March 2006 Edition
JOHN WILLIAMS' SHADOW GOVERNMENT STATISTICS
Issue Number 17
March 15, 2006
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Record Trade Deficit Eliminates 8.8 Million U.S. Jobs,
2.3 million Lost to Communist China, 1.4 Million Lost to NAFTA
M2 -- The New Broadest U.S. Money Measure -- Signals Deepening Recession
Fed Suggests There Has Been Some GDP Overstatement
Like a coin inexorably spiraling into the collection pit of one of those throw-away-your-quarter games that populate U.S. shopping malls and grocery stores, the U.S. economy and financial system completed several more downward spirals in 2005, approaching the eventual financial abyss.
The 2005 to 2007 inflationary recession showed signs of deepening in the latest reporting. Monthly data show plunging new orders for durable goods and contracting industrial production, retail sales, help-wanted advertising, real average weekly earnings and consumer confidence. Consumer credit growth also remained sub-par. As to inflation, both the CPI and PPI topped expectations, and oil prices have remained strong.
On a happier note for the Administration, the politically-rigged February employment numbers exceeded expectations, and annualized real fourth-quarter GDP growth revised from 1.1% to a still-tepid 1.6%. At the same time, however, a new Federal Reserve study suggested there has been some overstatement to GDP growth of recent years (see the GDP section). Further, the soon-to-be broadest measure of the money supply is signaling a deepening recession throughout 2006 (see "Reporting Focus").
While there are special circumstances that explain some of the current negative monthly numbers, and housing starts and the purchasing managers surveys gained, the U.S. economy is suffering an extraordinary structural change. This circumstance will tend to persist in generating consistent negative results in the less-manipulated economic series. The structural change is defined by the dual deficit catastrophes: the federal deficit and trade deficit. The U.S. trade deficit is a direct result of the shift of the U.S. manufacturing offshore. As a result, neither the U.S. government nor U.S. households are able to make ends meet. The resulting uncontrollable federal deficit, combined with the intractable trade deficit, doom the viability of the U.S. dollar and promise economic and financial market disruptions on an enormous scale.
With full trade and other key 2005 data now in hand, the balance of the opening comments will focus on these deficits of economic destruction.
Last week, Treasury Secretary John Snow asked Congress to pass a new debt ceiling so the U.S. could borrow beyond its current $8.18 trillion dollar limit. The fact that the reported February 28th gross federal debt level of $8.27 trillion (see the Deficit section) did not count as an event of default is due to the legalities and niceties of the cash games the Treasury Secretary has played within the federal system. Borrowing from trust funds to make day-to-day expenses would land a private-sector executive in jail, but such is not the fate of Mr. Snow. Instead, the Administration and Congress will play the politics of default brinkmanship, up until the last minute, and the debt ceiling once more will be extended. The talked about $781 billion extension is not likely to last a year before the cycle of nonsense begins anew.
Both parties in Washington are ignoring the dire nature of the nation's fiscal crisis, with annual GAAP deficits expanding at a pace that defies any remedy and promises an eventual massive breakdown of the financial system.
When Ronald Reagan expanded the federal deficit and pummeled the U.S. dollar, the world did not come to an end. Out of the resulting sense of relief was born a group of Washington insiders who were convinced that the budget and trade deficits "don't matter." Much of government policy since has been run on that basis, working political strategies in two-year shifts from one election to the next. This shortsightedness has left the country unable to control its fiscal balances and faced with an ever-growing trade deficit that cannot be fixed easily.
One offshoot of these policies is the rapidly expanding net-debtor status of the United States within the global community. Quarterly, the Federal Reserve Board publishes its "Flow of Funds Account of the United States." Doug Gillespie is one of few individuals who can take those voluminous tables and reduce them to meaningful numbers in a useful form.
Following last week's release of the 2005 numbers, he noted that "As recently as the mid-1980s, the United States was a net creditor nation. As of the end of 2005, however, the US was in the hole to others to the tune of more than $5.8 trillion. And this numbing figure continues to expand at an alarming rate!"
Full details of Doug's analysis, including details of those asset classes held by foreign investors that are subject to easy liquidation, are available in his piece "More Horrifying Foreign Investment Numbers from the Latest Fed Flow-of-Funds Data."
Also published recently were the full trade data for 2005. The following section first examines the cost of the trade deficit to today's economy, and then looks at how well imbedded the U.S. trade deficit position has become in the global marketplace. While this does not mean the trade deficit is beyond solution -- unlike the federal fiscal deficit -- any significant improvement will take decades and will rely upon individual companies involved in global trade.
Based on fourth-quarter GDP, net exports and employment data, the U.S. trade deficit has cost 8.8 million jobs over time, with 800,000 jobs lost in 2005, alone. The following several paragraphs explain how the preceding numbers were estimated.
Before inflation adjustment, the fourth-quarter GDP was reported at a seasonally-adjusted $12,760.4 billion. That GDP was generated by an average seasonally-adjusted employment level of 142,672,000 workers (this is from the Labor Department's household survey, since the payroll survey excludes farm payrolls), which works out to $89,439 of GDP per employed individual.
The trade deficit is a direct, dollar-for-dollar subtraction from the GDP. For the fourth-quarter GDP, the net export trade component subtracted an annualized $788.8 billion from GDP economic activity. If that deficit were zero, and the $788.8 billion had been produced domestically instead of being lost to foreign production, such would have meant an added 8.819 million jobs in the U.S. economy ($788,800,000,000 / $89,439).
Similar calculations for fourth-quarter 2004 show an $11,995.2 billion GDP versus employment of 140,092, average GDP/employed individual of $85,338. Against fourth-quarter 2004 net exports of $685.4 billion, that indicates lost employment 8.032 million jobs, and roughly an 800,000 jobs loss in 2005, alone, from the deteriorating trade circumstance.
The above graphs show the pattern of growth in the U.S. trade deficits with its two largest trading partners in terms of trade shortfall: Communist China and NAFTA (Canada and Mexico combined). The North American Free Trade Agreement (NAFTA) went into effect on January 1, 1994, and the related U.S. trade deficit has expanded ever since. In the cases of both China and NAFTA, countries not at full employment and with lower wages than in the United States have seen what once was manufactured in the United States shift to their own countries.
Using the ratios calculated above, the current deficits with China and NAFTA, respectively, have cost the U.S. economy roughly 2.3 million and 1.4 million jobs.
Of some note, growth in these deficits is starting to turn exponential, which means that it is just a matter of time before the current economic financial system faces a crisis of extraordinary proportions. The problems with U.S. trade, however, go far beyond China and NAFTA and are solidly imbedded in the economies of many major U.S. trading partners.
The following graph reflects the trade balance, as reported quarterly in the current account report, through fourth-quarter 2005.
Back in the 1960s and 1970s, when the United States ran regular trade surpluses, there were two markets for global manufacturers, the United States and the rest of the world. Before beginning my economic consulting business, in the late-1960s and 1970s, I was active in a family company in the import and export trade, primarily importing a major consumer product to the United States from West Germany. The following comments reflect my perspectives, though overly simplified, from then up to present.
In the days of surplus, with the exception of food producers and companies such as Boeing and IBM, too few U.S. manufacturers ignored or did not take global markets seriously. More than adequate sales volume could be generated at home without undertaking the trouble of learning the languages and customs of potential foreign buyers, or having to produce low volume special products that met the particular needs of foreign markets.
In contrast, European manufacturers had to sell beyond their borders in order to gain economic scale. Where the rest of the world never did quite catch on to U.S. consumers' addiction to disposable products, such as automobiles that became stylishly obsolete in three years, European manufacturers often had to provide a higher quality manufactured product for their customers than was available from U.S. manufacturers. Asian manufacturing at the time generally was noted for its low cost as well as generally low quality.
Not only did the competitors of many U.S. manufacturers dominate sales outside the United States, but also their often higher-quality products began to find broad markets within the United States, irrespective of higher prices. Eventually, quality improved for the lower cost Asian products, which also led to significant market gains in the United States and the rest of the world.
Of course, much of the shift in U.S. manufacturing offshore resulted from careful long-term strategies by U.S. competitors to accomplish just that. "Long-term" here refers to decades, not to two-year election cycles or quarter-to-quarter profit reporting cycles. In the late 1970s and early 1980s, Communist China eagerly was buying up as much as it could of available "antiquated" labor-intensive plant and equipment in the United States. China had the labor needed for it.
In a tragic 1989 explosion, the USS Iowa lost one of its large guns. At that time, the U.S. no longer had the machining capabilities to replace the gun, but China did.
As U.S. manufacturers began losing domestic market share to imported goods, a number sought lower-cost production offshore. Such was intensified by the effects of free-trade agreements that tended to shift manufacturing to under-employed, lower cost labor markets, such as Mexico. These shifts have been exacerbated up to present, which brings us to 2005.
As of 2005, here is how the U.S. trade balance broke out, as reported by the Commerce Department. The "services" component of the trade balance, which usually is reported as a small surplus that offsets the merchandise trade deficit, is a just plug number guessed at by the Commerce Department. Commerce does not try to break services out by country, because it has little hard data. Accordingly, the numbers broken out by country are for products, not services, and are as valued for customs purposes.
The numbers show that the structure of the U.S. goods deficit is broadly imbedded within the economies of the vast majority of the United States' major trading partners. This deficit will be difficult to rectify, particularly for a country that is increasingly service rather than manufacturing oriented.
On a customs basis, the 2005 U.S. trade deficit was $766.8 billion, the worst ever for any country in the history of the modern world. More discouraging, however, is the intractable nature of the shortfall. Of 227 counties with identifiable trade with the United States, the U.S. is in deficit with 117 for a total shortfall of $827.1 billion, and in surplus with 110, for a total positive offset of just $60.3 billion. The ratio of aggregate dollar deficits to surpluses is 13.7-to-1!
Looking first at the trading partners that generate employment in the United States, the top 10 trade surpluses (expressed in billions of dollars) are: Netherlands (11.6), Australia (8.4), Hong Kong (7.4), United Arab Emirates (7.0), Belgium (5.6), Singapore (5.5), Panama (1.8), Jamaica (1.3), Egypt (1.1), Bahamas (1.1). The remaining $9.4 billion in surpluses are split among 100 countries.
On the darker and more-massive side of the U.S. trade picture, the top ten trade deficits among trading partners sapping employment from the United States (expressed in billions of dollars) are: Communist China (201.6), Japan (82.7), Canada (76.5), Germany (50.6), Mexico (50.1), Venezuela (27.6), Malaysia (23.3), Nigeria (22.6), Saudi Arabia (20.4), Italy (19.5). The remaining $492.2 billion in deficits is divided among 107 countries.
In general, the broad economic outlook has not changed. The 2005 to 2007 inflationary recession continues to deepen. Recession, inflation and risks of heavy dollar selling are upon us and continue to offer a nightmarish environment for the still Pollyannaish financial markets.
The Shadow Government Statistics' Early Warning System (EWS) was activated in May 2005 and signaled the onset of a formal recession 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 four indicators moving beyond 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.
Despite low growth reported for fourth-quarter 2005 GDP, negative GDP growth is not likely to surface in regular government reporting until after the November 2006 election, given the rampant political manipulation of most key government numbers. The National Bureau of Economic Research (NBER) should time the downturn to mid-2005 and announce same also sometime after the election, so as not to be deemed politically motivated in its timing.
Whether or not there is a recession will be a hot topic in the popular financial media as 2006 progresses, with politics helping to fuel the debate as the election nears. 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 have softened, and the trend will accelerate sharply, with regular monthly contractions seen for both payroll employment and industrial production, although political manipulation 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 disaster recovery spending and the ongoing war in Iraq to accelerate deterioration in the federal deficit.
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, major natural disasters or a financial panic.
Market perceptions of the downturn in business activity are mixed. When expectations begin to anticipate weak data, expectations also will be lowered for inflation, although stagflation still seems to have gained a foothold in some consensus thinking. Consensus forecasts generally 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, weakness in the U.S. dollar and accelerating Fed monetization of federal debt, 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 exceptionally 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.
Risks of the current circumstance evolving into a hyperinflationary depression remain extraordinarily high.
The unfolding inflationary recession is 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. When the system re-stabilizes, post-crisis, there will be exceptional investment opportunities for those who have been able to preserve their wealth, capital and liquidity.
(Each of these series is explored in the background article "A Primer On Government Economic Reports," available on the home page.)
As discussed in this month's opening comments, manipulation of key economic data continues, but signs of acceleration to negative extremes in the catch-all dual deficits suggest the charade cannot be continued indefinitely.
Nonetheless, with the President's ratings continuing to bottom bounce at historic lows, near-term economic reporting will remain gimmicked as long as possible. Accordingly, reported economic results will continue having less than usual relevance to actual underlying activity, and upcoming reporting of the major series will be determined more by political need than by the economic factors that should drive the results.
As result of the unusually late employment report (March 10), off which the SGS is timed, the usual summaries of several series, including the trade deficit, retail sales and the federal deficit, cover two months of releases. Employment reporting was delayed to allow for a short February.
Employment/Unemployment -- Thanks to typical seasonal-adjustment shenanigans (shifting monthly seasonals as reporting progresses) and an unusually large positive swing in the monthly bias factor, the February payroll report topped expectations, coming in close to the 250,000 jobs per month the Clinton manipulators used to target in their gimmicked reporting.
The popularly followed seasonally-adjusted unemployment rate U-3 for February rose to 4.78% from January's 4.69%, a change well inside the published +/- 0.2% error margin. Reflecting the vulnerability of data to poor-quality seasonal adjustments, the unadjusted U-3 unemployment rose to 5.8% in February from January's 5.1%, while the broader U-6 unemployment measure jumped to 9.9% in February, up from 9.2% in January. February's seasonally-adjusted U-6 rate rose to 8.5% from January's 8.4%. Including the long-term "discouraged workers" defined away during the Clinton Administration, total unemployment remains roughly 12-percent.
The household survey showed seasonally-adjusted February employment (those people with at least one job) up by 183,000, following the non-reporting last month due to inconsistent series.
For February, the payroll survey showed a seasonally-adjusted gain of 243,000 (225,000 net of revisions) +/- 108,000, following January's revised gain of 170,000 (was 193,000). Annual growth in unadjusted February payrolls was 1.58%, slightly higher than January's 1.53%.
February's payroll gain of 243,000 included a swing from a negative bias of 193,000 jobs from the "net birth/death" adjustment in January to a positive bias of 116,000.
The latest report was against a background of declining January help-wanted advertising, but positive employment trends as reported in the various February purchasing managers surveys, and improved new claims for unemployment insurance (see the respective sections).
Next Release (April 7): The political needs of the Administration will continue to offset the impact of sharply slowing economic activity. While underlying reality would suggest downside surprises to March reporting, any needed number massaging should keep jobs growth at or above consensus expectations of 200,000-plus jobs growth in March and beyond. The developing pre-election target may be 250,000 jobs per month. This still appears to be part of an attempted statistical economic "miracle" for the Bush II Administration, leading up to the mid-term election.
Gross Domestic Product (GDP) -- Occasionally, one government agency conducts research that conflicts with information published by another government entity. Such has happened with the Federal Reserve Board (FRB) and the Bureau of Economic Analysis (BEA). The FRB recently released an analysis of its 2004 triennial survey of consumer finances. As discussed in "Recent Changes in U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances," by Brian K. Bucks, Arthur B. Kennickell and Kevin B. Moore of the FRB, the Fed's survey showed average U.S. household income, adjusted for inflation, had contracted in by 2.7% between the 2001 and 2004 surveys.
While those results were consistent with reporting out of the IRS and the BLS's annual poverty survey, they were inconsistent with GDP reporting of the period. As noted in the FRB report: "The national income and product accounts (NIPA) provide aggregate information on the incomes of households. If NIPA estimates of personal income are adjusted for inflation and growth in the number of households over the 2001-04 period, they imply virtually no change in household income."
The BEA cannot reconcile its numbers with income reported by the IRS, either.
With personal income accounting for about 82% of GDP, the implication is that real GDP growth of the 2001 to 2004 period was overstated by roughly 2.2% (82% of 2.7%).
Back in the world of monthly GDP reports and updates, the "preliminary" estimate revision of annualized inflation-adjusted growth for fourth-quarter GDP moved reported growth from 1.12% to 1.63%, still the weakest reading in three years. First-quarter growth remained well below the fourth quarter's robust 4.14%.
Year-to-year growth revised to 3.22% (was 3.09%) still down from the fourth quarter's 3.64%, and still the softest reading since second-quarter 2003. Final sales -- GDP net of inventory changes -- revised to flat from an annualized contraction of 0.28%, down from 4.56% growth in the third quarter. The GDP inflation rate (deflator) initially reported at an annualized 3.02% in the fourth quarter, revised upward to 3.31%, the same rate as in the third quarter.
The report still is rough enough that the BEA has not reported initial fourth-quarter estimates for Gross National Product or Gross Domestic Income, alternate GDP measures.
Administration apologists went to work rallying economic forecasts after the "advance" report showed 1.1% growth. As a result, consensus forecasts have moved towards an economic boom for the first quarter. Closer to "reality" for this methodologically-challenged series would be continued slowing, as suggested in this month's "Reporting Focus." The BEA, of course, can bring in the growth rate at any level it desires.
Despite the recent brush with near-standard reporting, these numbers generally are used as political propaganda and usually have little or no relationship to underlying economic reality. Given the long-term upside methodological biases built into the GDP, an actual quarterly contraction of roughly two-percent in fourth-quarter GDP would have been closer to reality.
Next Release (March 30): The "final" estimate revision for fourth-quarter GDP is likely to be little more than statistical noise.
Consumer Price Index (CPI) -- Playing some catch up in energy prices, the BLS reported the seasonally-adjusted January CPI-U up by 0.66% (0.76% unadjusted), following December's 0.05% decline (0.40% unadjusted decline). January's annual inflation rate rose to 3.99% from December's 3.42%.
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 of 3.41% in January, up from 2.88% in December.
Adjusted to pre-Clinton methodology, annual CPI growth would be about 7.0% as of December, while the SGS Standard CPI, net of all the methodology changes of the last 30 years that were designed to suppress inflation reporting, stood at 7.8%.
Contrasted with January's 2.1% annual Core CPI-U inflation rate that excludes the necessities of food and energy, the SGS Base CPI-U that includes only the necessities was up 4.4% in January. The SGS rate, however, still suffers the standard CPI-U methodological understatement.
Next Release (March 16): The February CPI and other inflation reports generally should surprise soft consensus forecasts on the upside, with "core" inflation increasingly reflecting the effects of higher energy prices.
Despite occasional one-month swings, annual inflation will remain high and should continue to accelerate to the upside as 2006 progresses, despite any one-month lapses. With seasonally-adjusted monthly inflation reported at 0.4% for February 2005, monthly February 2006 inflation above or below that will move the reported annual inflation rate in tandem.
To varying degrees, most of the following series have significant reporting problems. All series (including the more trouble free) will be addressed in a monthly "Reporting Focus," with this month's analysis exploring Money Supply M2 as the broadest measure of the U.S. monetary aggregates, by default.
In addition to the big three, other series that have been detailed are:
* The Federal Deficit (an original background article, update in the Alert of July 7, 2005, update in Supplement to December 2005 SGS);
* 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, Part II - June 2005 SGS, M3 update November 2005 Supplement);
* Financial- and Trade-Weighted U.S. Dollar Indices (July 2005 SGS);
* Short-Term Credit Measures (August 2005 SGS);
* Income Variance/Dispersion (September 2005 SGS);
* CPI (an original background article and October 2005 SGS);
* Help Wanted Advertising (January 2006 SGS);
* Purchasing Managers Survey (February 2006 SGS).
Federal Deficit -- Distorting the current federal debt picture, the U.S. Treasury is playing games with its cash accounts, to avoid default, while Congress is playing games with the White House on extending the U.S. debt ceiling, as mentioned in this month's opening comments.
As discussed in prior newsletters, the official, accounting-gimmicked 2005 deficit (fiscal year ended September 30th) was $318.5 billion, but it was eleven times higher -- at $3.5 trillion -- on a GAAP basis, per the U.S. Treasury (see the December 2005 SGS Supplement). The official, accounting-gimmicked deficit for 2004 was $412.8 billion.
As of February 2006, the fifth month in fiscal 2006, the twelve-month rolling accounting-gimmicked deficit was $312.6 billion, against $407.8 billion in February 2005, and against $307.3 billion and $319.4 billion, respectively, in January 2006 and December 2005.
Separate from the GAAP-based numbers and official deficit reporting, the change in gross federal debt is a fair indicator of actual net cash outlays by the government. As of fiscal-year-end 2005, the gross federal debt was $7.933 trillion, up $554 billion from September 2004, which, in turn, was up by $596 billion from September 2003.
The gross federal debt as of February 28, 2006 was $8,269.9 trillion, up $557 billion from February 2005, which, in turn, was up $621 billion from January 2004.
Going forward, the official federal deficit will inflate quickly, as government finances suffer tax revenue losses from the intensifying recession. While GDP growth estimates can be gimmicked, incoming tax receipts will remain an independent estimate of underlying economic reality.
Initial Claims for Unemployment Insurance -- Annual growth in initial claims moved deeper into negative territory (an economic positive), although the improvement was tied to the expiration of certain extended benefits. On a smoothed basis for the 17 weeks ended March 4th, annual change fell to a 7.4% contraction following January 28th's annual decline of 4.5%.
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 -- January's real earnings fell by 0.2% following December's revised 0.5% gain (was 0.1%). January's real earnings were down 0.4% from the year before, after December's 0.3% (was 0.4%) decline.
Volatility in this series comes primarily from variations in reported CPI growth. Allowing for the biases built into the CPI-W series used in deflating the average weekly earnings, annual change in this series signals ongoing financial strain on U.S. households and continuing recession.
Retail Sales -- February's seasonally-adjusted monthly retail salesfell by 1.3% +/-0.7%, following 2.9% gains in both January and December.
Inflation-adjusted year-to-year growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession. February's annual growth on that basis should be close to 2.9%, down from January's 5.4%. As CPI reporting continues its upward cycle in the month's ahead, real annual retail sales will fall gain below its recession threshold, signaling recession.
Next Release (April 13): March retail sales should come in below expectations, reflecting declining economic activity. A benchmark revision to the series is scheduled for March 30.
Industrial Production -- Seasonally-adjusted January production contracted by 0.2%, a decline blamed on collapsing utility usage during the unusually warm weather. Both the November and December monthly production gains of 0.8% and 0.6% were revised upwardly, significantly, to 1.1% and 0.9%, respectively. The Federal Reserve concluded the manufacturing disruptions from Katrina, in retrospect, were over. After all revisions, January 2006 production was up 3.1% versus the year before, down sharply from December's 3.6%.
Next Release (March 17): Industrial production increasingly should mirror the recession, entering a series of regular monthly contractions. Net of utilities distortions from unusual weather patterns, upcoming reports will tend to surprise market expectations on the downside.
New Orders for Durable Goods -- January's seasonally-adjusted new orders for durable goods plunged by 10.2% (down 9.2% net of revisions), backing off from a couple of months of strong orders that had been enhanced by large aircraft numbers. The January plunge was after a revised 2.5% gain (was 1.3%) in December orders. January's annual growth rate, however, still was up 5.7%, but that was much weakened from December's 14.8%.
The widely followed nondefense capital goods orders plummeted by 20.0%, following November's revised 2.0% gain (had been a decline of 0.6%).
A subscriber queried as to how this series differs from the manufacturing orders series that usually is released a week or so after the durable goods report. The durable goods numbers are part of and dominate the results of the later report, which includes non-durable goods such as clothing and pencils, as well as slightly more current durable goods numbers. Why are there two releases? It is my understanding that the two releases were published to meet the needs of two separate Congressional Committees, many years back. In these days, where publishing truly important numbers like M3 are prohibitively expensive, at least in the opinion of the Fed, it is surprising that no one has tried to save the taxpayers a little money by just preparing and releasing one report.
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.
Trade Balance -- The seasonally-adjusted January trade deficit widened to $68.5 billion, topping October 2005's record level of $67.8 billion. The December deficit revised to $65.1 billion (was $65.7 billion), up from November's $64.5 billion shortfall. The current trade balance circumstance is discussed in some detail in this month's opening comments.
Next Release (April 12): The February trade deficit should deteriorate relative to January, putting downside pressure on overly rosy political estimates of first-quarter GDP growth. Upcoming monthly deficits will continue to surge beyond consensus forecasts, with new record monthly deficits following regularly in the months ahead.
Consumer Confidence -- February Consumer confidence declined, with annual growth holding in recession territory. The Conference Board's consumer confidence index fell by 4.8% after January's 2.9%, while the University of Michigan's consumer sentiment dropped by 4.9% after January's 0.3% easing.
On a three-month moving-average basis, annual growth in the Conference Board's measure was unchanged, while the University of Michigan number was down 6.0% year-to-year. These lagging, not leading, indicators are signaling that the economy remains in recession.
Short-Term Credit Measures -- Annual growth in short-term credit measures for businesses remained strong, holding in double digits, while annual growth in consumer credit continued to founder, with annual growth at 2.9%.
Seasonally-adjusted consumer credit continues its serious slowdown, with January's consumer credit still below that of September 2005. Annual growth slowed has slowed from September's 4.3% to 2.9% in January. Without growth in income, growth in personal consumption can be supported short-term only by debt expansion or savings liquidation, and debt expansion is faltering.
Annual growth in commercial paper outstanding eased back to 17.7% in February after January's 19.8% pace. Annual growth in commercial and industrial loans was 13.0% in January, following a 12.9% annual gain in December. Rising sales can fuel short-credit needs, but so too can slowing sales, slowing collections and rising inventories.
Producer Price Index (PPI) -- The seasonally-adjusted January finished goods PPI rose by 0.3% (0.8% unadjusted) following December's revised 0.6% gain (was 0.9%). Seasonal adjustment revisions and "corrections" were made to the 2005 data in the current release. Annual PPI inflation rose to 5.7%, up from an unrevised 5.4% in December.
Next Release (March 21): Despite a large component of random volatility in monthly price variations, PPI inflation reporting over the next several months should, in tandem with the CPI, top market expectations. Inflation should be stronger than consensus forecasts increasingly in the "core" inflation measures.
Purchasing Managers Survey (Non-Manufacturing) -- 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.
The overall February index rose by 5.5% to 60.1, from January's 56.8. 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 February employment component rose to 58.2 from 51.1, suggesting an employment improvement in the service sector.
The prices paid component diffusion index is a general indicator of inflationary pressures. The February index dropped to 64.8 from January's 67.2, a level that still is highly inflationary. On a three-month moving average basis, the annual change in February was a drop of 3.0%, following January's decline of 1.6%.
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 -- The February new orders index rose by 6.7% to 61.9, after January's decline of 1.9% to 58.0. This measure breached its fail-safe point a number of months back, generating an SGS early warning indicator of pending recession.
The Commerce Department provides suspect seasonal factors for the series, and the resulting adjusted monthly numbers 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, the February index fell by 0.6% following January's decline of 4.1%. The index gradually has notched lower from its peak annual growth of 42.6% 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 February ISM index rose to 56.7 from 54.8 in January. An index level of 50.0 divides a growing versus contracting manufacturing sector. The February employment component rose to 55.0 from 51.3.
Help Wanted Advertising Index (HWA) -- The January help-wanted advertising index dropped to 37.0 from 39.0 in December. Annual change on a three-month moving-average showed a 3.4% contraction after December's 1.8% gain. At best, the series has continued to bottom bounce since the onset of the last recession, with the current reading near a cycle low.
Housing Starts -- January housing starts rebounded by 14.6%, presumably helped by nice weather, following December's 6.9% monthly plunge. On a three-month moving average basis, annual growth slowed rose to 8.4% from December's 4.9%, once again moving away from the brink of generating a recession warning signal.
Money Supply -- This month's "Reporting Focus" examines the imminent elimination of M3 as a monetary aggregate and the new status of M2 as the United States' broadest measure of money supply. While the last full monthly (four weeks February) report on M3 shows enough continued strength in annual growth to raise concern of inflation, inflation-adjusted annual M2 growth continues to signal recession.
Before inflation adjustment, M1, M2 and M3 monthly changes for February (preliminary estimate based on four weeks of data) versus January were down 0.5% and up 0.3% and 0.5%, versus up 1.0%, 0.9% and 0.9% respectively. Year-to-year rates of change in seasonally-adjusted February and January M1, M2 and M3, respectively, were up 0.4%, 4.8% and 8.1% versus up 1.1%, 4.8% and 8.0%.
Adjusted for CPI inflation, February's M1, M2 and M3 annual year-to-year rates of change were down 3.3%, up 0.9% and 4.1%, respectively, versus down 2.8%, up 0.7% and 3.9% in January. On a three-month moving-average basis, the January annual rates of change were down 3.2%, up 0.7% and 4.1%, levels, except for M3, that remain well underwater using the old-style CPI.
Inflation Indicators
Purchasing Managers Survey (Manufacturing) - Prices Paid -- The February prices paid diffusion index eased to 62.5 from 65.0 in January, remaining in strong inflation territory. On a three-month moving average basis, February's year-to-year change was down 7.7%, following January's 6.0% 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) eased in February to an average of $61.63, down 5.9% from the all-time high in January of $65.51. Oil prices persist at highly inflationary levels, with February's average price up 28.5% from February 2005, versus January's 39.9% annual gain.
Spot prices have and will continue to gyrate. Despite ongoing 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. Anecdotal evidence remains strong that cost pressures have already passed into the so-called "core" inflation sectors.
Oil price volatility affects CPI reporting. Downside oil price movements tend to be picked up more quickly and fully by the BLS in its inflation measures 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. February's monthly dollar average rose by 1.4%, following January's 1.8% drop. February's year-to-year gain rose to 7.3% from January 6.3%.
Showing a greater weighting of softness in the Canadian dollar, February's monthly average of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index rose by 0.9% after January's 1.6% decline. February's rate of annual change held at 4.2% for the month.
Dollar trading in early March has been slightly to the upside of the February average. The relative strength in the financial- versus trade-weighted dollar, however, still remains at a level that usually precedes a major dollar sell-off.
Underlying fundamentals remain extraordinarily negative for the greenback. With serious shocks looming in U.S. economic and fiscal data, heavy selling pressure against the U.S. currency could break at any time, with little warning. New record lows for the dollar still 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.
The Federal Reserve will cease reporting Money Supply M3 on March 23rd. At that time, M2 will become the broadest monetary aggregate published by the Federal Reserve.
As to M3, we have been looking at ways to estimate or model the components that will cease to be published, so that an M3 estimate could be published on at least a monthly basis. While efforts continue, the prospects for a meaningful M3 replacement do not look promising. This circumstance will be discussed in the April newsletter's money supply section.
While it is not as strong an indicator as M3, particularly as to indicating monetary inflation pressures, M2 does generate reasonably good signals of pending recessions, enough so as to be used as one of the traditional leading economic indicators. It is the relationship between M2 and GDP growth that is explored this month.
The historical relationship between M2 and GDP growth rates can be seen in the following graphs. Shown is the three-month moving average of year-to-year growth in real (inflation-adjusted) M2, plotted against year-to-year growth in quarterly, real GDP.
In both graphs, M2 is shown with two deflations. The solid red line is deflated by the Pre-Clinton CPI-U, which is net of methodological changes introduced in the early 1990s to suppress inflation reporting. The dotted red line is M2 deflated using the official CPI-U. In both instances, the M2 in the current period has seen historically low real annual growth.
The second graph is the same as the first, except the plot of M2 growth has been moved, shifted nine months into the future against the GDP, so as to show the best correlation with GDP. Slowing M2 growth in the second graph -- that already has taken place -- suggests that annual real GDP growth is going to slow for at least the better part of 2006.
While current real M2 growth patterns are consistent with recession, other periods of similar growth in the mid-1990s did not result in an official recession, although that may be more a GDP-reporting than M2-relationship problem.
Since we have the benefit of having had M3 (no false alarms there) previously signaling a current recession, however, the M2 signal also can be taken as one for recession and one where the already weakened real GDP growth patterns will slow over at least the next nine months.
Does the PPI lead the CPI? What really is covered by this measure of "wholesale" inflation? These and other questions will be answered.
This still-pending supplement continues to take much longer than had been planned. Its publication now is targeted for slightly before or in conjunction with the April newsletter. The supplement 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. The release date will be confirmed as soon as possible.
April's Shadow Government Statistics is scheduled for release on Wednesday, April 12, 2006. The monthly newsletter regularly is scheduled for posting on the Wednesday following the Friday release of the employment statistics. The posting of the next SGS on the Web site, as well as any supplements or interim alerts, will be advised immediately by e-mail.