- Federal Deficit Set to Explode.  The Congressional Budget Office estimates 2010 federal deficit at $1.35 trillion, virtually unchanged from 2009. Such assumes 2% GDP growth in 2010, which is not going to happen. President Obama’s recent deficit limiting proposals will have minimal impact. Intensifying economic contraction not only blows apart federal-deficit estimates, but it does the same to the fiscal planning for most states, projected banking system stability, etc.

- Fed Increasingly Likely to Monetize Debt. The political/fiscal problems from intensifying economic contraction and worse-than-projected borrowing needs for the U.S. Treasury likely will trigger increasing flight from the U.S. dollar. At such time as that moves to a panicked level, and U.S. Treasuries increasingly are dumped or otherwise shunned, the Fed will have little choice but to monetize the Treasury debt, becoming the buyer of last resort for Treasuries. Those circumstances should lead to mounting inflation woes and flight-to-safety outside the U.S. dollar, particularly to hard assets such as gold and silver, and to currencies such as the Canadian dollar, the Australian dollar and the Swiss franc.

Fourth-Quarter GDP Likely Will Mark Interim Peak in Double-Dip. Despite this morning’s reported "advance" estimate of 5.7% annualized real (inflation-adjusted) fourth-quarter 2009 GDP growth, the U.S. economy is not booming, although growth near 6% normally would be classified as such, versus 3.2% average GDP growth seen over the last 30 years. To the extent the fourth-quarter’s reported surge in economic activity holds up to future revisions, it most likely will serve as the delineating point in a double-dip depression. When consumption is weak, relative inventory gains, as seen today, often reverse in subsequent quarters, exacerbating the pace of economic decline.

Although it is the broadest economic measure of the U.S. economy published by the government, the GDP also is the worst quality and the most heavily politicized economic release, at least in its early estimates. An "advance" or initial estimate, as seen in today’s reporting, is practically worthless, since most of information is guessed at, and the resulting quarterly growth rate then is annualized for release of the happy headline number to the public and to the popular media.

Consider that the seasonally- and inflation-adjusted balance of trade deficit in October and November (December has not been published), worsened relative to the third quarter. A deteriorating deficit is a net negative for GDP, yet the net export account — based on guesstimates — reportedly accounted for 0.5 percentage points of the 5.7% GDP gain. Worth 3.6 percentage points, and by far the biggest contributor to the reported 5.7% growth rate, was a largely guesstimated improvement in nonfarm inventories, where reporting generally is of short-term poor quality. Personal consumption expenditures — heavily boosted by warped seasonal factors — accounted for 1.4 percentage points of the 5.7% (see Commentaries No. 269, 271). The booming numbers, however, have to be good news for the politically distraught Administration and incumbent members of Congress.

Modern Economic Reporting Was Never Designed to Handle a Massive Economic/Systemic Failure. Current reporting issues are exacerbated further, at the moment, by severe distortions to the reporting system itself from the effects of the extreme economic downturn. Those problems include lack of data due to companies going out of business, a downturn so protracted that seasonal factors that have started to reflect economic contraction as a normal seasonal variation, and government statistical agencies that appear to be oblivious to the estimation problems. Include unusual features, such as one-in-three home sales being a foreclosure, the federal government taking effective control of some major auto makers, banks and the largest insurance company, and the chances that the traditional economic models will yield an accurate picture of current economic activity are nil.

The downturn has been the longest and deepest of the post-World War II era, which also is the period in which most modern economic reporting was designed and introduced. Where the post-war environment generally has been one of growth, most reporting has been structured based on an underlying and politically-friendly assumption of ongoing economic growth, not on a deep, protracted contraction. 

This bias is evident, for example, in the Bureau of Labor Statistics’ birth-death model which adds a regular upside biases into the monthly payroll data. To prevent the underreporting of monthly jobs growth, an upside bias factor was added into the monthly numbers starting back in the 1980s. That evolved into the birth-death model, which assumes first that any payrolls not reported by companies because they have gone out of business are more than offset by jobs created by start-up companies. Second, the excess jobs creation from start-ups is estimated from five years of earlier data, which usually encompasses periods of regular economic growth. This system fell apart in 2008/2009, and, as a result, the BLS will publish next week a downward revision to May 2009’s previously reported payroll level of about 824,000 (BLS estimate). 

Historical Perspective: Worst Year of Post-World War II Era. While the joyous news out of Washington today pushed year-to-year change in fourth-quarter GDP into likely short-lived and marginally-positive territory, the annual declines reported in both real (inflation-adjusted) and nominal (not adjusted for inflation) numbers for full-year 2009 are without post-World War II precedent, as shown in the following graphs.

 

For 2009, real GDP fell by 2.43%, following a 0.44% gain 2008. The 2009 real decline was the deepest since the war-end production shutdown in 1946, which showed a 10.94% annual contraction. In nominal terms — the way companies usually track their sales and people count their income — 2009’s 1.27% annual decline was the worst since a 6.31% decline in 1938, during the second dip of the Great Depression. Nominal GDP rose by 2.58% for the year in 2008.

GDP.  The "advance" estimate of fourth-quarter 2009 Gross Domestic Product (GDP) released this morning (January 29th) by the Bureau of Economic Analysis (BEA) showed a statistically-significant annualized real growth rate of 5.73% +/- 3% (95% confidence interval). Such followed a 2.24% gain reported for third-quarter GDP.  The year-to-year change in real fourth-quarter GDP turned positive, up by 0.10%, following a 2.64% contraction in the third-quarter.

The annualized fourth-quarter GDP inflation measure (implicit price deflator) was 0.71% versus 0.56% in the third-quarter.  In contrast, reported 3.44% annualized fourth-quarter CPI-U inflation was down from an annualized positive inflation rate of 3.60% in the third-quarter. Generally, the weaker the inflation rate used in deflating the GDP, the stronger is the resulting "real" GDP growth.

The SGS Alternate-GDP estimate for fourth-quarter 2009 is for an annual contraction of 4.6% versus the official estimate of a 0.1% gain, less negative than the annual 5.7% (2.2% official) estimated contraction in the third-quarter. While annualized real quarterly growth is not formally estimated on an alternative basis, a flat quarter-to-quarter circumstance, plus or minus, likely was realistic, reflecting the bottom-bouncing at low levels of activity seen for much of the last year in key underlying economic series. Given the fourth-quarter distortions discussed earlier, renewed quarter-to-quarter contraction in the GDP as of first-quarter 2010 is a strong bet.

GNP and GDI. The initial estimated of Gross National Product and Gross Domestic Income for the fourth quarter likely will not be published until the third-estimate of fourth-quarter GDP at the end of March 2010. Since this reporting closes out the year, and since the early estimates are without substance, the BEA tends to hold off as long as possible with these other year-end estimates.

New Orders for Durable Goods Still Bottom Bouncing. The Census Bureau indicated it had found a "processing" error in the November report on durable goods that had understated November’s monthly contraction and now is publishing revised data. Although the net effect of all the revisions was to up current reporting (November was relatively weaker than previously reported), the general pattern of the series — before adjustment for inflation — remains one of bottom-bouncing. Against an average monthly level of $164.8 billion since last December, the December 2009 level of $167.9 billion remains within the realm of normal month-to-month volatility. With December’s level lower than September’s, the six month-moving-average plot in the graph should dip with next month’s reporting.

 

For the regularly volatile, seasonally-adjusted new orders for durable goods series, orders rose by 0.3% for the month, following a revamped 0.4% contraction in November. Year-to-year, December orders fell by 3.1%, following a 6.9% annual contraction in November. Orders declined by 20.2% for the full year.

The widely followed nondefense capital goods orders fell by 0.2% in December, after a 3.0% decline in November. Year-to-year orders fell by 2.5%, and were down by 24.2% for the full year.

Week Ahead. Given the underlying reality of a weaker economy and a more serious inflation problem than generally is expected by the financial markets, risks to reporting will tend towards higher-than-expected inflation and weaker-than-expected economic reporting in the months ahead. Such is true especially for economic reporting net of prior-period revisions. 

Payroll Employment and Unemployment Rate (January 2010). The January employment and unemployment data are is due for release on Friday, February 5th. Briefing.com shows consensus expectations of roughly a 50,000 jobs gain, following an 85,000 loss in December, with the unemployment rate holding at 10.0%. Generally I would look for weaker-than-expected numbers, with a rising unemployment rate and a negative payroll change.

Key to the payrolls is the annual benchmark revision, which has been promised as a big negative for early 2009 reporting. Usually those changes would be carried forward and enlarged in current reporting, but anything is possible in the volatile political environment.  A quick update on the employment report outlook will be put out by the middle of next week, as more data become available from underlying series.