JWSGS - MARCH 2005 EDITION
Issue Number Five
March 9, 2005
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2004 TRADE DEFICIT DETERIORATION COST 1.4 MILLION U.S. JOBS
REPORTING DISTORTIONS OVERSTATED FEBRUARY
EMPLOYMENT, UNDERSTATED JANUARY CPI
STAGFLATION DEEPENS, WITH RECESSION
HOLDING JUST OVER THE HORIZON
Stagnation and inflation remain the words for describing the current economic environment in the United States. The employment/unemployment data were predictable and were consistent with a weakening economy, contrary to popular market hype (see the employment/unemployment section). Inflation continued to deteriorate, but the CPI, like employment, was distorted due to reporting irregularities. The 0.1% gain in the January CPI should have been 0.4% (see the CPI section).
Still, the better leading indicators of business activity were mixed this last month, with the purchasing managers new orders index continuing to inch towards generating the first of what likely will be a series of recession signals,while help-wanted advertising took a breather from threatening such a signal. The economy can suffer inflation and recession at the same time. Stagflation's big brother, however, remains just over the forecast horizon, likely to hit in the second half of 2005. Its movement onshore awaits more meaningful shifts in activity of the SGS leading indicators.
Where signals from the good-quality (and some of the other) leading indicators can be combined to generate early warnings of major upturns and downturns in business activity, the growth levels that trigger a recession signal remain close but still have not been breached. Based on current trends, the first solid warning signals of a new recession remain possible any time within the next several rounds of monthly reports.
If such a warning were signaled, it would indicate a protracted period of contracting commercial activity likely beginning early third-quarter 2005. While the downturn would be reflected in vital indicators such as federal tax receipts, corporate profits, payroll employment and industrial production, GDP growth would slow but not necessarily turn negative, unless the contraction were particularly severe. The early warning system is explored partially in this month's "Reporting Focus" on retail sales.
As a general guideline, market perceptions continue to overestimate economic activity and to underestimate the inflation problem. Accordingly, most economic reporting will surprise consensus expectations on the downside and inflation numbers will tend to surprise the markets on the upside.
Also of particular note this month is the annual U.S. trade deficit for 2004. For those in Washington who claim the trade deficit does not matter, consider that its widening from $496.5 billion in 2003 to $617.7 billion in 2004 cost the U.S. economy a net of roughly 1.4 million jobs (see the trade balance section). That also is about the same number of net jobs now lost as a result of ten years of NAFTA.
Forgetting for a moment that none of Washington's free trade deals really have been based on free trade, or that the politicians pushing through flawed trade policies had agenda other than helping the U.S. economy, there is a basic flaw in the popular theory used to support free trade.
The problem lies in the prop so common to theoretical economists: simplifying assumptions. Assume two countries are at full employment and do not trade with each other. Country A is very efficient at making widgets, but weak in making wadgets. Country B is very efficient at making wadgets, but weak in making widgets. Now if the two countries trade freely, Country A eventually will make all the widgets and Country B all the wadgets. The good news is that given the different countries' respective efficiencies, more total widgets and wadgets will be made than had the two economies not traded. Everyone is happy and better off. Three cheers for free trade!
The problem is that neither the United States nor any of its free-trade partners were or are at full employment, at least not as traditionally measured (see the employment background article on the home page). Free trade, under such a circumstance, means that manufacturing will shift to the low cost producer, with the high cost producer losing jobs and national income. The economy of the high cost producer stagnates in a slowly deepening downward spiral, until costs and wages equalize among the trading partners.
Thanks to the trade-policy geniuses of the current and recent administrations, the U.S. now suffers a $110.8 billion deficit with its NAFTA trading partners (Mexico $45.1 billion, Canada $65.8 billion) up from $92.4 billion in 2003 (Mexico $40.7 billion, Canada $51.7 billion). Before NAFTA was enacted ten years ago, the U.S. enjoyed small trade surpluses with both Mexico and Canada.
THE BIG THREE MARKET MOVERS
(Each of these series is explored in the background article "A Primer On Government Economic Reports," available on the home page.)
Employment/Unemployment -- As predicted, the February unemployment rate turned higher and payroll employment enjoyed an upside "surprise," but those results were dominated by bad seasonal factors and bogus methodologies. The next several months' reporting should return to being dominated by sub-par economic growth if not an outright, unfolding recession.
The popularly followed unemployment rate U-3 for February 2005 rose to 5.39% from 5.23% in January, seasonally adjusted, nearly equal to the published +/- 0.2% margin of error of the household survey. The deterioration wiped out the prior month's reported improvement, which was due largely to poor-quality seasonal adjustments at a time of large seasonal gyration. Unadjusted, U-3 widened from 5.7% to 5.8%. The broader U-6 unemployment measure, however, narrowed 10.2% to 9.9%, unadjusted, and it held at 9.3% in February, seasonally adjusted. Including the long-term "discouraged workers" defined away during the Clinton administration, total unemployment remained roughly 12.3%.
Spotlighting the nonsense that comes out the household and payroll surveys, the February household survey showed a seasonally-adjusted plunge of 97,000 in the number of people who were gainfully employed. Such contrasted with a surge in payroll employment for the month. The Bureau of Labor Statistics has never been able to reconcile household and payroll survey results to within a million aggregate jobs, but that has never prevented the markets from hyperventilating over false perceptions of good news.
The February payroll survey showed a seasonally-adjusted gain of 262,000 jobs, with January's previously reported gain of 146,000 revising to 132,000. Annual growth rose to 1.83% in February, up from 1.64% in January. The relatively large monthly gain was due to two factors. First, the monthly bias factor, which now is formally modeled as the "net birth/death" rate of companies, swung from a minus 280,000 in January to plus 100,000 in February. While the birth/death rate is not seasonally adjusted, big swings tend to flow through to the adjusted data, biasing same.
Second, the monthly seasonal factors were screwy, again. The Bureau of Labor Statistics re-jiggers its seasonal factors every month, now, which enables all sorts of wonderful things to happen to the seasonally adjusted numbers. Evidence for the latest shenanigans is seen in the unadjusted January payrolls revising downward by 64,000, but with the adjusted payrolls revising upward by 8,000. That could not happen without the BLS playing around with the previously established seasonal factors for January.
Next Release (April 1): Based on the reported strong February payrolls, market expectations are likely to overshoot reality for the March data. With the bias factors relatively stable (roughly a 50,000 monthly upward swing in the bias, unadjusted), a weaker-than-expected economy should result in weaker-than-expected payroll growth. Also, look for the unemployment rate to continue moving higher in the months ahead.
Gross Domestic Product (GDP) -- The "preliminary" estimate and first revision of fourth-quarter 2004 annualized real GDP growth came in at 3.81% +/- 3.1%, revised from 3.15% in the "advance" estimate but still down from the third quarter's 4.00%. Half the revision was legitimate, due to a correction in faulty November trade data (see the Trade Balance section below). The other half was largely statistical noise tied to the re-guesstimation of personal and business consumption and an upward revision to inventories.
Revised fourth-quarter year-to-year growth still slowed for the third straight quarter at 3.90%, down from 3.99% in the third quarter and down from the cyclical peak of 5.04% in the first quarter of 2004. Average annual growth for 2004 was reported at 4.43% versus 3.04% in 2003.
The GDP implicit price deflator (the inflation rate used to deflate the GDP) rose from 1.4% in the third quarter to 2.1% (was 2.0%) in the fourth. Those rates compared with respective annualized quarterly inflation reported in the CPI of 1.9% in the third quarter and 3.4% in the fourth. The higher the rate of inflation used for the deflator, the weaker will be the resulting inflation-adjusted growth. A fourth-quarter deflator at the CPI inflation rate would have knocked the 3.8% GDP growth down to 2.6%.
The Bureau of Economic Analysis recognizes that data quality for fourth-quarter reporting is still too shaky to report the alternate GDP measures of Gross National Product (GNP) and Gross Domestic Income (GDI). The BEA is particularly sensitive about its fourth-quarter report and related annual data. Accordingly, fourth-quarter GNP and GDI guesstimates will be released next month, along with the "final" estimate of fourth-quarter GDP, instead of with the "preliminary" report, as usually is the case.
As discussed in the background articles, the GDP is the most heavily politicized of the popularly followed series and has little meaning other than as political propaganda, or for the impact it may have on the financial markets. It rarely indicates actual economic activity, except for an occasional coincidence. GDP reporting is overstated by about 3%, which would place actual annualized real growth at roughly 0.9% plus or minus about 3%, given published 90% confidence intervals.
Next Release (March 30): The "final" estimate revision of fourth-quarter 2004 GDP likely will be little more than statistical noise, in line with expectations. The "final" estimate, however, will be subject to further annual revisions later in the year, at which time growth should revise downward, reflecting pressures from recent underlying economic softness.
The "advance" estimate of first-quarter 2005 GDP growth, to be published April 28th, likely will come in below expectations, given current market overestimation of economic activity.
Consumer Price Index (CPI) -- The seasonally-adjusted January CPI-U rose by 0.1% (increased by 0.2% unadjusted), after being unchanged (revised from a decline of 0.1%) in December. That resulted in unadjusted January year-to-year inflation easing to 3.0% from December's 3.3%. The monthly number suffered unusual downside distortion in its regular reporting, due to seasonal-factor issues and to inconsistent handling of gasoline prices. Without these aberrations, the adjusted January CPI would have jumped by 0.4% and the annual inflation rate would have held at 3.3%.
While, in theory, the CPI never is revised, that only is on an unadjusted basis (except when the Bureau of Labor Statistics discovers an error). Revisions to seasonal factors resulted in the change to the previously reported December CPI. Those same seasonal factors, however, are distorting current reporting. While the monthly patterns are changed by the seasonals, the year-to-year variations should remain reasonably constant on both an adjusted and unadjusted basis. If the unadjusted annual changes were applied to calculating the adjusted CPI levels, January's month-to-month CPI increase would have been 0.2% instead of 0.1%.
As with the employment and unemployment data, new seasonal adjustment techniques appear to be creating unusual monthly distortions in the data. Where the levels of distortion may not be particularly significant, statistically, they have proven to be highly significant to financial market reaction.
Further, the seasonally-adjusted sales of gas stations in the retail sales report can be used as a surrogate for the monthly change in gasoline prices (seasonal volume and related business presumably are neutralized by the seasonal factors). January gasoline station sales rose by 1.8%, but the CPI shows adjusted gasoline prices down by 2.1%. That swing of 3.9% is worth an added 0.2% to the monthly CPI, which brings the prospective, corrected January CPI increase to 0.4%.
Using the CPI's original (pre-Clinton Era) methodological approach of a fixed basket of goods (vs. substitution of hamburgers for steak as estimated by geometric weighting) would leave year-to-year inflation at about 5.7% instead of the official 3.0%.
The "experimental" Chained Consumer Price Index (C-CPI-U), the fully substitution based CPI that presumably is the eventual replacement for current CPI reporting, showed a 2.6% year-to-year gain in January, down from 2.9% in December.
Next Release (March 23): Inflation pressures will continue to offer upside surprises in many reports, and the February CPI report may offer one of them, as recent underreporting catches up.
Any seasonally-adjusted monthly change above or below roughly 0.3% should subtract from or add directly to the currently reported annual growth of 3.0%.
OTHER TROUBLED KEY SERIES
To varying degrees, the following series have significant reporting problems. Each series will be addressed in a monthly "Reporting Focus," with Retail Sales covered this month. In addition to the big three, other series that have been detailed are The Federal Deficit (background article), Consumer Confidence (November 2004 SGS), the Trade Balance (December 2004 SGS), Industrial Production (January 2005 SGS), and Initial Claims for Unemployment Insurance (February 2005 SGS).
Federal Deficit -- The official deficit for the fiscal year ended September 30, 2004 was $412.3 billion, up from $374.8 billion the year before. For the twelve months ended January 2005, the rolling deficit was $390.0 billion versus $406.7 billion in January 2004. Gross federal debt as of the end of September was $7.379 trillion, up $596 billion from a year earlier; at month-end February 2005, gross federal debt was $7.713 trillion, up $622 billion from February 2004, which, in turn, was up by $645.3 billion from February 2003.
Initial Claims for Unemployment Insurance -- The annual change for new claims on a smoothed basis, for the 17 weeks ended February 26th, was a decline of 8.9% versus an 8.3% decline in the 17 weeks ended January 29th. While this is a slight improvement over the last several weeks, and means that fewer new unemployment claims are being filed than last year, the rate of decline has been narrowing and is on track for growth to turn positive (a negative economic development) by mid-year, possibly heralding the onset of a recession.
The volatility of the seasonally-adjusted weekly numbers is due partially to the seasonal-adjustment process. Used in terms of the year-to-year change in the 17-week (three-month) moving average, year-to-year change is a fair indicator of current economic activity.
Real Average Weekly Earnings -- January's seasonally-adjusted real average weekly earnings fell 0.2% from December, after December showed a 0.5% increase. January's level was 0.7% below January of 2004. Allowing for the biases built into the CPI series used to deflate the weekly earnings, annual change in this series continues on the brink of generating a recession warning signal.
Retail Sales -- (Also see this month's "Reporting Focus") Seasonally-adjusted January retail sales fell by 0.3% +/- 0.7% (down by 0.5% net of revisions) from December, which showed a 1.1% monthly gain (previously 1.2%). January retail sales were up a still strong 7.2% from the year before, a pace that slowed, however, from December's 8.7% annual growth (was 8.9%).
Where inflation-adjusted growth in retail sales below 1.8% (using the standard CPI for deflation) signals recession, annual growth still is slowing but holding above that level.
Next Releases (March 15, March 31): The February report should come in on the weak side of expectations, which, again, already are soft. A benchmark revision is scheduled for release on March 31, encompassing more comprehensive annual surveys. Look for historical retail sales of the last two years to have been weaker than initially reported.
Industrial Production -- Catching up some with a weakening purchasing managers' survey, seasonally-adjusted January industrial production was unchanged (down 0.1% net of revisions) from December, which showed a gain of 0.7% (was 0.8%). Year-to-year growth slowed from 4.3% in December to 3.9% in January. Part of the pullback was an artifact of milder than usual temperatures in January, which softened relative utility demand and the different measures it drives.
Next Release (March 16): February production is likely to remain soft, below market expectations, due to the combination of weak economic activity and another month of unusually temperate weather. The weather should reduce relative utility demand and the production numbers estimated from utility consumption.
New Orders for Durable Goods -- Seasonally-adjusted new orders for durable goods in January fell by 0.9% for the month (unchanged net of revisions), after December's 1.4% increase (previously reported as 0.6%). Year-to-year growth rose to 10.5% from 10.0% (previously reported at 9.0%). The widely followed Nondefense Capital Goods Orders gained 0.2% for the month, after falling 0.7% in December.
Monthly volatility is high for this series, which used to be one of the better leading indicators of broad economic activity, when smoothed using a three-month moving average. After the semi-conductor industry stopped reporting new orders, and the series' quality fell apart.
Trade Balance -- The December trade deficit in goods and services narrowed to $56.4 billion, seasonally adjusted, the second biggest monthly deficit in history, after November's previous reporting of $60.3 billion was revised to a still-record $59.3 billion. The revision included a correction of $1.4 billion Canadian underreporting of imports from the United States.
Since Canada counts its imports from the United States better than the United States counts its exports to Canada, the U.S. Bureaus of Economic Analysis and Census use the Canadian estimates in the monthly U.S. trade data, instead of using the U.S. data. Statistics Canada announced the error on January 31st, and the U.S. trade data and fourth-quarter GDP estimates were revised accordingly.
The monthly data, with minor variation, have been deteriorating monthly for years, nearly doubling from the monthly deficits just three years ago. Along with the December data came the annual summary for 2004, which best can be described as an economic nightmare from which the United States is not about to wake up (see opening comments).
For all of 2004, the deficit in goods and services was reported at $617.7 billion, up 24.4% from $496.5 billion in 2003. By itself, that deterioration cost the U.S. economy approximately 1.4 million jobs in 2004. Such was estimated by taking the nominal change in the trade deficit as a percent of nominal GDP, and applying that percentage to the total number of payroll jobs needed to generate the nominal GDP.
A sampling of trade results in 2004 versus 2003 shows the deficit with Communist China rose from $124.1 billion to $162.0 billion (not including trade that circumvented official reporting due to diversion through other countries), the deficit with Japan rose from $66.0 billion to $75.2, the deficit with South Korea rose from $13.2 billion to $19.8 billion, the deficit with NAFTA rose from $92.4 billion to $100.8 billion, the deficit with the European Union rose from $97.9 billion to S110.0 billion and the deficit with OPEC rose from $51.1 billion to $71.9 billion. Some good news in the reporting was that the deficit with Taiwan declined from $14.2 billion to $12.9 billion and the U.S. surplus with Jamaica increased from $1.0 billion to $1.1 billion.
Next Release (March 11): Look for a widening in the January trade deficit. Continued sharp deterioration is highly likely over the next six-to-nine months, with most reports consistently coming in worse than market expectations.
Consumer Confidence -- February 2005 confidence measures softened, but year-to-year change patterns were mixed. The Conference Board's Consumer Confidence eased by 1.0% for the month, while the University of Michigan's Consumer Sentiment fell by 1.5%. Smoothed with a three-month moving average, year-to-year change in Confidence rose by 12.3% in February, up from 7.1% in January, while Sentiment fell 1.4% in February, after a 1.6% decline in January. As lagging, not leading, indicators, these numbers confirm the economy was slowing throughout fourth-quarter 2004 and stagnating into early 2005.
Producer Price Index (PPI) -- The seasonally-adjusted January Finished Goods PPI rose by 0.3% (up by 0.7% unadjusted), after a 0.3% decline in December. January's 4.2% year-to-year inflation began inching back towards November's 14-year high of 5.0%.
Next Release (March 22): Despite a large component of random volatility in monthly price variations, PPI inflation reporting over the next three-to-six months still should average above consensus forecasts.
Purchasing Managers Survey (Non-Manufacturing) -- Published by the Institute for Supply Management (ISM), there is nothing unusually wrong with this survey of the service industry, except it does not have much meaning. Unlike its older counterpart, the manufacturing survey, if service companies such as law firms, hospitals or fast-food restaurants have "increased orders," that does not necessarily mean the economy is picking up.
That said, the overall index rose from 59.2 in January to 59.8 in February. The index is a diffusion index, where a reading above 50 indicates a growing service economy, in theory.
The Prices Paid component diffusion index, however, is a general indicator of inflationary pressures. The February index eased to a still-inflationary 66.4, from 66.6 in January, and was up 14.5% year-to-year after a 9.5% increase in January. On a three-month-moving-average basis, the February prices paid index was up 14.2% from February 2004, versus a 16.9% annual gain in January.
BETTER-QUALITY NUMBERS
The following numbers are generally good-quality leading indicators of economic activity and inflation that offer an alternative to the politically hyped numbers when the economy really is not so perfect. In some instances, using a three-month moving average improves the quality of the economic signal and is so noted in the text. Added this month are measures of the U.S. money stock or money supply.
Economic Indicators
Purchasing Managers Survey (Manufacturing) - New Orders -- This still looks like it will be the first of the key SGS early warning indicators to signal a recession.
The February index fell 1.2% from 56.5 to 55.8. Uncle Sam provides the seasonal factors, and the adjusted monthly numbers often can be misleading in the reporting of month-to-month change. This problem is overcome by using year-to-year change on a three-month moving average basis. February's index was down 16.7% from February 2004, compared with January's annual decline of 18.4%, and the three-month moving average annual change continued notching lower, with annual declines of 4.1% in October, 9.2% in November, 10.6% in December, 13.6% in January and 14.5% in February.
Published by the Institute for Supply Management (ISM), the New Orders component of the Purchasing Managers Survey is a particularly valuable indicator of economic activity. The index is a diffusion index, where a reading above 50 indicates rising new orders. The overall index dropped from 56.4 in January to 55.3, slowly closing in on the 50.0 that divides a growing versus contracting manufacturing sector. The current year-to-year downturn in the three-month moving average is close to generating a recession warning signal.
Help Wanted Advertising Index (HWA) -- The January index showed a sharp increase to 41, from 38 in December. This was the highest reading since February 2002, and the increase was in tandem with indications of increased help-wanted advertising on the Internet. An Internet advertising pick-up also is indicated for February.
Still, HWA is a series that never recovered from the 2000/2001 recession, having been at its cyclical nadir of 36 as recently as November 2004. Accordingly, current movement still is bottom bouncing but worthy of close attention.
The year-to-year change in the three-month moving average was up 0.9%, reversing the drop of 0.9% seen in December.
Published by the Conference Board, the HWA is a reliable leading indicator of employment activity. The series in January just backed away some from being borderline in signaling a pending recession.
Building Permits -- The building permits series was just broken by the Census Bureau. Beginning with the January 2005 release, the survey has been expanded from 19,000 to 20,000 permit-issuing places, and the new data are not comparable, and will not be made comparable, to the old. In theory, year-to-year change should be reasonably consistent in both series, and it is so approximated for January's reporting. It may be necessary, however, to scrap this series as a better-quality one and focus instead on housing starts. Housing starts is of good quality; it just has a shorter lead-time to broad economic activity than does the permits series.
On a three-month moving average basis, annual growth rose to 5.0% in January from 2.8% in December. In contrast, the three-month moving average of the year-to-year change in housing starts was down 0.5% in January, versus a 2.8% decline in December.
As a leading indicator of economic activity, the old building permits series had shown a meaningful slowdown and may continue borderline for generating a recession warning.
Money Supply -- At subscriber request, measures of the U.S. money supply are added to the SGS this month. They could have been listed under either the economic or inflation indicators, but the more significant impact, at present, is seen on the economic side. As with all statistical measures on the economy, the monetary aggregates have their problems, but they generally are among the better-quality series. The background of the various measures will be explored in April's "Reporting Focus."
Broadly, money supply growth is a measure of the change in cash and deposits in the economy and banking system, including money market funds and other money instruments. Money supply growth is a causal leading indicator to economic activity and to price and asset inflation. Compiled and published by the Federal Reserve, the three widely followed measures are M1, M2 and M3, ranging from narrow to broad, in scope. M2 encompasses M1. M3 encompasses M2.
At the moment, price inflation is more driven by commodity prices than money growth. Eventually, however, a severe monetary inflation appears to be the likely outcome of the federal government's generally unrecognized, but pending, insolvency (see SGS discussions of GAAP accounting for the federal deficit in recent months).
The economy, though, is suffering, and weak real growth in the broader money measures M2 and M3 is a factor. Deflated by the CPI, whenever M2 and M3 have turned negative year-to-year, using a three-month moving average, the economy always has followed shortly thereafter. Strong money growth, however, does not always lead to a strong economy. These concepts will be further explored next month.
Although real annual growth in both M2 and M3 slowed before the 2000/2001 recession, neither turned negative. That was largely because of the methodological changes made to CPI reporting in the 1990s and the resulting systematic underreporting of inflation that followed in the years after the 1990 recession.
Using inflation restated to the old methodology, M2, however, turned negative before the 2000 recession, and M3 sank to about 2%, a level when seen on a downswing usually is followed by recession. At present, though, year-to-year growth in both M2 and M3 is in negative territory, deflating using old-style inflation and a three-month moving average.
Before inflation adjustment, the year-to-year rates of change in the three-month moving averages of January M1, M2 and M3 were 5.4%, 5.5% and 6.0%, respectively, and trending higher. On the same basis, except adjusted for current CPI reporting, M1, M2 and M3 growth rates were up 2.1%, 2.2% and 2.6%, with little trend. All of the inflation-adjusted growth rates were underwater, however, using the old-style CPI.
Inflation Indicators
Purchasing Managers Survey (Manufacturing) - Prices Paid -- The February Prices Paid diffusion index continued to drop, falling to 65.5 from 69.0 in January. The index has been signaling a strong rise in inflation since late in 2003 but now has been softening for several months, partially reflecting a temporary pullback in oil prices. The current index still indicates strong inflation. On a three-month moving average basis, however, year-to-year change turned down by 7.4%, after rising by 4.6% in January.
Published by the Institute for Supply Management (ISM), the Prices Paid component of the Purchasing Managers Survey is a reliable leading indicator of inflation activity. The measure is a diffusion index, where a reading above 50 indicates rising inflation.
Oil Prices -- West Texas Intermediate Spot (St. Louis Fed) continued rebounding, up 2.3% in February, following an 8.1% increase in January's monthly average price. Year-to-year, the average February spot price is still up by a highly inflationary 30.5%, against a 34.8% gain in January. These numbers, however, are headed higher, with current spot prices playing with record highs.
Oil price changes permeate costs throughout the economy, ranging from transportation and energy costs, to material costs in the plastics, pharmaceutical, fertilizer, chemical industries, etc. Where effects of continued oil price volatility will affect CPI reporting, downside oil price movements tend to be picked up more quickly and fully than are upside movements. Even as currently understated, the, CPI inflation will be stronger than commonly predicted for the next six-to-nine months, partially as a result of continued high oil prices.
U.S. Dollar -- February's monthly dollar average (the Federal Reserve's Major Currencies U.S. Dollar Index) gained another 1.0%, after January's 1.1% rise. The year-to-year decline in the greenback narrowed to 3.6% from January's 3.9% decline.
As with oil prices, the "good" news seems to be at an end. Some renewed dollar weakness was seen, particularly when the South Korean central bank indicated it would be looking to invest its funds in something other than the U.S. dollar.
New record lows for the dollar remain likely in the months ahead, despite any continued near-term bouncing and official or unofficial supportive intervention by any central bank(s).
Generally, the weaker the dollar, the greater will be the ultimate inflation pressure and the eventual liquidity squeeze in the U.S. capital markets.
MARCH'S "REPORTING FOCUS" -- RETAIL TRADE
AND FOOD SERVICES (RETAIL SALES)
The Census Bureau's retail sales report is the broadest measure of U.S. consumer activity published on a monthly a basis. The monthly data are compiled using a random sampling of 5,000 retail outlets nationwide, which are estimated to account for 65% of the total volume of retail sales. The numbers are revised the next month and also annually, in a comprehensive benchmark revision.
The problems with the reporting generally are tied to the sampling and/or the seasonal adjustments. The sampling appears well designed, and the Census Bureau is upfront about sampling error. For example, the following was noted in the January "advance" report, where sales were reported as down 0.3% (+/- 0.7%): "The 90 percent confidence interval includes zero. The Census Bureau does not have sufficient statistical evidence to conclude that the actual change is different from zero."
There are some issues, though. For example, new auto sales account for roughly 15% of retail sales volume and about half the statistical margin of error for the total survey. Not only does the Census Bureau conduct a sampling of auto industry sales, but so too does the Bureau of Economic Analysis, which gives us the GDP. What is hard to understand is why neither government agency uses the 100% survey published on a timely basis by the auto industry, since that would reduce sampling error significantly.
Retail sales vary meaningfully by season, with monthly sales often affected by when Easter, Labor Day or Thanksgiving fall. Accordingly, seasonal adjustment is a necessity, but the government's seasonal-adjustment process is far from perfect and often distorts reported month-to-month changes. This problem can be overcome by looking at retail sales on a smoothed three-month moving average basis and by tracking year-to-year change.
Unlike the related personal consumption component of the GDP, however, the retail sales report is not burdened by massive theoretical imputations, and is not reported adjusted for inflation, with real growth inflated by artificially low inflation estimates.
Nonetheless, retail sales do reflect inflation pressures, directly, and it helps to know what portion of sales growth is due to physical volume and what portion is due to changing prices. Unfortunately, the government does not publish a meaningful inflation number any more. Our "consistent methodology" estimates, using pre-Clinton era CPI methodology offers one option (see graph on the home page).
Working with the limitations of official CPI reporting, it still is possible, however, to make meaningful predictions of broad economic activity using retail sales. Deflated by the official CPI, year-to-year change in a three-month moving average retail sales number shows a high correlation with economic activity, with roughly a three-month lead-time.
Retail sales is used as one of the SGS key leading indicators of economic activity, where the historical series has been statistically analyzed against reported year-to-year GDP growth. While GDP is distorted, there is some fair correlation with the pattern of the ups and downs in annual growth of reliable economic indicators. It is the reported magnitude of change in real annual GDP that is particularly off from reality.
The adjusted retail sales growth was assessed for levels that would signal either an economic boom (annual GDP growth of 6% or higher, as last seen in 1984) or bust (annual GDP growth of 0% or below, indicating a formal recession). What was found was that smoothed, real year-to-year retail sales of 9.5% or above and 1.8% or below reliably signaled a respective boom or bust.
The January 2005 smoothed real growth in retail sales is 4.2%, down from a near-term peak of 6.2% in April 2004. Look for a meaningful move to the downside after the next reporting and benchmark revision.
At such time as an actual recession signal is generated, full detail and graphics of the involved indicator will be highlighted in the SGS.
Upcoming "Reporting Focus" for April - Money Supply
The various money supply measures and components and their relationships to the economy, inflation and the financial markets will be explored. Related Fed policy movement also will be viewed from an historical perspective.
April's "Shadow Government Statistics" is scheduled for release on Wednesday, April 6, 2005. The posting of the April SGS on the website, as well as any interim alerts, will be advised immediately by e-mail.