010 poverty report, and August 2011 retail sales and PPI.  A subsequent Commentary on Thursday, September 15th, will cover the August CPI and industrial production.  A Special Commentary would be published, as appropriate, in response to any unusual market or economic developments.

—Best wishes to all, John Williams

 

Opening Comments and Executive Summary.  In a relatively quiet week for economic releases, today’s (September 8th) estimate of July’s trade deficit had positive implications for an otherwise increasingly bleak outlook for third-quarter GDP.  The sharp monthly narrowing in the July number reflected a gain in exports and a contraction in imports; the latter category was helped by lower oil prices and physical import volume.  Revisions showed minimally smaller monthly deficits for January through June 2011 than previously had been reported.

The trade series, however, has been showing unusual volatility recently, and a repetition of the July number in August is not a good bet.  A significant widening in the August deficit would eliminate the possible positive impact on GDP offered by today’s number.

Areas of ongoing greatest concern, at the moment, are financial-market and financial system instabilities.  Economic and inflation conditions will be updated with next week’s economic releases and associated Commentaries.

 

Hyperinflation Watch—Market Turmoil Reflects Systemic Instabilities and Dangers.  The U.S. and global financial markets remain extraordinarily volatile and unstable, with systemic instabilities offering the potential, again, of systemic failure.  Following the collapse of Lehman in 2008, the U.S. Treasury and the Federal Reserve committed to preventing a systemic collapse at any cost.  They created and spent, loaned or guaranteed whatever money was needed to forestall systemic failure, kicking the proverbial can down the road.  Most of the actions taken then and since, however, were stopgap measures; little was done to address the systemic and economic crises fundamentally.  At present, the system has moved enough further along the road that the can likely will be kicked again.  Now, though, the road ahead drops off a cliff, well within current kicking distance.

To the extent that the systemic-solvency crisis in the euro area threatens a global and/or U.S. systemic collapse, or where the ongoing U.S. systemic-solvency crisis comes to a head, the Federal Reserve likely will stand ready as the lender or liquidity-provider of last resort—overtly or covertly—to prevent such an event, as it did in 2008/2009 and beyond.  For the Fed, systemic failure is not an option. 

Facing what looks to be a strongly anti-incumbent 2012 election, those controlling the federal government likely will push hard for some form of new stimulus to counter an unfolding and unavoidable double-dip recession, irrespective of deficit-reduction talk.  President Obama is due to offer a new jobs program in a speech tonight.

As with the earlier emergency measures, any further stimulus or liquidity actions now by the federal government and/or the Federal Reserve likely will have limited positive impact on the crises, but they will have an ultimate cost to the United States in inflation.  Accordingly, legitimate investor fears have been reflected in safe-haven flight of capital into gold and the Swiss franc, particularly since the debt-ceiling/ deficit-reduction deal at the beginning of August. 

With the Swiss franc soaring against other currencies—particularly against the U.S. dollar and the euro—the Swiss National Bank took a number of actions, including jawboning, to quell the pro-franc speculation.  On Tuesday (September 6th), in an act of desperation, the SNB announced something akin to a fixed exchange rate for the franc versus the euro, where the SNB actively would support a floor value of the euro versus the franc.

It is highly unlikely that the SNB really wants to destroy the franc or to disrupt Switzerland’s long history of fiscal prudence.  If they wanted to do that, they would have joined with the euro a long time ago, and now would be suffering the same trials and tribulations as the Bundesbank in the euro crisis.  Instead, as has happened at other times when the franc has been “too strong,” short-term action has been taken to psych-out the markets, to discourage those wanting to hold francs.  Intervention against market demand, however, as is required here, quickly becomes extremely expensive and disruptive to the intervener’s financial system.  Accordingly, the quasi-franc-euro-fix should prove to be short-lived, and the SNB knows that.  Intervention and other measures are discussed on page 62 of the Hyperinflation Special Report (2011).

As discussed in the recent Commentaries and repeated here, the broad inflation and economic outlooks detailed in the Hyperinflation Special Report (2011) continue to unfold and are unchanged.  The financial markets still are unstable and extremely volatile, roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

 

 

__________

 

REPORTING DETAIL

 

TRADE BALANCE (JULY 2011)

July Trade Data Suggest A Potential Positive Contribution to Third-Quarter GDP Growth.  The monthly narrowing of July’s reported trade shortfall would be a plus for third-quarter GDP reporting, should it be repeated next month.  The series, however, has been showing unusual volatility in recent months, tied to the Japanese earthquake, and to oil and gold price variations, and I still expect the general trend in the U.S. trade deficit to be one of net deterioration.  Revisions showed minimally smaller monthly deficits for January through June 2011 than previously had been reported.

Nominal (Not-Adjusted-for-Inflation) Trade Deficit.  The Bureau of Economic Analysis (BEA) and the Census Bureau reported this morning (September 8th) that the nominal, seasonally-adjusted monthly trade deficit in goods and services for July 2011 narrowed to $44.8 billion from a revised $51.6 (previously $53.1) billion in June.  The narrower July deficit and the revised June number were in the context of general revisions that reduced the magnitudes of trade deficits reported previously in first- and second-quarter 2011.  The July 2011 deficit widened from an unrevised $41.8 billion in July 2010.

Against June, the July trade balance showed a gain in exports and a decline in imports.  Lower oil prices and physical import volume helped to dampen import activity for the month.  Specifically, for the month of July 2011, the not-seasonally-adjusted average price of imported oil was $104.27 per barrel, down from $106.00 in June 2011, but up from $72.09 in July 2010.  In terms of not-seasonally-adjusted physical oil imports, July 2011 volume averaged 9.067 million barrels per day, down from 9.889 million in June 2011, and down from 9.937 million in July 2010.

Real (Inflation-Adjusted) Trade Deficit.  Adjusted for seasonal factors and net of oil price swings and other inflation (2005 chain-weighted dollars as used in reporting real GDP), the reported July 2011 merchandise trade deficit came in at $45.3 billion, down from a revised $50.3 (previously $50.9) billion in June, and down from a monthly average of $47.3 billion in second-quarter 2011.

Based on just one-month’s reporting, the annualized deficit for the third-quarter would be $543.3 billion, down from the full reporting of a revised annualized real second-quarter 2011 merchandise deficit of $567.4 (previously $569.7) billion.  The potential quarterly narrowing of the deficit would be a positive for the GDP’s net export account and, accordingly, for third-quarter GDP reporting.

 

Week Ahead.  Though still not widely acknowledged, there is both an intensifying double-dip recession and a rapidly escalating inflation problem.  Until such time as financial-market expectations fully catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Generally, previously unreported economic weakness should show up in prior-period revisions. 

Annual Poverty Report (2010).  Due for release on Tuesday, September 13th, the 2010 annual poverty survey should show some deterioration in most measures of poverty and household income.  Look for ongoing declines in inflation-adjusted median and mean household income, as well as movement to a new extreme in income variance (shifting of income to lower and higher levels from the middle).

Retail Sales (August 2011).  Due for release on Wednesday, September 14th, the August 2011 retail sales report is at fair risk of coming in below likely strong consensus estimates.  In any event, consistent with reporting of recent months, any reported monthly retail sales gain should result primarily from higher prices, with a flat-to-minus showing for the month, net of inflation effects.

Producer Price Index—PPI (August 2011).  The release of the August 2011 PPI is scheduled for Wednesday, September 14th.  Finished goods inflation should top a likely soft consensus outlook, due to supportive seasonal factors for gasoline prices, and to the effects of still-spreading broader inflationary pressures from higher oil prices.

Consumer Price Index—CPI (August 2011).  The release of the August 2011 CPI is scheduled for Thursday, September 15th, and it again is at fair risk of topping what likely will be a relatively soft consensus outlook.  At work here will be a continued boost to gasoline prices from seasonal adjustments, while further inflationary pressures from the Fed-induced jump in oil prices continues to spread in the general, non-“core” economy.

Specifically, in terms of gasoline, unadjusted retail prices fell on average by 0.2% in August 2011 (Department of Energy).  Paralleling what should be similar seasonal impact in 2011 reporting, a 0.4% unadjusted monthly gain in August 2010 was boosted to a 3.9% increase after seasonal adjustments.

The reported, unadjusted, total year-to-year CPI-U inflation would increase or decrease in August 2011, dependent on the reported seasonally-adjusted monthly change, versus the 0.21% gain in the adjusted monthly level reported for August 2010.  I use the adjusted change here, since that is how consensus expectations are expressed.  To approximate the annual inflation rate for August 2011, the difference in August’s headline monthly change (or forecast of same) versus the year-ago monthly change should be directly added to or subtracted from July 2011’s reported annual inflation rate of 3.63%.  For example a 0.4% gain in the monthly CPI-U inflation should push annual August inflation up to about 3.8%.

Industrial Production (August 2011).  The release of August 2011 industrial production also is scheduled for release on Thursday, September 15th.  One-time factors (relatively extreme utility usage and the resumption of Japanese car assemblies in the United States) that boosted the initial estimate of July production by 0.9% are not likely to be repeated in the latest numbers.  Accordingly, August’s monthly change could be flat to minus, as the broad economy begins its formal double-dip recession.

 

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COMMENTARY NUMBER 387
August Employment, Unemployment, M3

September 2, 2011

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August Payrolls Were 58,000 Below the July Payroll Levels Reported One Month Ago

Concurrent Seasonal-Factor Adjustments Mute Bad News

August Unemployment Rates: 9.1% (U.3), 16.2% (U.6), 22.8% (SGS)

Money Supply M3 Growth Slowed in August

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PLEASE NOTE: The next regular Commentary is scheduled for Thursday, September 8th.  It will cover the release of U.S. trade balance details for July 2011.  A Special Commentary would be published, as appropriate, in response to any unusual market or economic developments.

—Best wishes to all for an enjoyable holiday weekend, John Williams

 

Opening Comments and Executive Summary.  The U.S. employment picture is much worse than reported, thanks partially to the Bureau of Labor Statistics’ (BLS) use of gimmicked revisions, which are a natural fallout of the “concurrent” seasonal-factor adjustment concept used in the payroll survey (also used by other statistical bureaus in reporting series such as retail sales and new orders for durable goods).  The effect has been to mute the reported impact of layoffs, with the result that today’s (September 2nd) seasonally-adjusted downside revisions to recent employment levels were shy by at least 85,000 jobs. 

Teacher Layoffs.  Consider new teacher layoffs reported for July.  Presumably better information led to today’s 116,000 downside revision to July’s not-seasonally-adjusted level of teacher payrolls.  As of July 2011 reporting—with many teachers on regular seasonal holiday—seasonal factors added roughly 17% to aggregate unadjusted July teacher payroll numbers. The unadjusted 116,000 downside revision to those payrolls would have been translated into a seasonally-adjusted 135,000 reduction, based on the original July 2011 seasonal adjustments.

With old-line seasonal-adjustment approaches, monthly seasonal adjustments were stable and not constantly recalculated.  Yet, with “concurrent” calculations, readjustments are made every month.  The unusually large layoff revisions were recalculated in August’s system as part of the “new normal,” with the effect of upping July’s seasonal adjustments for aggregate teacher payrolls and reducing the impact from the newly reported layoffs to an adjusted 50,000.  Non-regular teacher layoffs of 135,000 based on July’s initial adjustments were muted to 50,000 (a difference of 85,000 jobs) simply by the recalculation of seasonal factors in a system that treats current layoffs as part of the ongoing normal business cycle.

Prior-Period Revisions—Inaccurate Data Published in BLS Reporting.  Other, related reporting issues for the headline jobs-growth number were evident in today’s estimated monthly payroll change of 0 +/- 129,000 for August 2011.  Consider that the headline number published last month reflected July 2011 payrolls at 131.190 million, a monthly gain of 117,000.  With today’s August payrolls at 131.132 million, one might think that payrolls contracted by 58,000 for the month, but with a fortuitous downside revision of July’s payrolls to 131.132 million, the August number was unchanged.

Along with those revisions, July’s initial gain of 117,000 jobs revised to 85,000, and June’s gain of 46,000, as reported last month, revised to 20,000.

That June number, however, deliberately was misleading.  The BLS recalculates the seasonally-adjusted payroll levels each month, but it only publishes the last two months of revised estimates, so as not to “confuse” users of the data.  The recalculated level for May payrolls was about 131.003 million, not the published 131.027 million.  So June’s gain of 20,000 really was 44,000, but May was weaker than currently published.  May’s monthly gain now is 30,000, instead of the 51,000 indicated officially by the BLS (see the first section under Employment and Unemployment (August 2011) in the Reporting Detail.

August Employment and Unemployment Show Economic Bottom-Bouncing.  Although the BLS might be signaling a toss-up between improving and deteriorating labor market conditions, the U.S. economy continues in a downtrending bottom-bounce, with the odds strongly favoring ongoing deterioration in employment and in the unemployment rate.

There is enough rounding and guesstimating made with the BLS estimate of payroll levels to bring in the monthly payroll change at a small gain or small contraction, as opposed to exactly unchanged.  With a 95% confidence interval of +/- 129,000 around zero growth, the BLS is suggesting equal odds for employment growing or declining.  Whatever employment is doing, though, it is doing such from a lower level (see revisions discussion) than it was last month. 

Not only was the monthly employment gain unchanged, but so too was headline unemployment rate, at the second decimal point, 9.09% +/- 0.23%.  Again even-money is suggested as to actual improvement or deterioration, per the BLS.

With the biases and distortions built into the BLS reporting, ongoing actual deterioration remains a solid bet.  There also are suggestions of weakening labor conditions, from ongoing monthly contractions in the Conference Board’s still-nascent measure of online help-wanted advertising (the newspaper index has been discontinued), and from patterns of slowing employment (approaching contraction) in recent purchasing managers surveys.

Most important, though, the consumer’s structural liquidity problems are ongoing.  Actual income growth continues to lag rising inflation, while many consumers still lack the ability to expand their debt in order to make up shortfalls in maintaining standards of living.  Without positive growth in real income and/or debt, chances remain nil of any meaningful uptick in business activity.

 

Hyperinflation Watch—Money Supply Growth Is Not Picking Up.  As the U.S. economic crisis continues to deepen, so too does the U.S. solvency crisis.  Aggregate bank lending is flat, likely much more heavily due to balance sheet issues with banks than due to a lack of credit-worthy borrowers.

Fed Easing Remains Likely.  With ongoing economic and systemic solvency crises, the Fed remains likely to institute some new form of liquidity injection for the banking system, soon.  That action, though, should continue under the guise of trying to stimulate the economy.  Neither the Fed nor the Administration is in a position to put forth meaningful economic stimulation, although action by both entities increasingly is expected by the markets and/or the electorate.  As a point of clarification, I am not advocating any actions, only offering my opinion as to what likely will unfold.

As discussed in the regular Commentaries, the broad inflation and economic outlooks detailed in the Hyperinflation Special Report (2011) continue to unfold and are unchanged.  The financial markets still are unstable and extremely volatile, roiled by deepening crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even to address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

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REPORTING DETAIL

 

 

 

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COMMENTARY NUMBER 386
GDP Revision, July Durable Goods Orders and New Home Sales

August 26, 201

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Revised Second-Quarter GDP Change Remained Statistically Insignificant
—Could Have Been a Contraction as Easily as a Gain

Money Supply M2 Surge Reflects Shift from Large M3 Accounts

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PLEASE NOTE: The next regular Commentary is scheduled for Friday, September 2nd.  It will cover the release of employment and unemployment data for August 2011.  A Special Commentary would be published, as appropriate, in response to any unusual market or economic developments.

—Best to all, John Williams

 

Opening Comments and Executive Summary.   The economic data of the last week held no real surprises, although the smallest variation against the consensus outlook often is hyped to move the broadly irrational U.S. stock market.  The small decline in July new home sales and the gain in July new orders for durable goods were within the normal volatility of those series, and did not signal any change in the general economic outlook.  The downside revision to the estimate of second-quarter GDP growth was no more than statistical noise in a generally worthless series.

There has been a pattern developing in the Federal Reserve’s weekly money supply reporting, however, that is worthy of note, with surging M2 growth being reported in the Fed’s now-broadest money measure.  The growth largely can be accounted for by an apparent flight from large time deposits and institutional money funds (officially ignored components of the Fed’s once-broadest money measure, M3).  The cash flows here are suggestive of concerns over banking-system solvency (see Hyperinflation Watch).

The global financial markets remain unstable and highly volatile.  The cautions of recent Commentaries remain in place, as do the general outlooks for the U.S. economy, inflation, systemic-solvency and dollar. 

GDP Revision.  The reported growth in the revised second-quarter 2011 GDP was statistically meaningless, as usual, with the 95% confidence interval around the reported growth easily encompassing a possible quarterly contraction.  The revision itself was little more than statistical noise.

Annualized real (inflation-adjusted) quarterly growth in second-quarter GDP was lowered to 0.99% from 1.28%, versus an annualized growth rate of 0.36% in the first-quarter.  Year-to-year growth slowed further to 1.55% (previously 1.62%), versus 2.24% reported for the first-quarter.

The downside revision reflected a weakening trade picture (see Commentary No. 384) and a downward revision to inventories, offset by an upside revision to healthcare and commercial construction.  None of those components are measured meaningfully by the Bureau of Economic Analysis (BEA), in this most heavily followed, most heavily massaged and most worthless of government economic series. 

Initial reporting of second-quarter gross national product (GNP) and gross domestic income (GDI) showed stronger annualized real quarterly growth rates than reported for the GDP.  Neither alternate measure was statistically meaningful.  Money flow distortions from the ongoing systemic-solvency crisis have boosted GNP, with revamped income estimates impacting GDI. 

 

The broad inflation and economic outlooks discussed in the Hyperinflation Special Report (2011) continue to unfold and are unchanged.  As noted in recent Commentaries, the financial markets remain unstable and extremely volatile, roiled by crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of further near-term extreme volatility in the U.S. dollar—in either direction—versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even address its uncontainable fiscal condition; with the federal government and Federal Reserve standing ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

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REPORTING DETAIL

 

 

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COMMENTARY NUMBER 385
July CPI, PPI, Industrial Production and Housing Starts

August 18, 2011

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Inflation Spreads Throughout Economy as Annual “Core” Inflation Jumps Again

Consumer Inflation at 33-Month High 

July’s Annual Inflation: 3.6% (CPI-U), 4.1% (CPI-W), 11.2% (SGS)

Retail Sales Gain Vanishes, Net of Inflation

Unusual Heat and Japanese Auto Assembly Parts Boosted Production

Housing Activity Remains Moribund

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PLEASE NOTE: The next regular Commentary is scheduled for Friday, August 26th.  It will cover the first revision to the second-quarter 2011 GDP estimate, July 2011 new orders for durable goods and new home sales.  A Special Commentary would be published, as appropriate, in response to any unusual market or economic developments.

—Best to all, John Williams

 

 

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REPORTING DETAIL

 

Week Ahead.  Though still not widely acknowledged, there is both an intensifying double-dip recession and a rapidly escalating inflation problem.  Until such time as financial-market expectations fully catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Generally, previously unreported economic weakness should show up in prior-period revisions. 

New Home Sales (July 2011).  July existing home sales (National Association of Realtors) were released today, August 18th, and are covered above.  July 2011 new home sales (Census Bureau) are due for release on Tuesday, August 23rd.  As with the ongoing historic weakness in housing starts and existing sales, the volatile new home sales series should remain extremely weak, with any positive monthly change again lacking statistical significance.  Also, as usual, given the extreme volatility, reporting error and revisions in both these series, given the poor-quality seasonal adjustments, given continuing negative anecdotal evidence, and given ongoing massive distortions from irregularly volatile foreclosure activity, the monthly movements in these numbers (particularly to the upside) remain meaningless.

New Orders for Durable Goods (July 2011).  Due for release on Wednesday, August 24th, July’s new orders for durable goods likely will not show a meaningful monthly change, with odds slightly favoring ongoing decline in this irregularly volatile series.

Gross Domestic Product—GDP (Second-Quarter 2011—“Second” Estimate, First Revision).  The “second” estimate of second-quarter GDP is due for release from the Bureau of Economic Analysis (BEA) on Friday, August 26th.  Based on the June trade data (see Commentary No. 384), a downside revision to the initial 1.3% estimate of real, annualized quarterly GDP growth is a fair possibility.

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COMMENTARY NUMBER 384
Markets, July Retail Sales, June Trade Balance

August 12, 2011

__________

Financial Circumstances Remain Unstable and Threatening

U.S. Dollar Is in Serious Trouble

Retail Sales Gain Was Statistically Meaningless and Largely Reflected Inflation

Trade Data Suggest Downside Pressure on Upcoming GDP Revision

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PLEASE NOTE: The next regular Commentary is scheduled for Thursday, August 18th.  It will cover July 2011 CPI, PPI, industrial production and housing starts.  A Special Comment would be published, as appropriate, in response to any unusual market or economic developments.

—Best to all, John Williams

 

Opening Comments and Executive Summary.   The U.S. markets have not reacted well to the significant loss of global confidence in the U.S. dollar and in the U.S. government, and to the growing concerns of intensifying economic and systemic-solvency crises.  The unfolding crises of the last couple weeks have been exacerbated by comments out of the Fed and the Administration, who have no realistic, short-term positive options to offer to the system and the markets. 

The extreme volatility in a number of markets has reflected massive crosscurrents, shifting positions and covert and overt interventions by governments and central banks.  Ahead will be still further extreme volatility in the U.S. dollar against the stronger currencies and against gold.  At such time as intervention eases and somewhat normal market pressures come into play, the dollar should lose out.  The U.S. currency increasingly will come under broad selling pressure, regularly setting historic lows against the Swiss franc, the Canadian dollar and the Australian dollar, while the gold price will move higher, setting successive historic highs.  Oil prices—in dollar terms—also likely will rally sharply against the weakening dollar.  Again, this is the longer-term picture, beyond the current, panicked markets.

There have been heavy intervention, jawboning and overt actions to prop the U.S. dollar.  After the dollar pushed to successive historic lows against the Swiss franc—despite near-term efforts by the Swiss National Bank (SNB) to debase the franc—the SNB went so far as to threaten to peg the franc to the euro.  Such actions against market forces tend to be short-lived at best.  If the franc were pegged to the euro, the intervention needed to maintain that relationship would become prohibitively expensive, very quickly, for the SNB, as the Swiss central bank effectively would be intervening to prop the euro.  

Beyond the currency markets, it has been decades since the U.S. financial markets could have been considered free and open.  Accordingly, when major overt and covert interventions come into play, it is nonsensical for the financial media to hype fundamental interpretations to those rigged movements.  The President’s Working Group on the Financial Markets (PWGFM) is active, and official interventions and market machinations have been at play to stabilize the markets, although the specifics usually are not announced.

Suspect actions have seen at least twice in U.S. stock market trading during the last week.  First was the late-afternoon rally on Friday, August 5th, in advance of the S&P announcement of the downgrade to the U.S. sovereign debt rating.  The U.S. government knew the downgrade was coming.  If, as indicated by Allen Greenspan that the PWFGM intervened in the markets as the news was breaking on the planned invasion of Iraq, it most likely also would have acted in advance for something as market-rattling as the downgrade.  Second was the stock rally following the FOMC announcement on August 9th.  Interventions purportedly are worked through purchases of stock futures, handled by large, former investment banks, on behalf of the PWGFM, as directed by the New York Fed. 

As to the Treasury market, the Federal Reserve has held that under tight control for some time, having increased its net holdings of U.S. Treasuries, since the onset of QE2, by more than the Treasury’s net issuance of securities for public holding during that same period.  Given the Fed’s interrelationship with the banking system, it can move Treasury yields at will.  Treasuries increasingly will be the last place private investors would want to hold their money.

July 2011 Retail Sales.  The 0.5% monthly gain estimated for July retail sales was not meaningful, where the 95% confidence interval around the reported change also allowed for an outright monthly contraction.  Separately, most—if not all—of the monthly gain was accounted for by higher prices, not by a rising volume in physical consumption of goods and services.  Net of increases in gasoline-station and grocery-store revenues (surrogates for gasoline and food inflation), monthly retail sales rose by 0.2%. 

June 2011 Trade Deficit.  The June deficit widened “unexpectedly” to $53.1 billion from $50.8 billion in May, hitting its worst level since October 2008.  The number also widened net of inflation, with a now-complete second-quarter trade estimate suggesting a downside revision (August 26th) to the “advance” estimate of second-quarter 2011 GDP, which was based on only two months of trade reporting for the second quarter.  Other GDP components, however, also could be revised and offer some offset to the new trade numbers.

 

Hyperinflation Watch.  The financial markets have been roiled by crises of confidence in the U.S. dollar and in the long-term outlook for U.S. financial, economic, systemic and political stability.  For those living in a U.S. dollar-denominated world, regardless of any further near-term extreme volatility in the U.S. dollar, versus the stronger major currencies and gold, the stronger currencies and precious metals remain the fundamental hedges against what lies ahead.

Massive, fundamental dollar dumping and dumping of dollar-denominated assets could start at anytime, with little or no further warning.  With a U.S. government unwilling to balance or even address its uncontainable fiscal condition; with the federal government and Federal Reserve ready to prevent a systemic collapse, so long as it is possible to print and spend whatever money is needed; and with the U.S. dollar at risk of losing its global reserve currency status; much higher inflation lies ahead, in a circumstance that rapidly could evolve into hyperinflation.

The broad inflation and economic outlooks discussed in the Hyperinflation Special Report (2011) continue to unfold and are unchanged.  An updated economic and inflation outlook will follow in the August 18th Commentary.

   

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REPORTING DETAIL

 

 

 

Week Ahead.  Though still not widely acknowledged, there is both an intensifying double-dip recession and a rapidly escalating inflation problem.  Until such time as financial-market expectations fully catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead.  Generally, previously unreported economic weakness should show up in prior-period revisions. 

Residential Construction (July 2011).  The release of July 2011 housing starts is scheduled for Tuesday, August 16th.  The historic weakness in housing starts should continue, with an intensifying downtrend.  Any upside movement likely will not be statistically meaningful.

Industrial Production (July 2011).  The release of July 2011 industrial production also is scheduled for Tuesday, August 16th.  July production could be flat to minus, as the broad economy begins its formal double-dip.

Producer Price Index—PPI (July 2011).  The release of the July 2011 PPI is scheduled for Wednesday, August 17th.  Finished goods inflation should top a likely soft consensus outlook, due to a swing into supportive seasonal factors for gasoline prices, and to spreading, broader inflationary pressures.

Consumer Price Index—CPI (July 2011).  The release of the July 2011 CPI is scheduled for Thursday, August 18th, and it is at fair risk of topping what likely will be a soft consensus outlook.  At work here will be a strong reversal in gasoline seasonal-factors that will boost gasoline prices, as further inflationary pressures from the Fed-induced jump in oil prices continues to spread in the broad, non-“core” economy.

Year-to-year total CPI-U inflation would increase or decrease in the July 2011 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.35% gain in the adjusted monthly level reported for July 2010.  I use the adjusted change here, since that is how consensus expectations are expressed.  To approximate the annual inflation rate for July 2011, the difference in July’s headline monthly change (or forecast of same) versus the year-ago monthly change should be added to or subtracted directly from June 2011’s reported annual inflation rate of 3.56%.  Annual CPI-U inflation should move to top 4% in the next couple of months. 

 

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