October 2005 Edition
JOHN WILLIAMS' SHADOW GOVERNMENT STATISTICS
Issue Number 12
October 12, 2005
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September Jobs Report Fraud: New Orleans Unemployed Were
Ignored, Over 150,000 in Lost Payroll Employment Was Missed
Pre-Katrina Help Wanted Advertising Sinks to Cycle and 44-Year Lows
Actual Inflation Topped 8% in September
Economic numbers of the last month broadly confirmed an intensifying inflationary recession, but those data mostly pre-dated Hurricanes Katrina and Rita. The effects of the devastation in New Orleans and along much of the Louisiana, Mississippi and Alabama Gulf Coast have intensified the negative national economic trends but were not the root cause. Nonetheless, hurricane effects will dominate headline-grabbing economic reports of the next month or two, and Katrina likely will take much of the blame for a recession that has been in development for over a year and underway since July.
The September report on labor market conditions -- the government's first post-Katrina report -- fell far short of reality and within the range of malfeasance, somehow missing the loss of at least another 150,000 payroll jobs, while the unemployed of New Orleans simply were ignored. One could even make the case that the weaknesses shown could have been generated by ongoing economic softness, alone, with no obvious impact from Katrina whatsoever. It appears that the administration's early response to the Gulf Coast disaster indeed was rapid and effective, not in providing relief to storm victims, but in jiggering impacted economic data to minimize the storm's reported effects.
"Political morons" was the terminology used last month, and it appears to be adequately descriptive, at least of those controlling the employment/unemployment reporting. With President Bush's approval rating pushing the lowest level seen for any U.S. President dating back to Herbert Hoover's time, administration political advisors instinctively may have wanted to hide any signs of economic weakness.
The administration, however, is missing several significant points. First is risk of damaging its already limited credibility. Second, it has a nasty, inflationary recession on its hands, and, if it is not careful, the administration may find the public blaming it, not the hurricane, for the recession. Third, although the recession was in place before Katrina, the blame for the current economic woes could be shifted successfully to the effects of the natural disaster.
The Bureau of Labor Statistics (BLS) did not estimate Katrina's impact on September labor numbers, probably because the summary data would not have appeared to be reasonable. The labor reporting went awry because the BLS, for whatever reason, did not adequately adjust its surveying techniques to an unprecedented situation. Understandably, the BLS did not conduct regular household (unemployment) surveying in New Orleans, because the city had been evacuated and was under water. The BLS, however, also did not survey New Orleans residents who were in shelters. Anyone temporarily out of work and coping with the storm's aftereffects was judged to be out of the workforce, at least temporarily, and therefore technically could not be unemployed.
In fairness to the BLS, it has been, as usual, very open about its procedures. As discussed at "Effects of Hurricane Katrina on BLS Employment and Unemployment Data Collection and Estimation":
"In accordance with standard procedures, uninhabitable ouseholds, and those for which the condition is unknown, will be taken out of the CPS [Current Population/Household Survey] universe for the month. In such situations, persons in households that are successfully interviewed will be given a higher weight to account for those missed."
In other words, by statistical default, the households not surveyed in New Orleans and elsewhere were given the same employment/unemployment characteristics as households that could be surveyed, with roughly 95% reported as gainfully employed.
The payroll survey results were not of much better quality, with the BLS relying on sampling companies that could not possibly participate in its survey. Those that did not respond were assumed to have no payrolls, but this still was a just a small sampling of all businesses in the area. Based on companies reporting from out of state that still kept New Orleans residents on their payrolls, non-existent payroll employment was imputed for a number of New Orleans companies that were at least temporarily out of business.
One way of assessing the Katrina impact on the payroll report is to look at the month-to-month swing in payrolls. The 246,000 negative swing in payroll gains from an August increase of 211,000 to a September decline of 35,000 was about 150,000 shy of jobs lost based on initial jobless claims adjusted for multiple job holders. An extra 150,000 jobs would have meant a monthly jobs loss of 185,000, well within the range of reasonable consensus estimates.
Other Recent and Pending Reporting -- In the pre-Katrina reporting category, August CPI and PPI inflation surged to respective four- and 15-year highs. Those numbers and the post-Katrina CPI inflation surge likely to be reported on Friday have the Federal Reserve's knees knocking and the price of gold rallying. Not only is the September CPI likely to show annual inflation surging to 4.3% or 4.4%, but also, as discussed in this month's "Reporting Focus" on alternate CPI measures, actual inflation will be topping 8.0% for the first time since 1990.
Further reflecting pre-hurricane conditions, August help-wanted advertising hit its cycle low for a second time, dropping to a level otherwise last seen eight months after Dwight D. Eisenhower left office. August retail sales, real earnings and housing starts sank, while industrial production growth was negligible. The Fed, however, attributed part of the weakness in production to Katrina's impact.
In the post-Katrina category, September consumer confidence measures took their worst monthly beatings in decades, tumbling more than they did after the 9/11 terrorist attacks. Annual real growth in the September money supply measures continued to weaken, while the September purchasing managers surveys showed explosive inflation numbers. The purchasing managers manufacturing sector also saw stronger new orders from early recovery efforts and anticipated reconstruction in the hurricane-devastated region.
Upcoming reports should show significant impact from Katrina, with declines likely for September industrial production and retail sales. The trade deficit could narrow for August due to disrupted trade paperwork flows, and in September due to temporarily reduced trade levels through the Port of New Orleans. In addition to the CPI, the September PPI is due for a sharp spike.
Updated Recapitulation of Current Outlook -- In general, the broad economic outlook has not changed. The 2005 to 2007 inflationary recession continues to unfold, but its near-term development has been intensified a bit by Katrina. Recession, inflation and dollar problems are upon us and continue to offer a nightmarish environment for the financial markets.
The Shadow Government Statistics' Early Warning System (EWS) was activated in May and signaled the onset of a formal recession early in July 2005. The EWS 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, with three indicators moving below those levels, signaling a recession. Once beyond their fail-safe points, these indicators have never sent out false alarms, either for an economic boom or bust.
While negative GDP growth likely will not surface in regular government reporting until 2006, Katrina now offers a small possibility of a shallow, one-quarter dip in third-quarter 2005. 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 it will be blamed on Katrina. 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.
Most economic data already are softening, and the trend will accelerate sharply, with regular monthly contractions seen for both payroll employment and industrial production, even net of the short-term hits from Katrina. Political manipulation, if used, can keep the payroll data afloat for a while longer. Significant deterioration also will be seen in corporate profits and federal tax receipts. Lower tax receipts will combine with Katrina recovery spending and the ongoing war in Iraq to accelerate federal deficit deterioration rapidly.
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, another major natural disaster or a financial panic as the markets enter the squirrelly season.
Market perceptions of the downturn in business activity are accelerating, due to Katrina's impact. When expectations begin to anticipate weak data, expectations also will be lowered for inflation, although stagflation seems to be gaining in some consensus thinking. Consensus forecasts generally still will tend 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 to 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 the worst of all worlds 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.)
The ongoing impact of Hurricane Katrina on near-term economic reporting is discussed in this month's opening comments.
Employment/Unemployment -- Despite reasonable market expectations of a 150,000 to 200,000 drop in seasonally-adjusted September 2005 payroll employment, the monthly jobs loss was reported at just 35,000. A 0.2% rise in the unemployment was not statistically significant. How both the payroll and unemployment surveys went awry in post-Katrina reporting is detailed in this month's opening comments. The broad answer is political expediency and/or gross incompetence.
As part of the September labor market report, the BLS announced the level of the pending annual benchmark revision for March 2005. A downward adjustment to unadjusted March payrolls of 191,000, along with estimated monthly revisions, will be made in the January 2006 employment report to be published in February. Based on the pending 191,000 downward revision, annual unadjusted growth in payrolls, as of March 2005, was 1,986,000 instead of 2,171,000, an overstatement of 9.3% in reported growth.
The popularly followed unemployment rate U-3 for September rose to 5.10% from August's 4.93%, seasonally adjusted, within the published +/- 0.2% error margin. Unadjusted U-3 unemployment eased from 4.9% in August to 4.8% in September, while the broader U-6 unemployment measure declined from August's 8.8% to 8.5% in September. September's seasonally-adjusted U-6 rate notched higher to 9.0% from August's 8.9%. Including the long-term "discouraged workers" defined away during the Clinton administration, total unemployment remained roughly 12%.
The BLS rarely gets September back-to-school seasonal adjustments right, and such is a further issue clouding the accuracy of the September unemployment report. The household survey showed a seasonally-adjusted 17,000 decline in September's household employment, after August's 373,000 increase.
Moving in parallel with household employment, September payrolls showed a seasonally-adjusted loss of 35,000 (42,000 net of revisions) +/- 108,000 after August's gain of 211,000 (was 169,000). Annual growth in payrolls eased to 1.66% from August's 1.81% level.
The September payroll loss was despite an upward bias of 54,000 jobs from the "net birth/death" adjustment to potential reporting entities, a small increase from the prior year's 44,000, despite purported adjustments for Katrina's impact.
September's employment/unemployment data were against a background of plunging August help-wanted advertising, softness in employment as reported in the September purchasing managers surveys, and a sharp monthly deterioration in new claims for unemployment insurance (see the respective sections). The weakness reported in the labor data is about what might have been expected based just on intensifying economic weakness, with no noticeable impact from Katrina.
Next Release (November 4): October payrolls and unemployment reporting still will be dominated by Katrina's damage and BLS manipulations. While underlying reality suggests continued deterioration and a sharp downward revision to September's payroll levels, it would not be surprising to see 200,000 new jobs created as part of an unfolding statistical economic "miracle" for the Bush administration. The tone has been set. It will be several months before reporting will get back to normal.
Gross Domestic Product (GDP) -- The "final" estimate revision to annualized inflation-adjusted growth for second-quarter GDP took growth from 3.29% to 3.31%, which was no more than statistical noise, despite a small upward revision to nominal growth and an offsetting increase in the GDP deflator. Annual growth revised to 3.60% from 3.59%, versus 3.64% in the first quarter. These numbers predated Katrina by a quarter and remain virtually worthless as an indicator of economic activity.
Estimates of alternate second-quarter measures to the GDP, Gross National Product (GNP) and Gross Domestic Income (GDI), also were revised. GNP, which is the broadest economic measure, includes GDP and the trade balance in factor income (interest and dividend payments). Annualized real growth in second-quarter GNP revised to 3.16% from 3.05%, down from 3.88% in the first quarter. Real growth in GDI, which is the income-equivalent measure of the GDP's consumption side, notched upward to 4.43% from 4.42%, still up from 3.53% in the first quarter, due to a narrowing statistical discrepancy with the GDP.
Next Release (October 28): The "advance" estimate for third-quarter GDP will show the administration's official assessment of Katrina's impact on the broad economy. With production shutdowns, supply disruptions and population displacements for the month of September, annualized inflation-adjusted growth would be doing well to come in on the plus-side of flat but still could show a contraction. The Bureau of Economic Analysis, however, has broad latitude in reporting GDP growth. If the reporting of September's labor numbers is an indication, any slowing in reported third quarter growth may be just a hardly noticeable blip.
Consumer Price Index (CPI) -- The pre-Katrina seasonally-adjusted August CPI-U increased by 0.5% (0.5% unadjusted) after July's 0.5% jump. Gasoline prices held high enough in September, averaging 14.5% above August per the Energy Information Agency, to make a 0.9% monthly gain in seasonally adjusted September CPI a fair bet.
Unadjusted August year-to-year inflation rose to 3.64%, its highest level since January 2001, up from July's 3.17%. Annual inflation will jump again in September, probably to 4.3% or 4.4%, the worst inflation reported since early 1991. As discussed in this month's "Reporting Focus," current methodological understatement of annual CPI inflation is running about 3.7% -- nearly a percent above estimates SGS has used previously -- which would put September's likely annual inflation rate at or over 8.0%.
Closely tied to the CPI-U (All Urban Consumers) is the CPI-W (Urban Wage Earning and Clerical Workers), which is used to calculate the annual cost of living adjustment for Social Security payments, based on average annual CPI growth in July, August and September of each year. With July and August showing CPI-W annual gains of 3.30% and 3.84%, respectively, the Social Security adjustment could be 3.8% or 3.9%, the largest increase in 15 years. That possibility, however, provides a possible motivation for a surprise downside "surprise" in the CPI report.
Despite any "large" cost-of-living adjustment, it still will be well shy of reality, as measured by the CPI methodology as it existed before the Clinton administration or before. Using the CPI's 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 August inflation at about 6.5% instead of the official 3.6%, with September likely to top 7.2%. The Pre-Carter Era methodological approach would leave September at 8.0% or higher and the Social Security adjustment at 7.5% (see this month's "Reporting Focus").
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 annual inflation at 2.99% in August, up from 2.62% in July.
Next Release (October 14): Inflation reports should continue showing not only higher energy costs, but also increasingly higher broad inflation as high oil costs embed themselves throughout system. With last year's seasonally-adjusted monthly inflation reported at 0.2% for September, monthly September 2005 inflation above that will spike reported annual inflation in parallel.
OTHER TROUBLED KEY SERIES
To varying degrees, the following series have significant reporting problems. All series (including the more trouble free) will be addressed in a monthly "Reporting Focus," with the CPI revisited this month, along with an advance look at the Shadow Government Statistics Standard CPI alternative to the CPI-U. In addition to the big three, other series that have been detailed are The Federal Deficit (an original background article and an update in the Alert of July 7, 2005), 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), Money Supply - Part I / SGS Early Warning System (May 2005 SGS), Money Supply - Part II (June 2005 SGS), Financial- and Trade-Weighted U.S. Dollar Indices (July 2005 SGS), Short-Term Credit Measures (August 2005 SGS), Income Variance/Dispersion (September 2005 SGS).
Federal Deficit -- Commenting on the U.S. federal budget deficit to French Finance Minister Thierry Breton, Alan Greenspan reportedly admitted, "We have lost control [Reuters Sept. 24]." Nonetheless, the happy news out of the former malarial swamp on the Potomac is that the accounting-gimmicked 2005 U.S. budget deficit (fiscal year-ended September 30th) will be reported at about $319 billion, down from 2004's $412.8 billion. For the twelve months ended August 2005, the rolling deficit was $328.0 billion versus $410.6 billion in August 2004.
Gross federal debt as of September 30, 2005 was $7.933 trillion, up $554 billion from September 2004, which, in turn, was up by $596 billion from September 2003.
The actual federal deficit will be inflated quickly by billions being allocated to Katrina reconstruction and to the ongoing war in Iraq. Government finances also will suffer tax revenue losses from the Gulf Coast in addition to revenue shortfalls that will intensify along with the recession.
Initial Claims for Unemployment Insurance -- Katrina's impact began showing up in initial claims with the report for the week-ended September 10th, and new claims still were bloated in the week-ended October 1st. Against the seasonally-adjusted four weeks leading up to Katrina, new claims were 334,000 higher in the following four weeks. Estimates of Katrina-related claims are running around 370,000, which translates to roughly 400,000 jobs, accounting for multiple jobholders. Again, initial claims still are coming in.
On a smoothed basis for the 17 weeks ended October 1st, the annual decline for new claims narrowed sharply to 0.5% from 5.5% (revised from 5.4%) as of August 27th. The devastation of the Gulf Coast and its ripple effects throughout the national economy have accelerated the deterioration in the series' moving average and should contribute to turning annual growth positive (a negative economic development) in the current month. Positive year-to-year growth in initial claims series would confirm signals of recession.
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 -- August's pre-Katrina seasonally-adjusted real average weekly earnings fell by 0.5% from July, after July's decline narrowed from 0.2% to 0.1% in revision. August's reported real earnings fell 1.1% from the year before, after July's 0.4% loss. Recent volatility in this series has come primarily from variations in reported CPI growth.
Allowing for the biases built into the CPI-W series used to deflate the weekly earnings, annual change in this series continues to signal recession.
Retail Sales -- Largely pre-Katrina, seasonally-adjusted August retail sales plunged by 2.1% (down 1.9% net of revisions) +/- 0.7%, following July's unrevised 1.8% gain. On a year-to-year basis, August retail sales were up 7.9%, down from July's 10.4% annual gain.
As gasoline prices topped $3.00 per gallon, retail gasoline consumption appears to have been cut back, likely a combination of pocketbook economics and some efforts at energy conservation. Until gasoline consumption stabilizes relative to current prices, SGS is suspending use of retail gasoline sales growth as a simple surrogate for retail gasoline inflation. Nonetheless, a more detailed analysis of gasoline retail sales still can generate a second opinion on gasoline price inflation.
Inflation-adjusted growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession. Although annual growth again remained comfortably above that level in August reporting, that cushion largely could evaporate with September's reporting.
Next Release (October 14): September retail sales should come in below expectations, mirroring a combination of impaired economic activity and mixed Katrina impact with an offset from sales volume puffed by soaring consumer prices.
Industrial Production -- Seasonally-adjusted August industrial production was reported up 0.1% (up 0.2% net of revisions), with July's 0.1% gain holding after revisions. The Federal Reserve claims that Katrina reduced August production by 0.3%. If so, the storm's impact on September production should have been devastating, considering that Katrina hit at the very end of August. August's year-to-year growth held at 3.1% against July's measure.
Next Release (October 14): Industrial production was at an inflection point in August, about to turn down as a result of the recession. That process will be exacerbated by the impact of Katrina in September's reporting, with a sharper decline more likely than the 0.5% hit the consensus seems to be looking for. Once past any month-to-month post-Katrina gyrations, the index should enter a period of regular monthly contractions.
New Orders for Durable Goods -- Seasonally-adjusted new orders for durable goods in August (pre-Katrina) rose 3.3% (3.0% net of revisions), following July's 5.3% plunge (revised from a 4.9% drop). August year-to-year growth jumped to 9.5% from July's 2.9% (was 3.5%). The widely followed nondefense capital goods orders rebounded by 4.3% month-to-month in August after dropping 7.1% (was 7.3%) the month before.
A subscriber has asked for clarification as to how this series differs from the new orders component of the purchasing managers survey. The durable goods series measures orders for durable goods, such as washing machines, automobiles, aircraft and industrial manufacturing equipment. The series is denominated in dollars and is intended to approximate dollar volume of actual new orders received.
A single manufacturer can have major impact on the reporting. Consider Boeing, for example. When large aircraft orders are booked, they are added into the new orders, even though delivery may be years off, and canceled orders do not always get reported. Accordingly, month-to-month volatility has always been very high for this series. Durable goods orders once was 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, however, the series' predictive ability suffered a serious setback.
In contrast, the purchasing managers survey new orders component is a diffusion index that measures a simple reporting of whether new orders are up, down or the same from the month before. The index is constructed as the percent of responses that are "up" plus one-half of the responses that are "the same." A reading above 50 indicates expansion, below 50 indicates contraction. The series measures durable as well as non-durable manufacturers and gives each reporting company the same weight.
SGS uses the purchasing managers series smoothed with a three-month moving average. The series remains one of the better leading indicators of economic activity (see the Purchasing Managers Survey [Manufacturing] - New Orders section).
As to Katrina impact, reconstruction will tend to boost new orders in the replacing of storm-damaged goods ranging from automobiles to washing machines and computers. To the extent factories were destroyed or temporarily shut down, some impact may be reflected in new orders for durable goods (if the Commerce Department does not assume ongoing normal orders for non-responding companies in the devastated region). Given the nature of the diffusion index, the purchasing managers survey has not and will not show meaningful impact from non-responses.
Trade Balance -- The seasonally-adjusted July trade deficit in goods and services narrowed to $57.9 billion, from $59.5 billion in June. The revised June number (previously $58.8 billion) set a new record high.
While direct Katrina impact on the trade data will not be seen until September's reporting in November, all interim reports, including the July deficit are of suspect quality, due to disruptions in the trade data reporting system caused by Katrina difficulties at the Port of New Orleans. Similarly, trade paperwork flow was disrupted by the destruction of the World Trade Center back in 2001.
Shy of short-term hurricane disruptions to paperwork flow, and a temporary reduction in September and possibly October trade flows, the longer term outlook for the deficit remains one of continual deterioration and ongoing new monthly record deficits.
Next Release (October 13): The August trade deficit should widen, as should July in revision, but disruptions to paperwork flows may distort the next several reports.
Consumer Confidence -- Post-Katrina September 2005 confidence measures plunged in one of the worst monthly showings ever. The 17.9% or 18.9-point drop in the Conference Board's consumer confidence index was worse than September 2001, and topped only at onsets of severe recessions and the 1973 Arab oil embargo. In tandem, the University of Michigan's consumer sentiment took its biggest one-month hit, ever, down 13.7% or 12.2 points. Year-to-year change deteriorated for both measures. On a three-month moving average basis, annual growth in confidence swung from a 2.6% gain in August to a 1.8% decline in September, while the annual decline in sentiment widened from a contraction of 3.1% in August to a 10.0% plunge in September.
As lagging, not leading, indicators, these numbers suggest the economy is in serious trouble, and that Katrina brought to a head consumer concerns over gasoline prices and growing doubts on broad economic conditions.
Short-Term Credit Measures -- Short-term credit measures for businesses continued to show strong annual growth, well over 10 percent, while annual growth in consumer credit has held below five percent.
In the two reports on consumer credit since the last newsletter, annual growth was reported at 4.6% for July, slightly below June's 4.8% and little changed from May's 4.7%.
Annual growth in commercial paper outstanding jumped from 15.5% in August to 19.5% in September. Annual growth in commercial and industrial loans held at 12.4% in August. Rising sales can fuel short-credit needs, but so too can slowing sales, slowing collections and rising inventories.
Producer Price Index (PPI) -- The pre-Katrina seasonally-adjusted August finished goods PPI rose 0.6% (0.5% unadjusted) for the month, after July's 1.0% jump. August's annual inflation rate rose to 5.1%, the highest level since December 1990, up from 4.6% in July.
Next Release (October 18): Despite a large component of random volatility in monthly price variations, PPI inflation reporting over the next several months should continue soaring in tandem with the CPI, topping already strong market expectations.
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 that economic activity is increasing. Like its counterpart, it will show no noticeable impact from non-reporting of companies disrupted by Katrina.
Such considered, the overall post-Katrina September index plunged by 18.0% from 65.0 in August to 53.3 in September, running counter, again, to the manufacturing series. 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 September employment component eased to 54.9 from 59.6, suggesting softening employment in the service sector.
The prices paid component diffusion index is a general indicator of inflationary pressures. The September index exploded by 21.3%, rising from 67.1 in August to a record high 81.4. On a three-month moving average basis, the annual change in September swung into positive territory, up 3.5% after August's 8.4% drop.
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 -- In post-Katrina reporting, the September new orders index rose 13.1% to 63.8, up from August's 56.4. The measure breached its fail-safe point several months back, generating an SGS early warning indicator of pending recession. The nature of this index is that it would not reflect any impact from Gulf Coast area companies not reporting. (See the New Orders for Durable Goods Section for a contrast between the series.)
Of particular note related to Katrina, comments from the survey's respondents indicated some raw material supply disruptions as well as increased orders and anticipated increased orders from clean-up and reconstruction activities.
The Commerce Department provides suspect seasonal factors for this series, and 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, September's index was down 2.7% year-to-year versus a 7.2% contraction in August. The index gradually has notched lower from its peak annual growth of 36.6% in April of 2004, but with some upturn in the last several months.
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 September ISM index rose to 54.9 from August's 53.6. An index level of 50.0 divides a growing versus contracting manufacturing sector. The September employment component increased from 52.6 to 53.1, but, again, non-reporting of storm damaged companies would not show up as a negative in this series.
Help Wanted Advertising Index (HWA) -- The pre-Katrina August index plummeted 10.3% or four points to 35, matching its cycle low set in May 2003 and otherwise at the lowest level seen since September 1961. While this series is best assessed on a year-to-year basis with a three-month moving average, the accompanying graph is of index's monthly level going back to the inception of the series, showing a pattern that rarely has been seen.
For August, that annual change in the three-month moving average was unchanged for the second month. HWA is one of those series that never recovered from the 2001 recession. Accordingly, current movement still is bottom bouncing, but remains worthy of close attention. Published by the Conference Board, the HWA is a reliable leading indicator of employment activity.
Housing Starts -- Pre-Katrina seasonally-adjusted August housing starts fell 1.3% from July, which was down 1.5% from June (originally down 0.2%). On a three-month moving average basis, August year-to-year growth continued to slow, down to 4.6% from July's 6.1%. Housing starts remains a series at the brink of generating a recession warning signal.
Money Supply -- Post-Katrina annual money supply growth continued to show solid indications of recession. Before inflation adjustment, M1, M2 and M3 monthly changes for September (four weeks) versus August were down 1.0%, up 0.4% and 0.9%, respectively. Year-to-year rates of change in seasonally-adjusted September and August M1, M2 and M3, respectively, were down 0.3%, up 3.7% and 6.4%, and up 1.0%, 3.9% and 6.1%.
Adjusted for CPI inflation, September's M1, M2 and M3 annual year-to-year rates of change were down 4.4% and 0.7%, and up 2.0%, respectively, versus down 2.5%, up 0.3% and 2.4% in August. On a three-month moving average basis, these annual rates of change were down 2.9%, up 0.1% and up 2.2%, levels that still are well underwater using the old-style CPI.
Inflation Indicators
Purchasing Managers Survey (Manufacturing) - Prices Paid -- The September prices paid diffusion index continued to soar, gaining 24.8%, after August's 28.9% surge, with the index rising from 62.5 to 78.0, a serious inflation reading. On a three-month moving average basis, September's year-to-year change narrowed to a 19.4% decline versus August's 32.6% drop.
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 higher to still another monthly record high average in September, at $65.57 per barrel. That was up 0.9% from August and a highly inflationary 42.7% above September 2004. Spot prices have gyrated post-Katrina and are below September's average as we go to press. Despite the near-term price volatility, high oil prices will continue as a major contributing factor to the inflation side of the current 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 by the BLS than are upside movements. Even as currently understated, CPI and PPI inflation should be much stronger than commonly predicted for the next six-to-nine months, partially as a result of continued high oil prices.
U.S. Dollar -- The Shadow Government Statistics' Financial-Weighted U.S. Dollar Index is based on dollar exchange rates weighted for respective global currency trading volumes. September's monthly dollar average softened by 0.1% after August's 1.9% decline. Year-to-year change deepened from a 1.6% contraction in August to a 1.9% drop in September. Current dollar trading is above September's average, but below month-end levels.
Reflecting its stronger weighting of the Canadian dollar, September's monthly average of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index eased by 0.5% after August's 1.8% decline. September's rate of annual decline narrowed slightly to 2.7% from 2.8% in August.
Underlying fundamentals remain extraordinarily negative for the greenback. With serious shocks still looming in U.S. economic and fiscal data, heavy selling pressure against the U.S. currency could intensify at any time, with little warning. New record lows for the dollar remain likely in the months ahead, despite any overt or covert 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.
CPI MEASURE, AND SGS BASE CPI-U - ALTERNATE CORE CPI MEASURE
This month's "Reporting Focus" deals with two alternate measures to popularly followed CPI reporting. First is the SGS Standard CPI, which will offer regular monthly reporting of consumer inflation. Price changes and weightings have been stripped of the growth-dampening methodological alterations of the last thirty years, and underlying monthly prices are sourced, wherever possible, from sources independent of the U.S. Departments of Commerce and Labor.
The second measure, the SGS Base CPI-U is just a simple counterpoint to the inflation measure most popular with financial-market hucksters: the Core CPI.
SGS Standard CPI -- As announced in early-June, Shadow Government Statistics is developing an alternate, monthly consumer price index, that will be published on a regular basis, starting this quarter. A full methodology and current and reconstructed historical data will be published in next month's "Reporting Focus."
The new index will be called the SGS Standard CPI, with its index numbers set -- not subject to revision -- and usable in calculations in the same manner as the official CPI. The Standard CPI index construction calculations will be fully transparent and replicable, based on publicly available data, not on massaged surveying by the Bureau of Labor Statistics, or over-modeled and over-theorized price levels. A history going back to 1975 will be reconstructed, with a bridge to pre-1975 CPI reporting. Data will not be seasonally adjusted, so monthly reported inflation rates will be annual, year-to-year inflation rates.
SGS does not have the resources to survey prices of thousands of items nationwide four times a month, as the BLS does. That is not necessary, since a statistically meaningful inflation rate can be produced by a much smaller sampling of appropriate commodities, and SGS is using such simplified sampling of commodities in its index. Statistical significance of the approach will be addressed in the methodology.
By stripping current CPI reporting of all the methodological shenanigans of the last three decades that were aimed at artificially reducing reported inflation, one might expect that the resulting series would match the proposed SGS Standard CPI fairly closely. While the patterns of annual growth tend to match reasonably well, annual inflation rates appears to trend somewhat higher for the SGS Standard series than the cleansed CPI series, as had been suggested by some subscribers. The reasons for this will be discussed next month, but the differences appear to be tied largely to BLS misestimates of the impact of some of its methodological changes over time.
Based on detailed BLS estimates of the impact of its methodological changes over time, published in the Monthly Labor Review, June 1999 ("Consumer Price Index research series using current methods, 1978-98," by Kenneth J. Stewart and Stephen B. Reed), SGS has reworked the CPI-U series to remove the impact of the various methodological changes. The following two graphs show the results of that analysis.
The first graph shows the level of the CPI with December 1977 = 100. The middle line is the official CPI-U. The bottom line is the version of the CPI-U published by Messrs Stewart and Reed that estimates what the historical CPI-U would look like if all present-day methodologies were carried back in time and the CPI were restated.
The top line is the SGS reversal of the process, backing out the estimated impact on the CPI of all the methodological changes. The accelerating pattern of growth in the top line is due to the removed effects having cumulative impact moving forward in time.
We have labeled the cleansed CPI of the top line as "SGS CPI-Standard," as it approximates what the SGS Standard CPI will show, but we are not ready this month to publish the final SGS results. As indicated earlier, the SGS Standard CPI annual inflation tends to show somewhat stronger annual inflation than does the cleansed CPI series.
The second graph shows the year-end annual inflation rate for the official CPI-U and for the cleansed SGS CPI-Standard series. At present, SGS CPI-Standard annual inflation is running about 3.7 percentage points on top of the annual CPI-U inflation rate. As a point of interest for those following annual cost-of-living adjustments (COLA) for social security recipients, annual inflation, net of methodological changes has been running above five percent since 1992, while CPI-U inflation and COLA adjustments generally have been running below three percent.
SGS Base CPI-U -- Thanks to the suggestion of a subscriber, Shadow Government Statistics is pleased to add a new inflation measure to regular reporting, as a counterpoint to the popularly hyped "Core Inflation Rate." The SGS Base CPI-U measure is entirely separate from the SGS Standard CPI and is calculated using BLS data.
The Core CPI-U measures inflation net of price changes in food and energy. Its use over extended periods of time is nonsensical, because food and energy are basic necessities of life.
The SGS Base CPI-U measures inflation net of price changes in computers, recreation and new autos (weighting shifted to used autos), commodities where the inflation accounting is heavily gimmicked and commodities that most consumers could live without for six months or a year, if they had to. The index leaves intact the necessities of food and energy.
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Comparative Annual Inflation Rates for August 2005
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CPI-U/SGS Core CPI-U/SGS
Estimating Entity Standard CPI Base CPI-U
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Bureau of Labor Statistics 3.6%(1) 2.1%(2)
Shadow Government Statistics 7.3%(3)
SGS/BLS 4.2%(4)
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(1) Year-to-year change in unadjusted CPI-U.
(2) Year-to-year change in unadjusted CPI-U,
ex food and energy. (3) Approximation of SGS
Standard CPI, using CPI-U cleansed of BLS
methodological "improvements" of the last 30
years. (4) Year-to-year change in unadjusted
CPI-U, ex computers, new autos and recreation,
based on BLS reporting.
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As always, your comments and suggestions are invited.-- SGS STANDARD CONSUMER PRICE INDEX (PART TWO)
Next month's "Reporting Focus" will complete the introduction of SGS's alternative CPI measure, the SGS Standard CPI, including the formal reporting methodology, first reporting results and a reconstructed historical data base that will link back to pre-Jimmy Carter official CPI reporting.
November's Shadow Government Statistics is scheduled for release on Wednesday, November 9, 2005. The monthly newsletter regularly is posted on the Wednesday following the Friday release of the employment statistics. The posting of the November SGS on the website, as well as any interim alerts, will be advised immediately by e-mail.