JWSGS - JUNE 2005 EDITION
JOHN WILLIAMS' SHADOW GOVERNMENT STATISTICS
Issue Number Eight
June 8, 2005
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RECESSION MAY BE TIMED FROM APRIL/MAY
SIGNALS OF MAJOR BUSINESS DOWNTURN MULTIPLY AND INTENSIFY
SKEWED SEASONALS BOOSTED SOME APRIL DATA THAT SHOULD REVERSE IN MAY
INFLATION SURGE CONTINUES AS DOLLAR RALLY NEARS END
While the SGS recession warning signals increased in number and deepened during the last month, two key coincident indicators may have turned down. Industrial production and payroll employment are used officially in timing turning points in the business cycle, and industrial production showed an outright monthly contraction in April. Further, the meager increase in May payrolls was statistically indistinguishable from a contraction and is subject to significant revision, which allows for the possibility of a restated contraction for the month. If monthly changes in production and payrolls continue to slide, the 2005-2007 recession will be clocked from the April/May 2005.
Occasionally, a seasonal miscue from a difficult-to-model shift in Easter, Labor Day or the school year can throw off the seasonal adjustment factors that impact a number of series. The unusual spikes in April payrolls, retail sales, housing starts and average weekly earnings suggest that April data were skewed by such a miscue. The March trade deficit similarly may have been artificially depressed, although others factors likely were involved. Usually, such distortions reverse with the next month's reporting, and that could account partially for the unusually weak May payroll gains. Nonetheless, fundamental economic weakness also had its effect on May payrolls and the months ahead will start showing regular monthly contractions in payroll employment.
The Shadow Government Statistics' Early Warning System was activated last month and continues to signal the onset of a formal recession this month (June) or early in third-quarter 2005.
The system looks at historical growth patterns of key leading economic indicators in advance of major economic booms and busts and sets growth trigger points that generate warnings of major upturns or downturns when predetermined growth limits are breached. Since the beginning of 2005 a number of key indicators have been nearing or at their fail-safe points. In the last month or two, several indicators moved below those levels, signaling an imminent recession. Once beyond their fail-safe points, these indicators have not sent out false alarms, either for an economic boom or bust.
Last month's newsletter examined the recession signal generated by the money supply, and that signal has intensified significantly in the last few weeks (see the money supply section). As of the May SGS, real earnings growth also had dropped to levels that always have been followed by recession, as shown in the accompanying graphs. Further, the purchasing managers manufacturing new orders index just slipped below its fail-safe point. Its signal will be detailed next month.
Real average weekly earnings have been rolling downhill for more than 30 years. The official version, as shown by the solid line in the first graph, is that the Clinton "economic miracle" reversed the downward trend. The only miracle that was involved here is that the public sat by complacently as the CPI was redefined so as to understate inflation significantly (see background article on the CPI on the home page).
Average weekly earnings in this series are deflated by the CPI-W (for urban wage earners and clerical workers) as opposed to the CPI-U (for all urban consumers), but the CPI-U and CPI-W track each other very closely and are subject to the same reporting biases. The dotted line in the first graph shows the level of real earnings deflated in a manner consistent with the Pre-Clinton Era inflation methodology. Both lines show the seasonally-adjusted monthly earnings level.
The second graph is the one that shows the SGS recession warning. The plot is of the three-month moving average of the year-to-year change in real earnings. Again, the solid line is the official version, and even with last month's seasonally-distorted spike, current annual growth still is below the level that preceded the 2001 recession.
Corrected for the change in CPI reporting methodology, the dotted line shows annual growth to be at its lowest level (when in a downtrend) since right before the double-dip recession of the early 1980s. Since the level of the series is in something resembling perpetual decline, the fail-safe growth rate on the downside is negative, minus 2.0%. As can be seen in the second graph, each time the annual growth rate has fallen below 2.0%, recessions followed in 1973, 1980, 1981, 1990 and 2001.
The series actually has been sending a signal since 2003, but a new set of growth patterns has been difficult to separate from bottom-bouncing in the ongoing wake of the 2001 recession. Nonetheless, by itself and in conjunction with other indicators, annual growth in real earnings now is signaling clearly the second downleg of a major, double-dip recession that officially began its first downleg in 2001 (unofficially late 2000).
Other key series still are sitting on their trigger points, but that may be due partially to the seasonal factor miscalculations that have plagued recent data. Another month's reporting should push the bulk of the SGS leading indicators beyond their fail-safe levels.
In the wake of the current recession signals, here is a recapitulation of last month's discussion as to the broad picture of what lies ahead:
While sporadic, negative GDP growth likely will not surface in government reporting until later in 2005 or 2006. The National Bureau of Economic Research (NBER) should time the downturn to mid-2005 and announce same sometime in early-to-mid 2006. The popular financial media will begin to debate whether there is a recession underway by late 2005, but those Wall Street economists who act as shills for the market will keep up their "strong growth is just around the corner" hype regardless of any and all evidence to the contrary.
From the standpoint of common experience, this downturn will be considered the second leg of a double-dip recession, not an independent contraction as will be claimed officially.
The softening seen recently in most economic data already has started to accelerate sharply, with monthly contractions beginning or continuing for payroll employment and industrial production in the months ahead. Significant deterioration also will be seen in federal tax receipts (a widening budget deficit) and corporate profits. This outlook is predicated on economic activity that already has taken place and does not consider any risks from exogenous factors such as renewed terrorist activity in the United States.
Market perceptions will be slow to adjust to the renewed downturn in business activity. When expectations finally begin to anticipate weak data, expectations also will be lowered for inflation. As a result, consensus forecasts generally will tend to continue to be surprised on the downside for economic reports, and on the upside for inflation reports, for some time to come.
The roots of the current difficulties are structural in nature. A consumer starved of income growth and overburdened with debt cannot sustain the real (inflation-adjusted) growth in consumption needed to keep GDP growth in positive territory. The income weakness is a direct result of the loss of a significant manufacturing base to offshore locations and the ensuing explosive, perpetual growth of the U.S. trade deficit.
Exacerbating economic and financial woes will be unusually high inflation during this contraction. Inflation, fueled by high oil prices and weakness in the U.S. dollar, will not be brought under control simply by weakness in economic demand. Instead, persistently high prices only will serve to intensify the 2005-2007 recession, making it unusually long and protracted. Ongoing inflation woes and dollar problems will maintain upside pressure on long-term interest rates, inhibiting the traditional flattening of the yield curve expected with a recession.
An inflationary recession remains a nightmare for the financial markets. Particularly hard hit will be the U.S. dollar, with downside implications for both equity and bond prices.
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 -- May's weak payroll numbers reflected a combination of slowing business activity and some reversal in poor quality seasonal adjustments, as discussed in the opening comments. May's unemployment rate effectively was unchanged, and continued to be depressed by faulty seasonal factors. Along with monthly contractions looming for payrolls, the unemployment rate should rise sharply in the months ahead from both statistical catch up and the onset of recession.
The popularly followed unemployment rate U-3 for May 2005 was 5.13% against 5.15% in April, seasonally adjusted. Accordingly, the much-heralded decline in official unemployment from 5.2% to 5.1% was largely an artifact of the rounding process and was not statistically significant. The decline of 0.02% in unemployment was well within the +/- 0.22% published 90% confidence interval.
Unadjusted, U-3 unemployment held at 4.9% in May. The broader U-6 unemployment measure eased from 8.7% in April to 8.6% in May, with the seasonally-adjusted rate notching lower from 9.0% to 8.9%. Including the long-term "discouraged workers" defined away during the Clinton administration, total unemployment remained roughly 12.0%.
The household survey showed a seasonally-adjusted 376,000 gain in May employment, following April's 598,000 surge in the number of people who were gainfully employed.
Moving once again in the same direction as household employment, but not quite as robustly, the May payroll survey showed a below-consensus, seasonally-adjusted gain of 78,000 jobs (54,000 net of revisions), with April's original 274,000 increase unchanged in revision. The revisions were hidden back in the March data. The 78,000 payroll increase in May was well within the published 90% confidence interval of +/- 108,000 and was not distinguishable from a contraction, as officially viewed by the BLS.
Of course roughly 207,000 of the 78,000 gain was accounted for by the monthly bias factors. While the published monthly bias add-ins are not seasonally adjusted, seasonal adjustment has minimal impact on the net effect on the aggregate monthly bias changes, never more than +/- 2.0% or roughly 4,000 in the case of a 200,000 bias. The bulk of the bias adjustment flows through to impact the monthly change in the seasonally-adjusted payroll numbers.
Particularly telling of the deteriorating payroll growth situation is the pattern of slowing year-to-year growth. After hitting a post-2001 recession peak of 1.8% in February 2005, annual growth slowed to 1.7% in March and April and to 1.5% in May. Reality likely is something shy of that, given the alternate payroll measure available from state payroll totals (see SGS "Reporting Focus" of April 2005). The latest available alternate reporting shows an April 2005 seasonally-adjusted monthly gain of 243,000 versus the official 274,000, and year-to-year growth of 1.4% versus the official 1.7%.
These employment/unemployment data were against a background of weak help-wanted advertising, declining employment as reported in the manufacturing purchasing managers surveys, and deteriorating new claims for unemployment insurance (see the respective sections).
Next Release (July 8): The unfolding recession should generate much weaker than expected payroll numbers and higher than consensus unemployment for both June and July, with a monthly payroll decline a good bet in one, if not both months. This circumstance will be exacerbated by the monthly bias factors, which turn less positive in June and negative in July.
Gross Domestic Product (GDP) -- While the most widely followed barometer of domestic activity, GDP remains the most worthless and most overrated of the major economic reports published by Uncle Sam. The revision known as the "preliminary" estimate took first-quarter 2005 annualized real GDP growth to 3.48% +/- 3.1% from 3.08%, still hardly statistically distinguishable from zero growth. With final sales (GDP net of inventory change) revising from 1.87% to 2.71%, growth still was statistically indistinguishable from a contraction. Fourth-quarter 2004 GDP and final sales growth rates were 3.85% and 3.39% respectively.
The revision was driven by the sharp decline in the March trade deficit. Had the deficit not changed, GDP growth would have revised from 3.1% down to 2.6%, instead of up to 3.5% (see the trade deficit section).
First-quarter 2005 year-to-year growth revised from 3.56% to 3.66%, still in a slowing trend from 3.91% in fourth-quarter 2004, 3.99% in the third quarter and down from the cyclical peak of 5.04% in first-quarter 2004.
The GDP implicit price deflator (the inflation rate used to deflate the GDP) revised from 3.26% to 3.16%, after an annualized 2.26% in the fourth quarter. While the GDP deflator has overtaken the understated CPI, which gained 2.40% on an annualized basis in the first quarter, the minor downward revision to the annualized deflator represents one-quarter of the increase in the GDP annualized growth revision.
Preliminary estimates of two alternate GDP measures were published with this release. First-quarter 2005 annualized real growth in Gross National Product (GNP) was 3.65%, up from 3.47% in the fourth quarter. The GNP is a broader measure than GDP, including international flows in factor income such dividends and interest payments, and usually shows weaker growth than the GDP.
Gross Domestic Income (GDI) rose at an annualized 4.06%, down from 7.85% in the fourth quarter. In theory, the GDI equals the GDP, since it is the income-side measure to the GDP's consumption side. The difference between the two series is made up by a "statistical discrepancy" account that has swung from +$60.4 billion in third-quarter 2004 to -$52.1 billion in the fourth quarter and -$70.1 billion in the first quarter (all not adjusted for inflation). The unusual shifts in the statistical discrepancy show the income side is growing much faster than the consumption side, which again, in theory, cannot happen.
The discrepancy issues only add further direct evidence to the inadequacy of GDP reporting. 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 three percent, which would place actual annualized real growth a tad above zero, plus or minus about three percent, given 90% confidence intervals.
Next Release (June 29): Barring a major revision to the March trade data (see the trade deficit section), the next revision or "final" estimate should be no more than statistical noise. All recent GDP reporting will be subject to an annual revision that is released along with the "advance" estimate of second-quarter 2005 GDP on July 29.
Consumer Price Index (CPI) -- The seasonally-adjusted April CPI-U provided the markets with another upside surprise, rising by 0.5% (0.7% unadjusted), after gaining 0.6% in March. As a result, unadjusted April year-to-year inflation jumped to a four-year high of 3.5% from March's 3.1%.
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 6.2% instead of the official 3.5%.
The "experimental" Chained Consumer Price Index (C-CPI-U) for April, the fully substitution based CPI that presumably is the eventual replacement for current CPI reporting, showed annual inflation at 2.9%, an all-time high for the series, up from March's year-to-year inflation rate of 2.6%.
Next Release (June 15): Inflation pressures will continue offering upside surprises to market expectations in most inflation reports, and such is likely against currently soft inflationary expectations for May. Any seasonally-adjusted monthly change above or below roughly 0.6% in May should add directly to or subtract from the currently reported annual growth of 3.5%.
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 Money Supply - Part II covered this month. In addition to the big three, other series that have been detailed are The Federal Deficit (a background article that will be updated shortly), Consumer Confidence (November 2004 SGS), the Trade Balance (December 2004 SGS), Industrial Production (January 2005 SGS), Initial Claims for Unemployment Insurance (February 2005 SGS), Retail Sales (March 2005 SGS), Alternate Payroll Employment Measures (April 2005 SGS) and Money Supply - Part I / SGS Early Warning System (May 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 April 2005, the rolling deficit was $365.9 billion versus $454.0 billion in April 2005. The improvement reflected more normal individual and corporate tax collections than were seen last year.
Gross federal debt as of the end of September (U.S. fiscal year-end 2004) was $7.379 trillion, up $596 billion from a year earlier; at month-end May 2005, gross federal debt was $7.778 trillion, up $582 billion from May 2004, which, in turn, was up by $638 billion from May 2003.
The deficit outlook will turn quickly and sharply to deterioration as recession sets in. Since the government's borrowing needs will tend to exceed expectations, there remains a good chance that the Treasury will confirm the resurrection of the 30-year Treasury bond come August 3rd.
Initial Claims for Unemployment Insurance -- The annual change for new claims on a smoothed basis, for the 17 weeks ended May 28 was a decline of 5.6% versus a revised decline of 6.6% (was 6.5%) for April 30th. The deterioration in recent months remains on track for growth to turn positive (a negative economic development) by early third-quarter 2005, supporting signals of a recession onset.
The volatility of the seasonally-adjusted weekly numbers is due partially to the seasonal-adjustment process. When the series is viewed in terms of the year-to-year change in the 17-week (three-month) moving average, however, such is a fair indicator of current economic activity.
Real Average Weekly Earnings -- April's seasonally-adjusted real average weekly earnings gained 0.2% from March, which was down 0.3% from February. The April gain appears to have been a distortion from poor-quality seasonal factors that skewed a number of April indicators. April's level was 0.3% below April of 2004, against March's 0.5% annual decline.
Allowing for the biases built into the CPI-W series used to deflate the weekly earnings, annual change in this series is signaling a recession warning signal, as detailed in this month's opening comments.
Retail Sales -- Seasonally-adjusted April retail sales rose 1.4% (1.7% net of revisions) +/- 0.7%, following March's 0.4% gain (originally 0.3%). On a year-to-year basis, April retail sales were up 8.6% from the year before, versus a 6.0% annual gain in March (was 5.8%). The April data likely were skewed by bad seasonal factors that should reverse in May reporting.
Inflation-adjusted growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession, and annual growth bounced away from that level in the April reporting.
Next Release (June 14): Reflecting a reversal of April's bad seasonal adjustments and the contracting economy, the May report should be particularly weak, even against a consensus forecast for a small monthly contraction.
Industrial Production -- April's seasonally-adjusted industrial production declined by 0.2% for the month, following March's 0.1% increase (revised from a 0.3% gain). April's decline did reflect a reversal of the prior month's utility gains, but still was down enough possibly to signal the onset of the 2005-2007 recession (see opening comments). April's year-to-year change fell sharply to 3.1% from March's unrevised 3.9%.
Next Release (June 15): With the economy starting to contract, overall industrial production should be entering a period of protracted decline. Look for continued downside surprises in production reporting.
New Orders for Durable Goods -- Seasonally-adjusted new orders for durable goods in April rose by 1.9% (3.2% net of revisions) following March's 1.6% decline (revised from 2.8%). April year-to-year change rose to 3.8% from March's revised decline of 1.1% (was a 2.8% decline). The widely followed nondefense capital goods orders rebounded by 3.8% in April after a 3.2% decline (revised from a 6.2% drop) in March.
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, the series' predictive ability fell apart.
Trade Balance -- The seasonally-adjusted March trade deficit in goods and services plummeted to $55.0 billion from $60.6 billion (previously $61.0) in February. The large improvement dominated the upward revision to reported GDP growth (see GDP section).
The stated narrowing of the March trade shortfall is highly suspect from two angles and likely will revise away, eventually. To the extent the reporting problem was due to backlogs in export and import paperwork flows, called "carryover," as suggested by the relatively large revision to February, a major revision should be seen in the next report. To the extent the problem was bad seasonal factors, the revision will not be seen until next year. In any event, the trade deficit is widening on a regular basis and new record deficits will be seen in the months ahead.
Next Release (June 10): Look for a sharp widening in the April deficit along with a significant revision to March. Where March should deteriorate in revision, a major restatement could reverse the upward revision recently published for first-quarter GDP growth. Further sharp deterioration will follow for at least the next six-to-nine months, with most reports consistently coming in worse than consensus forecasts.
Consumer Confidence -- May 2005 confidence measures were mixed. The Conference Board's consumer confidence rose 4.8% after declining three month's in a row, while the University of Michigan's consumer sentiment fell for the fifth month, down by 0.9%. Always suspect in the Conference Board's number is the seasonal adjustment to the series (how do you seasonally adjust confidence). The unadjusted series never is published, so the whole system lacks a certain degree of transparency.
On a three-month moving average basis, year-to-year change in confidence slowed from 12.8% in April to 10.1% in May, and sentiment sank from a 3.5% contraction in April to a loss of 4.6% in May. As lagging, not leading, indicators, these numbers continue to confirm the economy was slowing throughout fourth-quarter 2004 and then stagnating and slowing again into second-quarter 2005.
Producer Price Index (PPI) -- The seasonally-adjusted April finished goods PPI surprised the markets, once more, on the upside, rising 0.6% (also 0.6% unadjusted) for the month, after March's 0.7% gain. The increase was not enough, though, to boost annual inflation above November's 5.0% high, with April's annual gain easing slightly to 4.8% from March's 4.9% year-to-year inflation.
Next Release (June 14): Despite a large component of random volatility in monthly price variations, PPI inflation reporting over the next three-to-six months should continue averaging above market expectations, particularly against a developing consensus of a May PPI decline.
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.
Such considered, the overall index eased again, from 61.7 in April to 58.5 in May. The index is a diffusion index, where a reading above 50.0 indicates a growing service economy, in theory. Both the employment and prices paid components, however, have some meaning.
The May employment component held at 53.4 in May against April's 53.3, suggesting stagnate employment growth on the services side of the economy.
The prices paid component diffusion index is a general indicator of inflationary pressures. The May index continued to decline, dropping to 57.9 from 61.9 in April, still consistent, however, with increasing inflation. On a three-month moving average basis, though, the annual change in the May prices paid index turned negative, down 9.0%, after a 2.2% increase in April.
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.
Economic Indicators
Purchasing Managers Survey (Manufacturing) - New Orders -- Nearing an outright contraction level, the new orders index looks has minimally breached its fail-safe point, generating an SGS early warning indicator of pending recession.
The May index fell again, dropping 3.7% to 51.4 (below 50.0 means a contraction) from April's 53.7. The Commerce Department provides the seasonal factors for this series, 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. On that basis, May's index was down 16.7% from May 2004 against April's 15.9%, having continually notched lower from its 36.6% peak annual gain in April of 2004.
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 50.0 indicates rising new orders. The overall May ISM index eased to 51.4 from 53.3 in April, rapidly closing in on the 50.0 that divides a growing versus contracting manufacturing sector.
Also of some note, the May employment component of the index dropped to 48.8 -- an outright contraction level -- from April's 52.3, consistent with an outlook for upcoming contractions in payroll employment.
Help Wanted Advertising Index (HWA) -- The April index held at March's 39 reading, just three points off the low of the 2001 recession and current cycle. This series is best viewed on a year-to-year basis with a three-month moving average.
For April, that annual change in the three-month moving average eased to 1.7% from March's 3.4%. HWA is a series that never recovered from the 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.
Published by the Conference Board, the HWA is a reliable leading indicator of employment activity.
Housing Starts -- Seasonally-adjusted April housing starts jumped 11.0% for the month, after declining by 17.6% in March. The unusual volatility in this usually volatile series likely is due to seasonal adjustment problems. On the three-month moving average basis, April year-to-year slowed to 4.7% from March's 8.1%, close to, but still above, generating a recession warning signal.
Money Supply -- Annual money supply growth has continued to slow, intensifying the recession signal. Before inflation adjustment, the year-to-year rates of change in seasonally-adjusted May (four weeks) and April M1, M2 and M3 were 2.1%, 3.2% and 3.7%, and 2.0%, 4.1% and 4.5%, respectively. A rapidly slowing trend in the annual growth rates by month has been evident for the last six to seven months.
Adjusted for CPI inflation, May's M1, M2 and M3 annual year-to-year rates of change were down 1.4%, 0.3% and up 0.2%, respectively, versus down 1.4%, up 0.7% and up 1.0% in April. On a three-month moving average basis, these annual rates of change were down 0.9%, up 0.7% and up 0.9%, levels that were well underwater using the old-style CPI.
Background material on the money supply series is continued in this month's "Reporting Focus."
Inflation Indicators
Purchasing Managers Survey (Manufacturing) - Prices Paid -- The May prices paid diffusion index continued declining, dropping sharply to 58.0 from April's 71.0. The 58.0 level suggests ongoing inflation pressure. Nonetheless, on a three-month moving average basis, year-to-year change was down 22.3% after Aprils 18.0% decline.
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 50.0 indicates rising inflation.
Oil Prices -- West Texas Intermediate Spot (St. Louis Fed) inched below $50 per barrel, on average, in May, although prices have been on the rebound again in recent days. Despite some price softening in May against rising prices a year ago, the average May spot price still was up a strong 27.7%, year-to-year, though down from April's 44.6% annual surge. Despite any near-term sell-offs or price volatility, high oil prices are likely to become a major feature of 2005's inflationary recession.
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 these continued high oil prices.
U.S. Dollar -- May's monthly dollar average (the Federal Reserve's Major Currencies U.S. Dollar Index) rose by 1.3% after April's 1.7% gain. Recent monthly increases still are following last year's patterns, though, with annual change down fairly consistently by 6.4% in March, 5.9% in April and 6.4% in May.
Despite weakness in the Euro, fundamentals remain extraordinary negative for the Greenback. With serious shocks looming in U.S. economic data, heavy selling pressure against the U.S. currency could develop in minutes, with very little warning. New record lows for the dollar remain likely in the months ahead, despite near-term bouncing and any 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.
Last month's "Reporting Focus" explored some of the relationship between money supply growth and economic activity. Specifically noted was the use of the broadest money measure (M3) in the SGS Early Warning System, where declines in inflation-adjusted annual growth in money, beyond a certain fail-safe point, always are followed by an economic contraction. This month, SGS review will briefly some general background to the Federal Reserve's money stock measures.
The Board of Governors of the Federal Reserve System publishes week1y measures of the nation's money stock on Thursday afternoon at 4:30 Eastern time. The data published are for the week ended the Monday of the prior week.
The Fed has been publishing information on domestic money supply since the central bank's founding in 1913. More extensive, earlier data and arguments as to certain historical relationships between money and the economy also can be found in Milton Friedman and Anna Jacobson Schwartz's classic "A Monetary History of the United State 1867-1960."
What has been defined and reported as money supply has changed meaningfully over time. Such has reflected the varying nature of the financial markets, the banking system and the Fed. Money growth, regardless of definition, often, though not always, has been a driving force behind economic activity and inflation. Often, though not always, changes in money growth have reflected Federal Reserve monetary policy, overt or covert. The best relationship established between money growth and business activity is that contracting money supply and its resulting liquidity squeeze will throw an economy into recession.
Here's a summary of the key monetary aggregates. The three major money measures are M1, M2 and M3. Each successive measure includes the prior measure (M2 includes M1, M3 includes M2), and each successive measure includes less-liquid assets than the one before.
M1 includes currency in circulation (outside the U.S. Treasury, Federal Reserve Banks and the vaults of commercial banks, savings banks, credit unions, etc.), checking accounts, travelers checks and other near-cash deposits.
What is unusual about and distorting to the M1 measure is that it includes U.S. currency outside the United States. The latest money supply report shows a seasonally-adjusted $706 billion of currency, accounting for more than half of M1, but a fair portion of that is abroad, fueling underground economies, serving as a store of wealth, etc. Accordingly, aggregate M1 changes do not always reflect what is going on in the U.S. economy, the U.S. financial markets or actual currency in circulation in the United States.
M2 includes M1 plus savings, small time deposits and retail money funds. Traditionally, growth in inflation-adjusted M2 has been touted as the best leading monetary indicator to economic activity. It was incorporated into the government's index of leading economic indicators, which was taken over by the Conference Board in recent years.
In contrast, our historical modeling during the last two decades found the broadest liquidity measure to be the best predictor of economic activity. That used to be the L (liquidity) measure, which included M3, but M3 is the broadest measure available today from the Fed.
M3 includes M2 plus large time deposits, institutional money funds, repurchase agreements and certain Eurodollar deposits. It is M3 that is used in the SGS Early Warning System, as discussed last month.
Current money supply reporting is described in some detail at the Fed's website as to its H.6 release and supporting documents: Board of Governors of the Federal Reserve System.
The broadly followed trade-weighted indices of the U.S. dollar sometimes do not fully explain dollar-related pressures in the financial markets. An SGS currency-trading-volume-weighted dollar index, which makes up for some of the shortcomings of the other series is introduced.
Due to popular demand, SGS plans to begin publishing an alternate, monthly consumer price index by fourth-quarter 2005. The index numbers will be set -- not subject to revision -- and usable in calculations in the same manner as the official CPI. A history going back to 1990 will be reconstructed, with a bridge to pre-1990 CPI reporting. Annual inflation in the new series will tend to run about three-percent higher than the government's official inflation reporting of recent years.
A full methodology will be published, in advance, and results will be replicable. The SGS index calculations will be fully transparent and based on publicly available data, not on massaged surveying by the Bureau of Labor Statistics, or over-modeled and over-theorized price levels. Further details will follow in upcoming newsletters. Comments and suggestions are welcome.
July's Shadow Government Statistics is scheduled for release on Wednesday, July 13, 2005. The monthly newsletter regularly is posted the Wednesday following the Friday release of the employment statistics. The posting of the July SGS on the website, as well as any interim alerts, will be advised immediately by e-mail.