August 2007 Edition
JWSGS - August 2007 EDITION - Aug. 19, 2007
JOHN WILLIAMS' SHADOW GOVERNMENT STATISTICS
Issue Numbers 34
August 19, 2007
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Terrible Financial Tempest Nears Landfall
Fear of Bank Runs Appeared to Force Bernanke into His Tap-Dancing-on-the-Dollar-Landmine Routine
Deteriorating Inflationary Recession Promises Greater Liquidity Woes
Key Reporting Appears Shifted to "Let's Not Hurt the Markets" Mode
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PLEASE NOTE: The SGS-Alternate CPI measure and SGS-Ongoing M3 (based on full-month data) for July have been posted to the Alternate Data tab at www.shadowstats.com. Best wishes to all -- John Williams
OVERVIEW -- OPENING COMMENTS
The systemic liquidity crisis began running out of control last week, with stories of a run on a major bank. Keep in mind that there is not enough physical cash in the system to handle a major bank run in the traditional sense (see March 2007 SGS). Circumstances became dire enough to force Federal Reserve Chairman Ben Bernanke into publicly visible actions, announcing a 50-basis-point cut in the discount rate and starting to play a three-card monte game with the federal funds rate. Stocks rallied Friday in response, but the Fed's actions have set the stage for a massive dollar sell-off, which can frustrate lower market rates. With the economy in a deepening, inflationary recession, and with the first major Atlantic hurricane of the season within striking range of Gulf of Mexico energy infrastructure, financial-market turmoil likely has only just begun to unfold.
Bank Runs and Commercial Paper Woes Shake the Fed. The Fed issued two statements on Friday (August 17th). First, was the announced cut from 6.25% to 5.75% for the discount rate cut, which is the interest rate charged by the central bank to troubled banks borrowing at the discount window. The "temporary changes" to the Fed's primary credit discount window facility also included "term financing for as long as 30 days, renewable by the borrower" -- versus the usual overnight lending -- and an emphasis on the "broad range of collateral for discount window loans, including home mortgages and related assets."
With its primary responsibility of maintaining the liquidity and solvency of the banking system, the Fed ostensibly made these moves to assure liquidity to any banks that needed it. Yet, the Fed could have done all that sub rosa, without signaling to the public that systemic problems had reached crisis levels. Accordingly, the moves appear to have been aimed more at reassuring depositors that their banks would remain liquid.
The Fed's discount window announcements followed a collapse in the commercial paper market and a day of press reports of a run on Countrywide Bank, a federal savings bank with "more than $107 billion in assets." In addition, rumors of troubled commercial banks had started to surface.
On Friday afternoon, following the Fed's morning actions, Countrywide issued a press release, with bank president Tim Wennes emphasizing, "It is important for Countrywide Bank's valued customers to know that the highly publicized issues related to the mortgage market do not impact the safety of FDIC insured deposits at Countrywide Bank."
The release added: "Bank representatives are trained experts in helping customers structure their accounts to maximize the FDIC protections available to them." The release also mentioned that the bank "continued to receive 'investment-grade' ratings by the three major credit rating agencies."
With due respect to the banking strategists who structured that press release, if I had deposits in excess of FDIC limits, that press release would have me moving my cash out of that bank as soon as possible. It would be quite surprising if any bank runs or stories and rumors of same have yet run their course.
Also reflecting liquidity stresses, commercial paper outstanding collapsed an unprecedented 4.1% for the week-ended August 15th (seasonally adjusted, with similar movement in the unadjusted series), with total outstandings dropping by $89.1 billion, from $2,223.5 billion to $2,132.4 billion.
The Fed's second announcement on Friday was an implicit shift in outlook to a weaker economy and to an easing bias. "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth," noted the Fed. Temporarily dropping "inflation" from its vocabulary, the U.S. central added that, "... downside risks to growth have increased appreciably."
Market sentiment shifted immediately to an easing at the next FOMC meeting, along with further rate cuts in the year ahead. There are, however, major complicating factors to such a simplistic and Pollyannaish view.

First, the Fed already has eased -- at least tacitly -- as shown in the graph above. The effective federal funds rate has been between 25 and 75 basis points below target for the last week.
Second, inflation is as much problem as it was a week ago. The myths that the Fed's primary missions are to contain inflation and promote sustainable economic growth -- goals that supposedly can be met simply with respective tightening or easing policies -- will fall to the reality of a banking system in trouble. The inflation fight was just trumped by one liquidity crisis. The stimulate-the-economy fight is likely to be abandoned in the even greater liquidity crisis that looms with a massive dollar sell-off.
Indeed, the third complicating factor is the U.S. Dollar, which has been sitting at the edge of the abyss for some time. The Fed's actions most likely will trigger massive dumping of the greenback. Central bank intervention can provide short-lived mitigation, and the dollar has had mixed pressures from flight-to-quality issues and some unwinding of the yen carry trade. Exacerbated by perceptions of U.S. interest rates headed lower, however, liquidity flight shortly should shift to be out of the U.S. dollar and dollar-denominated assets. A plunge in the greenback's value combined with U.S. financial market dependence on foreign capital for liquidity would make significant or protracted easing by the Fed a difficult, if not counter-productive, task.
Systemic liquidity problems will get much worse as the effects of the still largely unrecognized recession take their toll on a variety of carefully structured securities and investment/hedging instruments. The crisis should intensify sharply when the dollar's sell-off begins. Despite the trillions of dollars in electronic "cash," if the banking crisis expands and there are any major physical runs on banks, it is conceivable that a cash shortage could force a short-term banking holiday. Despite all assurances of adequate liquidity in the system, the impact likely would not be a happy one for the financial markets.
Economic Problems Persist. Although the "advance" estimate of second-quarter real (inflation-adjusted) GDP growth rebounded to above average, it contracted by an annualized 0.9%, net of the annual revisions (see Reporting/Market Focus). Retail sales, industrial production and new orders for durable goods were soft. The employment report and help-wanted advertising were much worse than expected, as were the purchasing managers surveys. The annual decline in housing deepened, again.

As shown in the graph of the three-month moving average of annual change in housing starts, the recent decline in starts remains the weakest since the 1990/1991 recession.
The trade deficit, however, showed a healthy but highly suspect narrowing in June. As reported, the numbers suggest there will be some upside revision to the already heavily bloated estimate of second-quarter GDP growth. More importantly, though, the "good" trade report helped support the dollar when such was needed. The trade data easily are manipulated by altering the paperwork flows of monthly exports and imports. Such was done following the 1987 panic and Alan Greenspan's abandonment of the dollar, in an effort to help stabilize and turn the U.S. dollar to the upside. Such was accomplished in early 1988 in conjunction with extraordinarily massive central bank dollar-support intervention.
PLEASE NOTE: A "General background note" provides a broad background paragraph on certain series or concepts. Where the language used in past and subsequent newsletters usually has been or will be identical, month-after-month, any text changes in these sections will be highlighted in bold italics upon first usage. This is designed so that regular readers may avoid re-reading material they have seen before, but where they will have the material available for reference, if so desired.
General background note: The U.S. economy is in a protracted and deepening structural recession that will prove to be the second leg of a double-dip recession, which began in 2000/2001. The current downleg was signaled in mid-2005 by a series of leading indicators used for that purpose by SGS. With neither traditional fiscal nor monetary stimulus available to help turn economic activity, the current circumstance is likely to evolve into a hyperinflationary depression (see December 2006 SGS).
Inflation Problems Persist. With annual M3 growth holding at 13% in June, along with a generally weakening dollar, near-record-high oil prices and sharply spiking food costs, contained inflation is not in the offing. Standard PPI inflation was stronger than expected, standard CPI was weaker than expected. In the both instances, though, food costs clearly were understated. Despite "unexpected" moves in the full inflation measures, the gimmicked "core" concept -- spun so strongly by Wall Street hypesters -- keeps coming in at or below consensus forecasts. That circumstance strongly suggests those numbers are being massaged.
Market Turmoil Likely to Increase. The markets are in turmoil with extreme daily stock-market volatility and flight to quality issues impacting the dollar, gold and interest rates. Key to near-term activity is what happens to the U.S. dollar. If it begins a significant sell-off, as I expect, that will frustrate any easing attempts by the Fed, boost long-term interest rates and bolster gold, while meaningfully tanking equities. Chances that the liquidity crisis has run its course are close to nil.
Alternate Realities. General background note: This section updates the Shadow Government Statistics (SGS) alternate measures of official CPI and GDP reporting. When a government economic measure does not match common public experience, it has little use outside of academia or the spin-doctoring rooms of the Federal Reserve, White House and Wall Street. In these alternate measures, the effects of gimmicked methodological changes have been removed from the official series so as to reflect more accurately the common public experience, as embodied by the post-World War II CPI and the pre-Reagan-Era GDP. The methodologies for the series are discussed in the August 2006 SGS (see Archives page at www.shadowstats.com).
GDP. The alternate second-quarter GDP growth reflects the "advance" estimate, with many of the methodological gimmicks of recent decades removed. The alternate second-quarter inflation-adjusted annual growth rate (year-to-year, as opposed to the popularly-touted annualized quarter-to-quarter rate) for GDP was a decline of roughly 2.3% versus the official year-to-year gain of 1.8%. These numbers incorporate the annual revisions published on July 27th, which are reviewed in this month's Reporting/Market Focus.

General background note: Historical data on both the official and SGS-Alternate GDP series are available for download on the Alternate Data page of www.shadowstats.com. The Alternate GDP numbers tend to show deeper and more protracted recessions than have been reported formally or reflected in related official reporting. Nonetheless, the patterns shown in the alternate data are broadly consistent with the payroll employment and industrial production series (as revised), which are major indicators used by the National Bureau of Economic Research in determining the official timing of U.S. business cycles.
CPI. The annual non-core annual inflation rates eased somewhat in July, while the so-called "core" inflation rates held at June's levels. Food and oil-related price pressures remain a problem, due primarily to supply issues, but those pressures have been avoided in much of the government's reporting of the non-core inflation, so far. Both core and regular annual inflation reporting should rise sharply in the months ahead.

General background note: Historical data on both the official and SGS-Alternate CPI series are available for download on the Alternate Data page of www.shadowstats.com. The Alternate CPI numbers tend to show significantly higher inflation over time, generally reflecting the reversal of hedonic adjustments, geometric weighting and the use of a more traditional approach to measuring housing costs, measures all consistent with the reporting methodology in place as of 1980.
MARKETS PERSPECTIVE
Last month, I noted, "little action can be expected from the Fed, until either a dollar panic or systemic liquidity issues force its hand. The Fed otherwise remains hamstrung, unable with its impaired monetary tools either to contain a commodity-driven inflation or to stimulate a structurally damaged economy. Unfortunately, signs of both risk cases -- dollar selling and possible systemic liquidity issues -- are starting to surface."
The systemic liquidity crisis should continue blossoming for at least the next several weeks, with the dollar-panic risk case likely to kick in soon. At such time as the "flight-to-safety" switches from into to out of the dollar and Treasuries, stocks and bonds will sell off heavily.
General background note: The U.S. economy remains in a severe, structural inflationary recession, saddled with an impotent Fed and a federal government that is fiscally bankrupt in all but name. In combination, these factors offer the worst of all environments to the financial markets. Ahead lie higher long-term interest rates and much lower U.S. equity prices. On the plus side is the outlook for gold, which provides a solid hedge against many of the problems that have started to surface. Key to the near-term movements of these markets remains the fate of the U.S. dollar, which appears to be near a major downside move.
U.S. Equities -- After hitting all-time highs a month ago, most U.S. stock indexes have sold off fairly sharply. The burgeoning liquidity problems have generated increasing volatile and generally negative market activity. Underlying fundamentals are not likely to improve for some time.
General background note: As the equity markets catch up with the underlying economic and looming financial fundamentals, the downside adjustments to stock prices should be quite large, eventually rivaling the 90% decline in equities seen in the 1929 crash and ensuing several years. The decline might have to be measured in real terms (net of inflation), as a hyperinflation eventually will kick in as the Fed moves to liquefy the system. Stocks do tend to follow inflation, since revenues and earnings get denominated in inflated dollars. Hence with a hyperinflation, a DJIA of 100,000 or 100,000,000 could be expected, but such still would be below today's levels, adjusted for inflation.
General background note: The approaching financial maelstrom already has come over the horizon and now is nearing landfall. When it hits, those investors who have taken shelter in cash, gold and outside the U.S. dollar will be the ones with the wealth and assets available to take advantage of the extraordinary investment opportunities that should follow.
U.S. Credit Market -- Recent credit market activity has been dominated by the still unfolding liquidity crisis, and the markets will continue to gyrate accordingly. Some "flight to quality" has pushed down long-term Treasury yields, while Fed actions have raised market expectations of an imminent easing.
Confounding any efforts to force a protracted period of lower interest rates likely will be a severe decline in the U.S. dollar, and that can break at any moment. Inflation problems also will worsen markedly, frightening the already battered markets. As a result, six months to a year from now, I expect long-term interest rates will be much higher than they are now, with a sharp, positively-sloped yield curve.
U.S. Dollar -- With the Fed rumbling about easing and already tacitly targeting a lower fed funds rate, the U.S. dollar is poised for a major sell-off. At times of disorderly markets, central banks are noted for covert intervention in various markets, particularly the currency markets. Such intervention, however, usually proves to be short-lived. In the matter of a week, the timeframe for a likely massive hit on the greenback has moved much closer, perhaps within the next week or two, depending how market conditions break.
[Following paragraph text corrected from original posting] Opening the markets for an across-the-board dollar rout, the dollar tumbled against the yen in the last week or so, due to the unwinding of the carry trade, while the greenback held even or strengthened slightly against most other major currencies.
Potentially exacerbating the circumstance are recent moves by Communist China to threaten use of their dollar sales "nuclear option" (see Alert of August 12th), and by Iran requesting that Japanese buyers pay for their oil purchases in yen. The U.S. markets are particularly vulnerable, at the moment, to "surprises" from those countries that are not so friendly to the United States, or even from those who simply would like to avoid large losses on the dollars they hold.
The fundamentals underlying the U.S. currency remain extraordinarily negative, as discussed below, and have been upped a significant notch by the systemic liquidity crisis and the Fed's response to same. A full blown dollar crisis can break with little or no warning.
Beyond Federal Reserve missteps, or major negative surprises out of the liquidity crisis, the proximal trigger for a dollar panic could come from a bad economic statistic, political missteps by the Administration, negative trade or market developments in Asia, or a terrorist attack or even still-likely military action against Iran. When it hits, the broad selling pressure should be strong enough to overcome any short-lived central bank intervention.
General background note: In terms of underlying fundamentals that tend to drive currency trading, the dollar's portfolio could not be worse. Relative to major trading partners, the U.S. economy is much weaker, interest rates are lower and promised to go lower still, inflation is higher, fiscal and trade-balance conditions are abysmal, and relative political stability is at a nadir. The President's approval rating commonly has moved currency trading in the past, and, despite any near-term bouncing, it remains lower than has been seen for any other U.S. President in the post-World War II era. Relative political stability issues are compounded by the presence of a Congress that is increasingly hostile to the President. Generally, the greater the magnitude of the dollar selling, the greater will be the ultimate inflation pressure and liquidity squeeze in the U.S. capital markets.
As shown in the following graph, the U.S. dollar weakened in July, setting or approaching new record lows on both a financial- and trade-weighted basis. The added August 17th data points show current levels at or slightly above the July averages.

General background note: Historical data on both dollar series are available for download on the Alternate Data page of www.shadowstats.com. See the July 2005 SGS for methodology.
U.S. Dollar Indices. The Shadow Government Statistics' Financial-Weighted U.S. Dollar Index (FWD) is based on dollar exchange rates weighted for respective global currency trading volumes. For July 2007, the monthly dollar average fell by 2.03% after a monthly gain of 0.11% in June. The July 2007 average index level of 49.25 (base month of January 1985 = 100.00) was down 6.08% from July 2006, with June down 4.11% from the year before. The index's historic monthly-average low was 48.98 in April 1995.
Dropping to another all-time monthly-average low, July's level of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index (TWD) fell 1.80% versus June, which was down by 0.34% from May. The July 2007 index level of 55.78 (base month of January 1985 = 100.00) was down 5.41% from July 2006, against June's 3.16% decline from the year before.
Gold -- As of Friday (August 17th), gold was trading around $658 per troy ounce and silver around $11.70. For July, the monthly-average gold price (London afternoon fix per Kitco.com) averaged $665.30 per troy ounce, against June's $655.49 per troy ounce. Silver averaged $12.91 per troy ounce in July, down from $13.14 in June.
Gold price volatility continues but generally, price movement has been mixed during the breaking systemic liquidity crisis. Highly suspect here is the possibility of covert central bank intervention. At such time as the U.S. dollar begins its massive sell-off, gold and silver likely will spike sharply to the upside. Indeed, despite central-bank machinations or intervention, the upside potential for the precious metals remains explosive, new record high prices loom.
General background note: As discussed in the Hyperinflation Series (see the December 2006 to March 2007 SGSs), the eventual complete collapse of the U.S. dollar -- the world's reserve currency -- will force the creation of a new international currency system. Gold likely will be structured into any replacement system, in an effort by those organizing the new currency structure to gain public acceptance.


The updated gold versus oil and Swiss franc graphs show July averages as well as added points for closing prices on August 17th. As we go to press, gold is trading around $658, oil is around $72 and the Swiss franc is around $0.83. Look for all three measures to trade significantly higher in the months ahead.
REPORTING PERSPECTIVE
The Big Three Market Movers
With the financial markets in turmoil, recent CPI and trade reporting, in particular, showed unusual results, suggestive of some manipulation aimed at soothing unfortunate market pressures. The bulk of the other major economic reports, however, generally have continued coming in on the soft side of expectations.
Friday's Fed statements helped move financial-market sentiment towards recession, and increasingly towards the view of a recessionary economy beset by inflation problems. The full extent of the economy's plight, however, is far from having broad recognition.
With the President's positive rating still bottom bouncing and with a nervous Fed trying to contain an expanding systemic meltdown, recent and upcoming releases of major series have been, and likely will continue to be, subject to some manipulation, as mentioned above. Statistical games are being played for both the perceived political needs of the Administration and the increasingly heavy financial market needs of an impotent Federal Reserve. We are looking now at moves that border on national security issues.
Absent manipulation, and against lagging and still largely distorted market expectations, most near-term economic reporting should tend to surprise the markets on the downside, while most inflation reporting should tend to surprise expectations on the upside.
Employment/Unemployment -- The seasonally-adjusted July nonfarm payrolls rose by 92,000 (84,000 net of revisions) +/- 129,000 for the month. June payrolls were up a revised 126,000 (previously 132,000). Annual growth slowed sharply from 1.47% in June to 1.34% in July.
As noted in the August 5th Alert, the only thing surprising about the July employment and unemployment report was that the rigging was not set to show stronger numbers. Most of the following commentary is repeated from that Alert.
As with other recent monthly reports, applying consistent not-seasonally-adjusted year-to-year change to the seasonally-adjusted numbers yielded lower than advertised jobs growth. Applying July's unadjusted annual growth rate, to the adjusted numbers, yields an adjusted monthly July payroll increase of 47,000, about half of the official 92,000 gain.
The statistically-sounder household survey, showed employment down by 30,000 for the month, with the seasonally-adjusted U.3 unemployment rate rising to 4.65% +/- 0.23% in July, from 4.53% in June. Unadjusted U.3 rose to 4.9% from 4.7% in June, while the broader U.6 measure rose to 8.6% from 8.5% (unadjusted) and to 8.3% from 8.2% (adjusted). Net of the "discouraged workers" defined out of existence during the Clinton Administration, traditional unemployment continues to run around 12%.
The payroll data appear to be under careful management, as seen in the most recent revisions and seasonal-adjustment gimmicks. In revision, the unadjusted total nonfarm payrolls in May and June moved higher, respectively, by 32,000 (138,623 to 138,655) and by 34,000 (139,127 to 139,161). What is unusual is that the adjusted series were nearly unchanged in revision, down by 2,000 in May (137,906 to 137,904) and down by 8,000 in June (138,038 to 138,030). Normally, the changes in the unadjusted series would flow through to the adjusted series with little variation. Where revisions to the data come in on an unadjusted basis, seasonal adjustments for May and June were altered so as to maintain something close to the original reporting level. Why, still remains a question, but the data have been carefully adjusted to maintain someone's reporting agendum.
The July employment gain was against a background of plunging help-wanted advertising, slightly positive movement in new claims for unemployment insurance and weaker employment numbers in the July purchasing managers surveys (see respective sections). These background numbers remain consistent with continued weakness in official jobs and unemployment reporting.
The monthly bias factor (birth/death model) in July was an add-on of 26,000, compared with 21,000 a year ago. Where the August 2006 bias factor was 122,000, such suggests some upside pressure on the August 2007 payroll estimate.
Next Release (September 7): The August payroll survey should show underlying economic weakness and disappoint market expectations. Financial market instabilities, however, would tend to favor a massaged number that could be deemed a positive for the markets. In like manner, reality should be an ongoing rise in the unemployment rate, barring manipulations.
Gross Domestic Product (GDP) -- The "advance" estimate of annualized real (inflation-adjusted) growth for the second quarter of 2007 was 3.38% +/- 3%, matching consensus forecasts (the Bureau of Economic Analysis has been known to target consensus forecasts with its advance guesstimate), but well beyond credibility for this most politicized of economic series. The second quarter's gain rebounded from 0.60% in the first quarter, while year-to-year growth jumped to 1.78% in the second quarter, up from 1.55% in the first.
These numbers reflected significant annual revisions (see this month's Reporting/Market Focus). The changes were sharp enough on the downside that net of revisions, annualized second quarter GDP showed a contraction of 0.86% and annual growth was up by 1.1%.
On the inflation front, the GDP deflator in the second quarter helped to spike real growth, with annualized inflation of just 2.69% against the 4.23% inflation pace estimated for the first quarter. Generally, historical deflator estimates were revised so as to show meaningfully higher inflation than had been previously reported.
Although the GDP report is the government's broadest estimate of U.S. economic activity, it is also the least meaningful and most heavily massaged of all major government economic series. Published by the BEA, it primarily has become a tool for economic propaganda. Adjusting for methodological distortions built into GDP reporting over time, the SGS-Alternate GDP measure suggests economic reality is much weaker than officially reported. Alternate year-to-year annual contractions continue, with an annual 2.3% contraction in the second quarter deepening from the 2.2% decline in the first quarter (see the graph in the Alternate Reality section of the Opening Comments).
Next Release (August 30): The "preliminary" estimate revision of annualized quarterly real GDP growth for the second quarter should show even stronger growth, given the nonsense published with the reported narrowing of the June trade deficit.
Consumer Price Index (CPI) -- The BLS reported the seasonally-adjusted July CPI-U (I.6) up by 0.13% (down by 0.03% unadjusted) +/- 0.12% (95% confidence interval) for the month, compared with a 0.19% (0.19% unadjusted) gain in June. Annual inflation eased to 2.36% in July from 2.69% in June. Annualized year-to-date inflation through July was 4.56% adjusted, 5.60% unadjusted. The accounting for both CPI-U and PPI inflation was suspiciously shy in the area of food inflation, against significant anecdotal evidence to the upside.
Annual inflation for the Chain Weighted CPI-U (C-CPI-U) (I.5) -- the substitution-based series that increasingly gets touted by the manipulators as the replacement for the CPI-U -- was 2.08% in July, versus 2.32% in June.
Adjusted to pre-Clinton (1990) methodology (I.7), annual CPI growth was about 5.7% in July versus 6.1% in June, while the SGS-Alternate Consumer Inflation Measure (I.8), which reverses gimmicked changes to official CPI reporting methodologies back to 1980, was roughly 10.1% in July versus 10.3% in June. The eight levels of annual inflation, I.1 to I.8, are shown in the table in the Alternate Reality section, along with the graph of SGS-Alternate Consumer Inflation.
Next Release (September 19): Annual inflation generally will continue rising into at least the early part of 2008. Seasonally-adjusted, monthly CPI-U increased by 0.3% in August 2006. Any monthly reporting above or below that for the pending release of August 2007 CPI will add or subtract directly to or from the current annual CPI-U inflation rate. Reporting risks generally favor an upside surprise to modest market expectations. A renewed upside movement in core inflation remains long overdue.
Other Troubled Key Series
Federal Deficit -- General background note: The federal government's fiscal 2006 (fiscal year-end September 30th) deficit, prepared based on generally accepted accounting principles (GAAP), widened to $4.6 trillion from 2005's $3.5 trillion. Those numbers dwarfed the officially-gimmicked 2006 federal budget deficit of $248.2 billion, which was down $70.8 billion from 2005's $318.5 billion (see the December SGS).
General background note: Although it lacks the accrual accounting of the GAAP numbers, the change in gross federal debt bypasses several of the reporting manipulations and is a better indicator of actual net cash outlays by the federal government than is the official, gimmicked deficit reporting. As of fiscal year-end 2006, the gross federal debt stood at $8.507 trillion, up $574 billion from 2005, which in turn was up $554 billion from 2004.
For the rolling 12 months through July 2007, the gimmicked deficit was $165.8 billion versus $255.4 billion in July 2006, compared with the rolling deficits of $162.7 billion in June 2007 and $275.5 billion in June 2006. The gap in the year-to-year rolling deficits has continued to narrow.
For July 31, 2007, the gross federal debt stood at $8.932 trillion, up $64 billion from June and up $488 billion from July 2006, which in turn was up $557 billion from July 2005. For June 30, 2007, the gross federal debt stood at $8.868 trillion, up $39 billion from May and up $448 billion from June 2006, which in turn was up $584 billion from June 2005.
General background note: The Administration and Congress continue playing bookkeeping games. Even so, the gimmicked deficit should widen in the next 12 months, as government finances begin to suffer from tax revenue losses due to the intensifying recession and relative tax receipt declines after the expiration of recent corporate tax incentives. While GDP growth estimates can be gimmicked, incoming tax receipts (based on consistently applied tax policies) remain an independent estimate of underlying economic reality and eventually will reflect the economy's mounting difficulties.
Initial Claims for Unemployment Insurance -- Annual growth in initial claims has continued to soften, turningd marginally negative (an economic positive). On a smoothed basis for the 17 weeks ended August 11th, annual change was a contraction of 1.7%, versus the 17 weeks ended July 14th, where annual growth was 0.1%.
General background note: More often than not, week-to-week volatility of the seasonally-adjusted weekly claims numbers is due to the Labor Department's efforts to seasonally adjust these numbers around holiday periods, such as Easter, Memorial Day, July 4th and Labor Day. The Labor Department has demonstrated an inability to do such adjusting successfully. When the new claims series is viewed in terms of the year-to-year change in the 17-week (four-month) moving average, however, such generally is a fair indicator of current economic activity.
Real Average Weekly Earnings -- July's seasonally-adjusted monthly real earnings fell by 0.1% after a revised 0.6% (was 0.5%) gain in June. Annual growth held at 1.3% for both July and June.
General background note: Gyrations in the poor quality of reported CPI growth account for most month-to-month volatility in this series. Adjusting for the major upside biases built into the CPI-W inflation measure used in deflating the average weekly earnings, annual change in this series shows the average worker to be under severe financial stress in an ongoing recession.
Retail Sales -- July's seasonally-adjusted retail sales rose by 0.29% (up 0.59% net of revisions) +/- 0.9% (95% confidence interval), after declining by a revised 0.72% (previously down 0.89%). With monthly CPI up by 0.13%, seasonally-adjusted monthly retail sales were up by roughly 0.1% after inflation. What is unusual. though, is that the increases in food and restaurant sales -- largely due to food inflation -- were not reflected fully in the CPI. Fully reflected, CPI inflation would have been higher and real retail sales growth would have been negative. Increasingly, retail sales are reflecting relative strength due to rising prices, and the real retail sales number will become more important in assessing the strength of consumer spending.
On a year-to-year basis, July retail sales were up by 3.25% before inflation and by just 0.89% after inflation, compared with respective annual growth numbers for June of 4.01% (previously 3.77%) and 1.32%.
General background note: Real (inflation-adjusted) year-to-year growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession, and a signal first was generated in this business cycle back in June 2006.
Next Release (September 14): August retail sales should come in below market expectations, barring manipulation, and increasingly below the rate of inflation on both a monthly and a year-to-year basis.
Industrial Production -- Seasonally-adjusted industrial production rose by 0.3% (0.4% net of revisions) in July, against a revised 0.6% (was 0.5%) in June. Despite the intermittent monthly gains, annual growth continues to slow to recessionary levels. Annual growth from February through July has slowed as follows: February 2.88%, March 2.25%, April 1.91%, May 1.77%, June 1.44%, July 1.38%.
Next Release (September 14): Look for August industrial production to move once again towards a pattern of contraction, shy of any utility surge from unseasonably hot weather. Eventually, monthly contractions in this series should become regular, with the rapidly slowing annual growth turning negative.
New Orders for Durable Goods -- For June, the usually volatile durable goods orders gained 1.4% for the month, on a seasonally-adjusted basis, after falling a revised 2.3% (was down 2.8%) in May. As noted in the July 29th Alert, June's new orders were down 0.5%, net of Boeing's successful launch of the 787, where production from the orders will be stretched out over years, instead of one month. On an annual basis, durable goods orders fell a recessionary 0.6%
The closely followed nondefense capital goods new orders rose by 4.6% after falling 5.8% in May. Again, they were down in June net of aircraft orders. June's annual growth rate for nondefense capital goods was 5.5%.
General background note: Durable goods orders lost its status as a solid leading economic indicator when the semi-conductor industry stopped reporting new orders in 2002.
Trade Balance -- The seasonally-adjusted monthly trade deficit for June narrowed to $58.1 billion, with May's reading revising to $59.2 billion (previously $60.0 billion). The June detail showed higher oil imports, based both on higher prices and higher physical volume, but the current trade shortfall remains well shy of reality.
The latest data promise some upside revision to second-quarter GDP growth, and also helps the dollar, with the Fed starting to look like it is abandoning the greenback. Historically, such as in 1987/1988, disruptions of import paper flows have been used to adjust initial trade deficit reporting. Something like that appears to be in play at the moment. Revisions next year should tell the story.
Next Release (September 11): Odds favor renewed deterioration in the July monthly trade deficit, barring ongoing manipulation. Reporting risk generally remains on the negative side of consensus forecasts. The months ahead should see a pattern of regularly increasing deficits that shortly, again, will be setting new records.
Consumer Confidence -- July confidence measures rose, and Wall Street hypesters trumpeted the highest Conference Board reading in six years. That, of course, was in the middle of the last formal recession. Like help-wanted advertising, consumer confidence never recovered from the last economic downturn.
Indeed, July consumer confidence rose, with the Conference Board's Confidence measure up 6.9% for the month, and the three-month moving average up by 2.9% year-to-year. The University of Michigan's Sentiment measure rose by 6.0% for the month, with the three-month moving average up by 6.2% year-to-year.
These lagging, not leading, indicators tend to reflect the tone of the popular financial media and recently have suggested that the economy has continued to falter. Wait until you see the numbers for August! The current financial crisis will not play out well for these series.
General background note: The Conference Board measure is seasonally adjusted, which can provide occasional, but significant distortion. The adjustment does not make much sense and is of suspect purpose, given that the Conference Board does not release the unadjusted number. The Michigan survey is unadjusted. How does one seasonally-adjust peoples' attitudes? Also, beware the mid-month Consumer Sentiment release from the University of Michigan. Its sampling base is so small as to be virtually valueless in terms of statistical significance.
Short-Term Credit Measures -- Patterns of annual growth in consumer and commercial borrowing were mixed through June/July, with consumer credit growth slowing in contrast to generally stronger commercial borrowing. As noted in the Opening Comments, however, commercial paper outstanding plunged in the August 15th week as part of the unfolding liquidity crisis.
Annual growth has held at 5.0% for April, May and June, for seasonally-adjusted consumer credit, which includes credit cards and auto loans, but not mortgages. In the current environment, where inflation-adjusted growth in income is not adequate to support meaningful growth in the personal consumption component of GDP, GDP growth only can come from temporary debt expansion or savings liquidation. Accordingly, stagnant consumer debt expansion places a constraint on economic growth.
Commercial borrowing growth, however, continued to be strong on a year-to-year basis before the liquidity crunch hit, with annual growth in commercial paper outstanding rising at 18.8% in July versus 19.6% in June. Annual growth in commercial and industrial loans was 12.8% in July, up from 12.3% in June. Solid growth in the commercial credit measures can signal credit needs tied either to rising sales and receivables/inventory, or to slowing sales and slowing collections and involuntarily rising inventories, but the mid-August liquidity crisis quickly could negatively impact business activity.
Producer Price Index (PPI) -- Rebounding beyond market expectations, the July finished goods PPI rose by a seasonally-adjusted 0.6% (0.7% unadjusted), versus a decline of 0.2% (down 0.4% unadjusted) in June. Annual PPI in July rose to 4.0% from June's 3.3%. Seasonally-adjusted intermediate and crude goods rose by 0.6% and 1.2% in July, against gains of 0.5% and 0.3% in June. The accounting for both PPI and CPI-U inflation, however, was suspiciously shy in the area of food inflation, against significant upside anecdotal evidence.
Next Release (September 18): Despite the regular random volatility of the monthly price variations, PPI inflation reporting over the next six-to-nine months generally should come in above market expectations. As with the CPI, the core PPI inflation rate still is long overdue for an upside surprise.
Better-Quality Numbers
General background note: 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 -- Playing some catch up and resuming its trend toward showing a recession in manufacturing, the overall July ISM manufacturing index fell to 53.8 from 56.0 in June, with the July employment index down to 50.2 from June's 51.1. Continued decline in the broad series is a good bet in the next several months, based on declining annual activity in a variety of underlying series.
The July new orders index backed off to 57.5, from June's 60.3. Seasonal-factor distortions, which have been present, usually are overcome by viewing the series using year-to-year change on a three-month moving average basis. On that basis, the July new orders index was up by 5.7% versus a 5.1% gain June.
General background note: 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 below 50.0 indicates contracting new orders. The index gradually has notched lower from its peak annual growth of 42.6% in April of 2004. As an SGS early warning indicator of a major economic shift, the new orders measure breached its fail-safe point in mid-2005, generating a signal of pending recession.
Service Sector Index. The service-sector ISM index does not have much meaning related to overall business activity, since new order activity at law firms, hospitals or fast-food restaurants has little obvious relationship to broad economic activity. That said, the overall July services sector index also declined in July, to 55.8 from June's 60.7. Both the services employment and prices paid components, however, have some meaning. The July employment component plunged to 51.7 from 55.0 in June. The prices paid component is covered in the Inflation Indicators.
Help-Wanted Advertising Index (HWA) -- The Conference Board reported that help-wanted advertising plummeted still again, to 26 in June, down from 27 in May, closing in on an all-time low. Even allowing for the advertising volume lost to the Internet in recent years, the current weakness is enough to signal a deepening problem in the employment sector. The June number was down 18.8% from the year before, compared with an 18.2% drop in May.
Viewed on a three-month moving-average basis, June's year-to-year change was a contraction of 17.2% versus May's 18.3%. The series still indicates rapidly deteriorating employment conditions. Where the index never recovered from the 2000/2001 recession, its renewed and ongoing plunge has signaled a new and rapid contraction in economic activity. Continued deterioration remains likely in the months ahead.
Housing Starts -- As discussed again in this month's Opening Comments, ongoing weakness in the housing starts remains in place, with an updated graph showing annual growth on a three-month moving-average basis.
July's seasonally-adjusted housing starts fell by 6.1% +/- 10% (95% confidence interval) for the month, after a revised 2.1% (previously 2.3%) monthly gain in June. Year-to-year, July starts were down by 20.9% (+/- 7.1%), versus a drop of 19.4%% in June.
Confirming ongoing weakness in the housing sector, July building permits were down 2.8% for the month and 22.6% for the year. In June reporting, new home sales were down 22.3% year-to-year, while June existing home sales were down 11.4% at an annual rate.
Inflation Indicators
Money Supply -- The money supply comments move into the Inflation Indicators section this month, given their import in that area. The SGS Ongoing M3 estimate of annual growth for the July average came in at 13.0%, the same as in June. That pace of growth remains uncomfortably high in terms of its inflationary implications.

General background note: Historical annual growth data for the money supply series, including the SGS Ongoing M3 estimates, are available for download on the Alternate Data page of www.shadowstats.com. See the August 2006 SGS for methodology. The indicated M3 levels below are our best estimate and are provided at specific subscriber request. Keep in mind that regular revisions in the related Fed series affect historical M3. Usually, annual growth rates hold, although levels may shift a little. We have not attempted, nor do we plan to recreate a revised historical series for an M3 monthly-average level going back in time. The purpose of the SGS series was and is to provide monthly estimates of ongoing annual M3 growth. We are comfortable with those numbers and that our estimated monthly growth rates are reasonably close to what the Fed would be reporting, if it still reported M3. With those caveats on the table, here are the monthly-average levels for M3:
Based on the July data, annual growth for monthly M1 fell by 0.28%, versus a 0.70% contraction in June, while July M2 annual growth held at 6.15%, the same as in June.
Purchasing Managers Surveys: Prices Paid Indices -- The July prices paid indices were slightly softer, again, still not reflecting the recent surge in oil prices. The levels, however, remain high and in inflation territory, suggestive of ongoing inflation issues in both purchasing managers surveys.
On the manufacturing side, the July price index eased to 65.0 from June's 68.0. On a three-month moving average basis, July's annual change was down by 12.1%, following June's 5.8% drop. The manufacturing price indicator is not seasonally adjusted and, therefore, is a generally better indicator of pricing activity. Keep in mind that the oil market was particularly strong at this time last year.
On the non-manufacturing side, the seasonally-adjusted July prices diffusion index softened again, to 61.3 from June's 65.5. On a three-month moving-average basis July's annual change was a decline of 11.2% following June's decrease of 9.2%.
General background note: Published by the Institute for Supply Management (ISM), the prices paid components of the purchasing managers surveys are reliable leading indicators of inflationary pressure. The measures are diffusion indices, where a reading above 50.0 indicates rising prices.
Oil Prices -- For the month of July, the monthly-average West Texas Intermediate spot price (Department of Energy) rose 9.9% to $74.18 per barrel from $67.48 in June. Against last year's record high oil price, July's year-to-year decline in average monthly price was just 0.3%, narrowed from June's 4.9% contraction. Price movement remains highly volatile, but generally is trending higher, and shortly should settle above the new daily record high price level set in the last month.
Meaningful upside risks to oil prices remain in play, both from the looming peak in the hurricane season and ever-volatile Middle Eastern political tensions. Hurricane Dean, the first major storm of the season, is in striking range of Gulf of Mexico energy infrastructure. As we go to press, forecasts have the storm moving well south of Houston, but storms can shift quickly and unexpectedly. Other storms, and attendant increased financial market speculation of risk, are likely in the next month or so.
General background note: Global political conditions continue to favor a further sharp spike in oil prices in the months ahead, irrespective of any ongoing games-playing by the Administration and OPEC. Overhanging the market remains the potential for a change in the dollar-based pricing of oil, particularly as dollar selling intensifies. Where dollar weakness is the equivalent of an oil price cut for oil purchasers denominated in an appreciating currency, market forces tend to push dollar-based oil prices higher, and that exacerbates inflation problems in the United States. Even worse, if oil pricing were shifted to something other than the U.S. currency, as appears to be happening between Iran and Japan (see U.S. Dollar section), U.S. inflationary pressures would be even more intense, since any drop in the dollar would be reflected directly as an increase in the price of foreign oil for U.S. consumption.
General background note: Whether from supply and demand, geo-political or currency pressures, oil prices will remain at highly inflationary levels and will continue as a major contributing factor to U.S. inflation woes. Historically high oil prices still are working their way through all levels of U.S. economic activity, ranging from transportation and energy costs, to material costs in the plastics, pharmaceutical, fertilizer, chemical industries, etc. These broad inflationary pressures will remain intact despite any near-term oil price volatility. Although these pressures may be slow to surface in government reporting of the so-called "core" inflation measures, they will surface.
Reporting/Market Focus (August 2007) --
Annual GDP Revisions and the SGS Alternate Measure
Once again, and as estimated by SGS, annual GDP revisions have shown that previously reported GDP growth was overstated meaningfully. The current revisions out of the Bureau of Economic Analysis (BEA) reflect some of the downside benchmark revisions made to such series as retail sales, industrial production and housing. This continuing pattern of successive downward revisions over the years also tends to show some of the regular upside growth bias built into the GDP series.
Nonetheless, current and historical reported U.S. economic growth rates of recent years still remain heavily overstated, due largely to methodological "innovations" that have generated these and other upside biases in the official series. The Shadow Government Statistics Alternate GDP measure continues to approximate historical annual GDP with those biases removed (see the "Alternate Realities" section and Alternate Data Series tab at www.shadowstats.com for the latest plot and data, and the August 2006 SGS Newsletter for methodology). Given that the official 2007 annual revisions were in the normal scope of the previous SGS analysis, the SGS alternate growth estimates are unrevised.
The first set of graphs are as shown in the July 29th Alert. Prior GDP reporting is shown as the thin red lines, and the revisions, as well as the new "advance" second-quarter GDP estimate, as the thick blue lines. The first graph shows GDP growth on a year-to-year basis, the second graph shows it on an annualized quarterly basis.


The third graph shows the regular pattern of downward revision to GDP annual growth from initial reporting to the latest revision or estimate.

The successive annual GDP revisions are represented by the bars for each quarter, moving left to right in chronological order. With few exceptions, each revision has resulted in lowered growth than previously reported or previously revised.
The current annual revision only starts with first-quarter 2004. The revision patterns suggest downside surprises await the period of GDP growth during the now almost defunct 2000 recession. Those revisions have to wait for the five-year benchmark revisions, when the base inflation year is revised. At that time, all the accounts will be updated back to 1929. The next such revision is scheduled for 2009, when the base inflation adjustment year will be changed from 2000 to 2005. At that time, the 2000 recession should be recognized as having been much longer and deeper than previously reported. Full reporting of the current downturn may wait until 2014 or 2019, at which point newly reported quarterly contractions in 2006 and 2007 would be considered ancient history.
The "good" news out of the most revision is that the much-ballyhooed negative U.S. saving rate disappeared. While economic growth was revised lower, income generally, and quite questionably, was revised higher. Lower consumption and higher income lead to a higher saving rate. Such indeed would be good news if the series, which is the residual of two worthless series, was not meaningless itself, even in revision.
A final note, in terms of revisions that were not made: Included in that area are contentions in a recent Business Week article "The Real Cost of Offshoring" (June 18, 2007, page 29). I was asked by several subscribers to look at the analysis. Author Michael Mandel contended that inflation reported on U.S. imports of offshore products from Communist China, etc. was overstated and should be reduced. Since imports are subtracted from GDP, and lowering inflation inflates real growth, real GDP growth would be revised downward, perhaps significantly.
As best I can figure it, there is an offset in the BEA's bookkeeping, double-entry and otherwise. A downward revision to import inflation, by itself, indeed would reduce reported real GDP growth. Yet, cheaper imported goods also would reduce the cost of those goods either in inventories or in personal consumption expenditure numbers, etc., which get added into GDP. Those changes largely would offset the effects of the cheaper imports. Aggregate real GDP growth would hold about the same, unchanged in net revision.
Upcoming Reporting/Market Focus for September --
Annual Income Variance Analysis
The extreme variance in the current distribution of U.S. income and wealth has received considerable press, recently. The government's annual estimate of this long-range indicator of economic and financial activity is due for late-August release in conjunction with the annual Poverty Report. The latest data and implications of same will be examined. Last year's report showed income distribution at its most extreme since before the 1929 stock market crash and the Great Depression. It is not likely that the situation has improved.
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PLEASE NOTE: The Hyperinflation Summary Report still is pending and will follow soon. The September "Shadow Government Statistics" newsletter is targeted for the week of September 10th. Postings on the Web site of monthly newsletters, interim Flash Updates and Alerts are advised immediately by e-mail.
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Issue Numbers 34
August 19, 2007
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Terrible Financial Tempest Nears Landfall
Fear of Bank Runs Appeared to Force Bernanke into His Tap-Dancing-on-the-Dollar-Landmine Routine
Deteriorating Inflationary Recession Promises Greater Liquidity Woes
Key Reporting Appears Shifted to "Let's Not Hurt the Markets" Mode
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PLEASE NOTE: The SGS-Alternate CPI measure and SGS-Ongoing M3 (based on full-month data) for July have been posted to the Alternate Data tab at www.shadowstats.com. Best wishes to all -- John Williams
The systemic liquidity crisis began running out of control last week, with stories of a run on a major bank. Keep in mind that there is not enough physical cash in the system to handle a major bank run in the traditional sense (see March 2007 SGS). Circumstances became dire enough to force Federal Reserve Chairman Ben Bernanke into publicly visible actions, announcing a 50-basis-point cut in the discount rate and starting to play a three-card monte game with the federal funds rate. Stocks rallied Friday in response, but the Fed's actions have set the stage for a massive dollar sell-off, which can frustrate lower market rates. With the economy in a deepening, inflationary recession, and with the first major Atlantic hurricane of the season within striking range of Gulf of Mexico energy infrastructure, financial-market turmoil likely has only just begun to unfold.
Bank Runs and Commercial Paper Woes Shake the Fed. The Fed issued two statements on Friday (August 17th). First, was the announced cut from 6.25% to 5.75% for the discount rate cut, which is the interest rate charged by the central bank to troubled banks borrowing at the discount window. The "temporary changes" to the Fed's primary credit discount window facility also included "term financing for as long as 30 days, renewable by the borrower" -- versus the usual overnight lending -- and an emphasis on the "broad range of collateral for discount window loans, including home mortgages and related assets."
With its primary responsibility of maintaining the liquidity and solvency of the banking system, the Fed ostensibly made these moves to assure liquidity to any banks that needed it. Yet, the Fed could have done all that sub rosa, without signaling to the public that systemic problems had reached crisis levels. Accordingly, the moves appear to have been aimed more at reassuring depositors that their banks would remain liquid.
The Fed's discount window announcements followed a collapse in the commercial paper market and a day of press reports of a run on Countrywide Bank, a federal savings bank with "more than $107 billion in assets." In addition, rumors of troubled commercial banks had started to surface.
On Friday afternoon, following the Fed's morning actions, Countrywide issued a press release, with bank president Tim Wennes emphasizing, "It is important for Countrywide Bank's valued customers to know that the highly publicized issues related to the mortgage market do not impact the safety of FDIC insured deposits at Countrywide Bank."
The release added: "Bank representatives are trained experts in helping customers structure their accounts to maximize the FDIC protections available to them." The release also mentioned that the bank "continued to receive 'investment-grade' ratings by the three major credit rating agencies."
With due respect to the banking strategists who structured that press release, if I had deposits in excess of FDIC limits, that press release would have me moving my cash out of that bank as soon as possible. It would be quite surprising if any bank runs or stories and rumors of same have yet run their course.
Also reflecting liquidity stresses, commercial paper outstanding collapsed an unprecedented 4.1% for the week-ended August 15th (seasonally adjusted, with similar movement in the unadjusted series), with total outstandings dropping by $89.1 billion, from $2,223.5 billion to $2,132.4 billion.
The Fed's second announcement on Friday was an implicit shift in outlook to a weaker economy and to an easing bias. "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth," noted the Fed. Temporarily dropping "inflation" from its vocabulary, the U.S. central added that, "... downside risks to growth have increased appreciably."
Market sentiment shifted immediately to an easing at the next FOMC meeting, along with further rate cuts in the year ahead. There are, however, major complicating factors to such a simplistic and Pollyannaish view.

First, the Fed already has eased -- at least tacitly -- as shown in the graph above. The effective federal funds rate has been between 25 and 75 basis points below target for the last week.
Second, inflation is as much problem as it was a week ago. The myths that the Fed's primary missions are to contain inflation and promote sustainable economic growth -- goals that supposedly can be met simply with respective tightening or easing policies -- will fall to the reality of a banking system in trouble. The inflation fight was just trumped by one liquidity crisis. The stimulate-the-economy fight is likely to be abandoned in the even greater liquidity crisis that looms with a massive dollar sell-off.
Indeed, the third complicating factor is the U.S. Dollar, which has been sitting at the edge of the abyss for some time. The Fed's actions most likely will trigger massive dumping of the greenback. Central bank intervention can provide short-lived mitigation, and the dollar has had mixed pressures from flight-to-quality issues and some unwinding of the yen carry trade. Exacerbated by perceptions of U.S. interest rates headed lower, however, liquidity flight shortly should shift to be out of the U.S. dollar and dollar-denominated assets. A plunge in the greenback's value combined with U.S. financial market dependence on foreign capital for liquidity would make significant or protracted easing by the Fed a difficult, if not counter-productive, task.
Systemic liquidity problems will get much worse as the effects of the still largely unrecognized recession take their toll on a variety of carefully structured securities and investment/hedging instruments. The crisis should intensify sharply when the dollar's sell-off begins. Despite the trillions of dollars in electronic "cash," if the banking crisis expands and there are any major physical runs on banks, it is conceivable that a cash shortage could force a short-term banking holiday. Despite all assurances of adequate liquidity in the system, the impact likely would not be a happy one for the financial markets.
Economic Problems Persist. Although the "advance" estimate of second-quarter real (inflation-adjusted) GDP growth rebounded to above average, it contracted by an annualized 0.9%, net of the annual revisions (see Reporting/Market Focus). Retail sales, industrial production and new orders for durable goods were soft. The employment report and help-wanted advertising were much worse than expected, as were the purchasing managers surveys. The annual decline in housing deepened, again.

As shown in the graph of the three-month moving average of annual change in housing starts, the recent decline in starts remains the weakest since the 1990/1991 recession.
The trade deficit, however, showed a healthy but highly suspect narrowing in June. As reported, the numbers suggest there will be some upside revision to the already heavily bloated estimate of second-quarter GDP growth. More importantly, though, the "good" trade report helped support the dollar when such was needed. The trade data easily are manipulated by altering the paperwork flows of monthly exports and imports. Such was done following the 1987 panic and Alan Greenspan's abandonment of the dollar, in an effort to help stabilize and turn the U.S. dollar to the upside. Such was accomplished in early 1988 in conjunction with extraordinarily massive central bank dollar-support intervention.
PLEASE NOTE: A "General background note" provides a broad background paragraph on certain series or concepts. Where the language used in past and subsequent newsletters usually has been or will be identical, month-after-month, any text changes in these sections will be highlighted in bold italics upon first usage. This is designed so that regular readers may avoid re-reading material they have seen before, but where they will have the material available for reference, if so desired.
General background note: The U.S. economy is in a protracted and deepening structural recession that will prove to be the second leg of a double-dip recession, which began in 2000/2001. The current downleg was signaled in mid-2005 by a series of leading indicators used for that purpose by SGS. With neither traditional fiscal nor monetary stimulus available to help turn economic activity, the current circumstance is likely to evolve into a hyperinflationary depression (see December 2006 SGS).
Inflation Problems Persist. With annual M3 growth holding at 13% in June, along with a generally weakening dollar, near-record-high oil prices and sharply spiking food costs, contained inflation is not in the offing. Standard PPI inflation was stronger than expected, standard CPI was weaker than expected. In the both instances, though, food costs clearly were understated. Despite "unexpected" moves in the full inflation measures, the gimmicked "core" concept -- spun so strongly by Wall Street hypesters -- keeps coming in at or below consensus forecasts. That circumstance strongly suggests those numbers are being massaged.
Market Turmoil Likely to Increase. The markets are in turmoil with extreme daily stock-market volatility and flight to quality issues impacting the dollar, gold and interest rates. Key to near-term activity is what happens to the U.S. dollar. If it begins a significant sell-off, as I expect, that will frustrate any easing attempts by the Fed, boost long-term interest rates and bolster gold, while meaningfully tanking equities. Chances that the liquidity crisis has run its course are close to nil.
Alternate Realities. General background note: This section updates the Shadow Government Statistics (SGS) alternate measures of official CPI and GDP reporting. When a government economic measure does not match common public experience, it has little use outside of academia or the spin-doctoring rooms of the Federal Reserve, White House and Wall Street. In these alternate measures, the effects of gimmicked methodological changes have been removed from the official series so as to reflect more accurately the common public experience, as embodied by the post-World War II CPI and the pre-Reagan-Era GDP. The methodologies for the series are discussed in the August 2006 SGS (see Archives page at www.shadowstats.com).
GDP. The alternate second-quarter GDP growth reflects the "advance" estimate, with many of the methodological gimmicks of recent decades removed. The alternate second-quarter inflation-adjusted annual growth rate (year-to-year, as opposed to the popularly-touted annualized quarter-to-quarter rate) for GDP was a decline of roughly 2.3% versus the official year-to-year gain of 1.8%. These numbers incorporate the annual revisions published on July 27th, which are reviewed in this month's Reporting/Market Focus.

General background note: Historical data on both the official and SGS-Alternate GDP series are available for download on the Alternate Data page of www.shadowstats.com. The Alternate GDP numbers tend to show deeper and more protracted recessions than have been reported formally or reflected in related official reporting. Nonetheless, the patterns shown in the alternate data are broadly consistent with the payroll employment and industrial production series (as revised), which are major indicators used by the National Bureau of Economic Research in determining the official timing of U.S. business cycles.
CPI. The annual non-core annual inflation rates eased somewhat in July, while the so-called "core" inflation rates held at June's levels. Food and oil-related price pressures remain a problem, due primarily to supply issues, but those pressures have been avoided in much of the government's reporting of the non-core inflation, so far. Both core and regular annual inflation reporting should rise sharply in the months ahead.
Eight Levels of Inflation Annual Inflation for April to July 2007
2007 Measure Apr May Jun Jul I.1 Core PCE Deflator (r) 2.1% 2.0% 1.9% n.a. I.2 Core Chained-CPI-U 2.0% 1.9% 1.8% 1.8% I.3 Core CPI-U 2.3% 2.2% 2.2% 2.2% I.4 PCE Deflator (r) 2.3% 2.4% 2.3% n.a I.5 Chained-CPI-U 2.3% 2.3% 2.3% 2.1% I.6 CPI-U 2.6% 2.7% 2.7% 2.4% I.7 Pre-Clinton CPI-U 6.0% 6.1% 6.1% 5.7% I.8 SGS Alternate Consumer Inflation 10.2% 10.3% 10.3% 10.1%
(r) Revised upwardly in annual revisions of July 27/31. Notes: I.1 to I.3 reflect the core inflation rates, respectively, of the substitution-based personal consumption expenditure (PCE) deflator, the Chained-CPI-U and the geometrically-weighted CPI-U. I.4 to I.6 are the same measures with energy and food inflation included. The CPI-U (I.6) is the measure popularly followed by the financial press, when the media are not hyping core inflation. I.7 is the CPI-U with the effects of geometric weighting (Pre- Clinton Era as estimated by SGS) reversed. This is the top series in the CPI graph on the SGS home page www.shadowstats.com. I.8 reflects the SGS Alternate Consumer Inflation measure, which reverses the methodological gimmicks of the last 25 years or so, plus an adjustment for the portion of Clinton-Era geometric weighting that is not otherwise accounted for in BLS historic bookkeeping.

General background note: Historical data on both the official and SGS-Alternate CPI series are available for download on the Alternate Data page of www.shadowstats.com. The Alternate CPI numbers tend to show significantly higher inflation over time, generally reflecting the reversal of hedonic adjustments, geometric weighting and the use of a more traditional approach to measuring housing costs, measures all consistent with the reporting methodology in place as of 1980.
Last month, I noted, "little action can be expected from the Fed, until either a dollar panic or systemic liquidity issues force its hand. The Fed otherwise remains hamstrung, unable with its impaired monetary tools either to contain a commodity-driven inflation or to stimulate a structurally damaged economy. Unfortunately, signs of both risk cases -- dollar selling and possible systemic liquidity issues -- are starting to surface."
The systemic liquidity crisis should continue blossoming for at least the next several weeks, with the dollar-panic risk case likely to kick in soon. At such time as the "flight-to-safety" switches from into to out of the dollar and Treasuries, stocks and bonds will sell off heavily.
General background note: The U.S. economy remains in a severe, structural inflationary recession, saddled with an impotent Fed and a federal government that is fiscally bankrupt in all but name. In combination, these factors offer the worst of all environments to the financial markets. Ahead lie higher long-term interest rates and much lower U.S. equity prices. On the plus side is the outlook for gold, which provides a solid hedge against many of the problems that have started to surface. Key to the near-term movements of these markets remains the fate of the U.S. dollar, which appears to be near a major downside move.
U.S. Equities -- After hitting all-time highs a month ago, most U.S. stock indexes have sold off fairly sharply. The burgeoning liquidity problems have generated increasing volatile and generally negative market activity. Underlying fundamentals are not likely to improve for some time.
General background note: As the equity markets catch up with the underlying economic and looming financial fundamentals, the downside adjustments to stock prices should be quite large, eventually rivaling the 90% decline in equities seen in the 1929 crash and ensuing several years. The decline might have to be measured in real terms (net of inflation), as a hyperinflation eventually will kick in as the Fed moves to liquefy the system. Stocks do tend to follow inflation, since revenues and earnings get denominated in inflated dollars. Hence with a hyperinflation, a DJIA of 100,000 or 100,000,000 could be expected, but such still would be below today's levels, adjusted for inflation.
General background note: The approaching financial maelstrom already has come over the horizon and now is nearing landfall. When it hits, those investors who have taken shelter in cash, gold and outside the U.S. dollar will be the ones with the wealth and assets available to take advantage of the extraordinary investment opportunities that should follow.
U.S. Credit Market -- Recent credit market activity has been dominated by the still unfolding liquidity crisis, and the markets will continue to gyrate accordingly. Some "flight to quality" has pushed down long-term Treasury yields, while Fed actions have raised market expectations of an imminent easing.
Confounding any efforts to force a protracted period of lower interest rates likely will be a severe decline in the U.S. dollar, and that can break at any moment. Inflation problems also will worsen markedly, frightening the already battered markets. As a result, six months to a year from now, I expect long-term interest rates will be much higher than they are now, with a sharp, positively-sloped yield curve.
U.S. Dollar -- With the Fed rumbling about easing and already tacitly targeting a lower fed funds rate, the U.S. dollar is poised for a major sell-off. At times of disorderly markets, central banks are noted for covert intervention in various markets, particularly the currency markets. Such intervention, however, usually proves to be short-lived. In the matter of a week, the timeframe for a likely massive hit on the greenback has moved much closer, perhaps within the next week or two, depending how market conditions break.
[Following paragraph text corrected from original posting] Opening the markets for an across-the-board dollar rout, the dollar tumbled against the yen in the last week or so, due to the unwinding of the carry trade, while the greenback held even or strengthened slightly against most other major currencies.
Potentially exacerbating the circumstance are recent moves by Communist China to threaten use of their dollar sales "nuclear option" (see Alert of August 12th), and by Iran requesting that Japanese buyers pay for their oil purchases in yen. The U.S. markets are particularly vulnerable, at the moment, to "surprises" from those countries that are not so friendly to the United States, or even from those who simply would like to avoid large losses on the dollars they hold.
The fundamentals underlying the U.S. currency remain extraordinarily negative, as discussed below, and have been upped a significant notch by the systemic liquidity crisis and the Fed's response to same. A full blown dollar crisis can break with little or no warning.
Beyond Federal Reserve missteps, or major negative surprises out of the liquidity crisis, the proximal trigger for a dollar panic could come from a bad economic statistic, political missteps by the Administration, negative trade or market developments in Asia, or a terrorist attack or even still-likely military action against Iran. When it hits, the broad selling pressure should be strong enough to overcome any short-lived central bank intervention.
General background note: In terms of underlying fundamentals that tend to drive currency trading, the dollar's portfolio could not be worse. Relative to major trading partners, the U.S. economy is much weaker, interest rates are lower and promised to go lower still, inflation is higher, fiscal and trade-balance conditions are abysmal, and relative political stability is at a nadir. The President's approval rating commonly has moved currency trading in the past, and, despite any near-term bouncing, it remains lower than has been seen for any other U.S. President in the post-World War II era. Relative political stability issues are compounded by the presence of a Congress that is increasingly hostile to the President. Generally, the greater the magnitude of the dollar selling, the greater will be the ultimate inflation pressure and liquidity squeeze in the U.S. capital markets.
As shown in the following graph, the U.S. dollar weakened in July, setting or approaching new record lows on both a financial- and trade-weighted basis. The added August 17th data points show current levels at or slightly above the July averages.

General background note: Historical data on both dollar series are available for download on the Alternate Data page of www.shadowstats.com. See the July 2005 SGS for methodology.
U.S. Dollar Indices. The Shadow Government Statistics' Financial-Weighted U.S. Dollar Index (FWD) is based on dollar exchange rates weighted for respective global currency trading volumes. For July 2007, the monthly dollar average fell by 2.03% after a monthly gain of 0.11% in June. The July 2007 average index level of 49.25 (base month of January 1985 = 100.00) was down 6.08% from July 2006, with June down 4.11% from the year before. The index's historic monthly-average low was 48.98 in April 1995.
Dropping to another all-time monthly-average low, July's level of the Federal Reserve's Major Currency Trade-Weighted U.S. Dollar Index (TWD) fell 1.80% versus June, which was down by 0.34% from May. The July 2007 index level of 55.78 (base month of January 1985 = 100.00) was down 5.41% from July 2006, against June's 3.16% decline from the year before.
Gold -- As of Friday (August 17th), gold was trading around $658 per troy ounce and silver around $11.70. For July, the monthly-average gold price (London afternoon fix per Kitco.com) averaged $665.30 per troy ounce, against June's $655.49 per troy ounce. Silver averaged $12.91 per troy ounce in July, down from $13.14 in June.
Gold price volatility continues but generally, price movement has been mixed during the breaking systemic liquidity crisis. Highly suspect here is the possibility of covert central bank intervention. At such time as the U.S. dollar begins its massive sell-off, gold and silver likely will spike sharply to the upside. Indeed, despite central-bank machinations or intervention, the upside potential for the precious metals remains explosive, new record high prices loom.
General background note: As discussed in the Hyperinflation Series (see the December 2006 to March 2007 SGSs), the eventual complete collapse of the U.S. dollar -- the world's reserve currency -- will force the creation of a new international currency system. Gold likely will be structured into any replacement system, in an effort by those organizing the new currency structure to gain public acceptance.


The updated gold versus oil and Swiss franc graphs show July averages as well as added points for closing prices on August 17th. As we go to press, gold is trading around $658, oil is around $72 and the Swiss franc is around $0.83. Look for all three measures to trade significantly higher in the months ahead.
With the financial markets in turmoil, recent CPI and trade reporting, in particular, showed unusual results, suggestive of some manipulation aimed at soothing unfortunate market pressures. The bulk of the other major economic reports, however, generally have continued coming in on the soft side of expectations.
Friday's Fed statements helped move financial-market sentiment towards recession, and increasingly towards the view of a recessionary economy beset by inflation problems. The full extent of the economy's plight, however, is far from having broad recognition.
With the President's positive rating still bottom bouncing and with a nervous Fed trying to contain an expanding systemic meltdown, recent and upcoming releases of major series have been, and likely will continue to be, subject to some manipulation, as mentioned above. Statistical games are being played for both the perceived political needs of the Administration and the increasingly heavy financial market needs of an impotent Federal Reserve. We are looking now at moves that border on national security issues.
Absent manipulation, and against lagging and still largely distorted market expectations, most near-term economic reporting should tend to surprise the markets on the downside, while most inflation reporting should tend to surprise expectations on the upside.
Employment/Unemployment -- The seasonally-adjusted July nonfarm payrolls rose by 92,000 (84,000 net of revisions) +/- 129,000 for the month. June payrolls were up a revised 126,000 (previously 132,000). Annual growth slowed sharply from 1.47% in June to 1.34% in July.
As noted in the August 5th Alert, the only thing surprising about the July employment and unemployment report was that the rigging was not set to show stronger numbers. Most of the following commentary is repeated from that Alert.
As with other recent monthly reports, applying consistent not-seasonally-adjusted year-to-year change to the seasonally-adjusted numbers yielded lower than advertised jobs growth. Applying July's unadjusted annual growth rate, to the adjusted numbers, yields an adjusted monthly July payroll increase of 47,000, about half of the official 92,000 gain.
The statistically-sounder household survey, showed employment down by 30,000 for the month, with the seasonally-adjusted U.3 unemployment rate rising to 4.65% +/- 0.23% in July, from 4.53% in June. Unadjusted U.3 rose to 4.9% from 4.7% in June, while the broader U.6 measure rose to 8.6% from 8.5% (unadjusted) and to 8.3% from 8.2% (adjusted). Net of the "discouraged workers" defined out of existence during the Clinton Administration, traditional unemployment continues to run around 12%.
The payroll data appear to be under careful management, as seen in the most recent revisions and seasonal-adjustment gimmicks. In revision, the unadjusted total nonfarm payrolls in May and June moved higher, respectively, by 32,000 (138,623 to 138,655) and by 34,000 (139,127 to 139,161). What is unusual is that the adjusted series were nearly unchanged in revision, down by 2,000 in May (137,906 to 137,904) and down by 8,000 in June (138,038 to 138,030). Normally, the changes in the unadjusted series would flow through to the adjusted series with little variation. Where revisions to the data come in on an unadjusted basis, seasonal adjustments for May and June were altered so as to maintain something close to the original reporting level. Why, still remains a question, but the data have been carefully adjusted to maintain someone's reporting agendum.
The July employment gain was against a background of plunging help-wanted advertising, slightly positive movement in new claims for unemployment insurance and weaker employment numbers in the July purchasing managers surveys (see respective sections). These background numbers remain consistent with continued weakness in official jobs and unemployment reporting.
The monthly bias factor (birth/death model) in July was an add-on of 26,000, compared with 21,000 a year ago. Where the August 2006 bias factor was 122,000, such suggests some upside pressure on the August 2007 payroll estimate.
Next Release (September 7): The August payroll survey should show underlying economic weakness and disappoint market expectations. Financial market instabilities, however, would tend to favor a massaged number that could be deemed a positive for the markets. In like manner, reality should be an ongoing rise in the unemployment rate, barring manipulations.
Gross Domestic Product (GDP) -- The "advance" estimate of annualized real (inflation-adjusted) growth for the second quarter of 2007 was 3.38% +/- 3%, matching consensus forecasts (the Bureau of Economic Analysis has been known to target consensus forecasts with its advance guesstimate), but well beyond credibility for this most politicized of economic series. The second quarter's gain rebounded from 0.60% in the first quarter, while year-to-year growth jumped to 1.78% in the second quarter, up from 1.55% in the first.
These numbers reflected significant annual revisions (see this month's Reporting/Market Focus). The changes were sharp enough on the downside that net of revisions, annualized second quarter GDP showed a contraction of 0.86% and annual growth was up by 1.1%.
On the inflation front, the GDP deflator in the second quarter helped to spike real growth, with annualized inflation of just 2.69% against the 4.23% inflation pace estimated for the first quarter. Generally, historical deflator estimates were revised so as to show meaningfully higher inflation than had been previously reported.
Although the GDP report is the government's broadest estimate of U.S. economic activity, it is also the least meaningful and most heavily massaged of all major government economic series. Published by the BEA, it primarily has become a tool for economic propaganda. Adjusting for methodological distortions built into GDP reporting over time, the SGS-Alternate GDP measure suggests economic reality is much weaker than officially reported. Alternate year-to-year annual contractions continue, with an annual 2.3% contraction in the second quarter deepening from the 2.2% decline in the first quarter (see the graph in the Alternate Reality section of the Opening Comments).
Next Release (August 30): The "preliminary" estimate revision of annualized quarterly real GDP growth for the second quarter should show even stronger growth, given the nonsense published with the reported narrowing of the June trade deficit.
Consumer Price Index (CPI) -- The BLS reported the seasonally-adjusted July CPI-U (I.6) up by 0.13% (down by 0.03% unadjusted) +/- 0.12% (95% confidence interval) for the month, compared with a 0.19% (0.19% unadjusted) gain in June. Annual inflation eased to 2.36% in July from 2.69% in June. Annualized year-to-date inflation through July was 4.56% adjusted, 5.60% unadjusted. The accounting for both CPI-U and PPI inflation was suspiciously shy in the area of food inflation, against significant anecdotal evidence to the upside.
Annual inflation for the Chain Weighted CPI-U (C-CPI-U) (I.5) -- the substitution-based series that increasingly gets touted by the manipulators as the replacement for the CPI-U -- was 2.08% in July, versus 2.32% in June.
Adjusted to pre-Clinton (1990) methodology (I.7), annual CPI growth was about 5.7% in July versus 6.1% in June, while the SGS-Alternate Consumer Inflation Measure (I.8), which reverses gimmicked changes to official CPI reporting methodologies back to 1980, was roughly 10.1% in July versus 10.3% in June. The eight levels of annual inflation, I.1 to I.8, are shown in the table in the Alternate Reality section, along with the graph of SGS-Alternate Consumer Inflation.
Next Release (September 19): Annual inflation generally will continue rising into at least the early part of 2008. Seasonally-adjusted, monthly CPI-U increased by 0.3% in August 2006. Any monthly reporting above or below that for the pending release of August 2007 CPI will add or subtract directly to or from the current annual CPI-U inflation rate. Reporting risks generally favor an upside surprise to modest market expectations. A renewed upside movement in core inflation remains long overdue.
Federal Deficit -- General background note: The federal government's fiscal 2006 (fiscal year-end September 30th) deficit, prepared based on generally accepted accounting principles (GAAP), widened to $4.6 trillion from 2005's $3.5 trillion. Those numbers dwarfed the officially-gimmicked 2006 federal budget deficit of $248.2 billion, which was down $70.8 billion from 2005's $318.5 billion (see the December SGS).
General background note: Although it lacks the accrual accounting of the GAAP numbers, the change in gross federal debt bypasses several of the reporting manipulations and is a better indicator of actual net cash outlays by the federal government than is the official, gimmicked deficit reporting. As of fiscal year-end 2006, the gross federal debt stood at $8.507 trillion, up $574 billion from 2005, which in turn was up $554 billion from 2004.
For the rolling 12 months through July 2007, the gimmicked deficit was $165.8 billion versus $255.4 billion in July 2006, compared with the rolling deficits of $162.7 billion in June 2007 and $275.5 billion in June 2006. The gap in the year-to-year rolling deficits has continued to narrow.
For July 31, 2007, the gross federal debt stood at $8.932 trillion, up $64 billion from June and up $488 billion from July 2006, which in turn was up $557 billion from July 2005. For June 30, 2007, the gross federal debt stood at $8.868 trillion, up $39 billion from May and up $448 billion from June 2006, which in turn was up $584 billion from June 2005.
General background note: The Administration and Congress continue playing bookkeeping games. Even so, the gimmicked deficit should widen in the next 12 months, as government finances begin to suffer from tax revenue losses due to the intensifying recession and relative tax receipt declines after the expiration of recent corporate tax incentives. While GDP growth estimates can be gimmicked, incoming tax receipts (based on consistently applied tax policies) remain an independent estimate of underlying economic reality and eventually will reflect the economy's mounting difficulties.
Initial Claims for Unemployment Insurance -- Annual growth in initial claims has continued to soften, turningd marginally negative (an economic positive). On a smoothed basis for the 17 weeks ended August 11th, annual change was a contraction of 1.7%, versus the 17 weeks ended July 14th, where annual growth was 0.1%.
General background note: More often than not, week-to-week volatility of the seasonally-adjusted weekly claims numbers is due to the Labor Department's efforts to seasonally adjust these numbers around holiday periods, such as Easter, Memorial Day, July 4th and Labor Day. The Labor Department has demonstrated an inability to do such adjusting successfully. When the new claims series is viewed in terms of the year-to-year change in the 17-week (four-month) moving average, however, such generally is a fair indicator of current economic activity.
Real Average Weekly Earnings -- July's seasonally-adjusted monthly real earnings fell by 0.1% after a revised 0.6% (was 0.5%) gain in June. Annual growth held at 1.3% for both July and June.
General background note: Gyrations in the poor quality of reported CPI growth account for most month-to-month volatility in this series. Adjusting for the major upside biases built into the CPI-W inflation measure used in deflating the average weekly earnings, annual change in this series shows the average worker to be under severe financial stress in an ongoing recession.
Retail Sales -- July's seasonally-adjusted retail sales rose by 0.29% (up 0.59% net of revisions) +/- 0.9% (95% confidence interval), after declining by a revised 0.72% (previously down 0.89%). With monthly CPI up by 0.13%, seasonally-adjusted monthly retail sales were up by roughly 0.1% after inflation. What is unusual. though, is that the increases in food and restaurant sales -- largely due to food inflation -- were not reflected fully in the CPI. Fully reflected, CPI inflation would have been higher and real retail sales growth would have been negative. Increasingly, retail sales are reflecting relative strength due to rising prices, and the real retail sales number will become more important in assessing the strength of consumer spending.
On a year-to-year basis, July retail sales were up by 3.25% before inflation and by just 0.89% after inflation, compared with respective annual growth numbers for June of 4.01% (previously 3.77%) and 1.32%.
General background note: Real (inflation-adjusted) year-to-year growth in retail sales below 1.8% (using the official CPI-U for deflation) signals recession, and a signal first was generated in this business cycle back in June 2006.
Next Release (September 14): August retail sales should come in below market expectations, barring manipulation, and increasingly below the rate of inflation on both a monthly and a year-to-year basis.
Industrial Production -- Seasonally-adjusted industrial production rose by 0.3% (0.4% net of revisions) in July, against a revised 0.6% (was 0.5%) in June. Despite the intermittent monthly gains, annual growth continues to slow to recessionary levels. Annual growth from February through July has slowed as follows: February 2.88%, March 2.25%, April 1.91%, May 1.77%, June 1.44%, July 1.38%.
Next Release (September 14): Look for August industrial production to move once again towards a pattern of contraction, shy of any utility surge from unseasonably hot weather. Eventually, monthly contractions in this series should become regular, with the rapidly slowing annual growth turning negative.
New Orders for Durable Goods -- For June, the usually volatile durable goods orders gained 1.4% for the month, on a seasonally-adjusted basis, after falling a revised 2.3% (was down 2.8%) in May. As noted in the July 29th Alert, June's new orders were down 0.5%, net of Boeing's successful launch of the 787, where production from the orders will be stretched out over years, instead of one month. On an annual basis, durable goods orders fell a recessionary 0.6%
The closely followed nondefense capital goods new orders rose by 4.6% after falling 5.8% in May. Again, they were down in June net of aircraft orders. June's annual growth rate for nondefense capital goods was 5.5%.
General background note: Durable goods orders lost its status as a solid leading economic indicator when the semi-conductor industry stopped reporting new orders in 2002.
Trade Balance -- The seasonally-adjusted monthly trade deficit for June narrowed to $58.1 billion, with May's reading revising to $59.2 billion (previously $60.0 billion). The June detail showed higher oil imports, based both on higher prices and higher physical volume, but the current trade shortfall remains well shy of reality.
The latest data promise some upside revision to second-quarter GDP growth, and also helps the dollar, with the Fed starting to look like it is abandoning the greenback. Historically, such as in 1987/1988, disruptions of import paper flows have been used to adjust initial trade deficit reporting. Something like that appears to be in play at the moment. Revisions next year should tell the story.
Next Release (September 11): Odds favor renewed deterioration in the July monthly trade deficit, barring ongoing manipulation. Reporting risk generally remains on the negative side of consensus forecasts. The months ahead should see a pattern of regularly increasing deficits that shortly, again, will be setting new records.
Consumer Confidence -- July confidence measures rose, and Wall Street hypesters trumpeted the highest Conference Board reading in six years. That, of course, was in the middle of the last formal recession. Like help-wanted advertising, consumer confidence never recovered from the last economic downturn.
Indeed, July consumer confidence rose, with the Conference Board's Confidence measure up 6.9% for the month, and the three-month moving average up by 2.9% year-to-year. The University of Michigan's Sentiment measure rose by 6.0% for the month, with the three-month moving average up by 6.2% year-to-year.
These lagging, not leading, indicators tend to reflect the tone of the popular financial media and recently have suggested that the economy has continued to falter. Wait until you see the numbers for August! The current financial crisis will not play out well for these series.
General background note: The Conference Board measure is seasonally adjusted, which can provide occasional, but significant distortion. The adjustment does not make much sense and is of suspect purpose, given that the Conference Board does not release the unadjusted number. The Michigan survey is unadjusted. How does one seasonally-adjust peoples' attitudes? Also, beware the mid-month Consumer Sentiment release from the University of Michigan. Its sampling base is so small as to be virtually valueless in terms of statistical significance.
Short-Term Credit Measures -- Patterns of annual growth in consumer and commercial borrowing were mixed through June/July, with consumer credit growth slowing in contrast to generally stronger commercial borrowing. As noted in the Opening Comments, however, commercial paper outstanding plunged in the August 15th week as part of the unfolding liquidity crisis.
Annual growth has held at 5.0% for April, May and June, for seasonally-adjusted consumer credit, which includes credit cards and auto loans, but not mortgages. In the current environment, where inflation-adjusted growth in income is not adequate to support meaningful growth in the personal consumption component of GDP, GDP growth only can come from temporary debt expansion or savings liquidation. Accordingly, stagnant consumer debt expansion places a constraint on economic growth.
Commercial borrowing growth, however, continued to be strong on a year-to-year basis before the liquidity crunch hit, with annual growth in commercial paper outstanding rising at 18.8% in July versus 19.6% in June. Annual growth in commercial and industrial loans was 12.8% in July, up from 12.3% in June. Solid growth in the commercial credit measures can signal credit needs tied either to rising sales and receivables/inventory, or to slowing sales and slowing collections and involuntarily rising inventories, but the mid-August liquidity crisis quickly could negatively impact business activity.
Producer Price Index (PPI) -- Rebounding beyond market expectations, the July finished goods PPI rose by a seasonally-adjusted 0.6% (0.7% unadjusted), versus a decline of 0.2% (down 0.4% unadjusted) in June. Annual PPI in July rose to 4.0% from June's 3.3%. Seasonally-adjusted intermediate and crude goods rose by 0.6% and 1.2% in July, against gains of 0.5% and 0.3% in June. The accounting for both PPI and CPI-U inflation, however, was suspiciously shy in the area of food inflation, against significant upside anecdotal evidence.
Next Release (September 18): Despite the regular random volatility of the monthly price variations, PPI inflation reporting over the next six-to-nine months generally should come in above market expectations. As with the CPI, the core PPI inflation rate still is long overdue for an upside surprise.
General background note: 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 -- Playing some catch up and resuming its trend toward showing a recession in manufacturing, the overall July ISM manufacturing index fell to 53.8 from 56.0 in June, with the July employment index down to 50.2 from June's 51.1. Continued decline in the broad series is a good bet in the next several months, based on declining annual activity in a variety of underlying series.
The July new orders index backed off to 57.5, from June's 60.3. Seasonal-factor distortions, which have been present, usually are overcome by viewing the series using year-to-year change on a three-month moving average basis. On that basis, the July new orders index was up by 5.7% versus a 5.1% gain June.
General background note: 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 below 50.0 indicates contracting new orders. The index gradually has notched lower from its peak annual growth of 42.6% in April of 2004. As an SGS early warning indicator of a major economic shift, the new orders measure breached its fail-safe point in mid-2005, generating a signal of pending recession.
Service Sector Index. The service-sector ISM index does not have much meaning related to overall business activity, since new order activity at law firms, hospitals or fast-food restaurants has little obvious relationship to broad economic activity. That said, the overall July services sector index also declined in July, to 55.8 from June's 60.7. Both the services employment and prices paid components, however, have some meaning. The July employment component plunged to 51.7 from 55.0 in June. The prices paid component is covered in the Inflation Indicators.
Help-Wanted Advertising Index (HWA) -- The Conference Board reported that help-wanted advertising plummeted still again, to 26 in June, down from 27 in May, closing in on an all-time low. Even allowing for the advertising volume lost to the Internet in recent years, the current weakness is enough to signal a deepening problem in the employment sector. The June number was down 18.8% from the year before, compared with an 18.2% drop in May.
Viewed on a three-month moving-average basis, June's year-to-year change was a contraction of 17.2% versus May's 18.3%. The series still indicates rapidly deteriorating employment conditions. Where the index never recovered from the 2000/2001 recession, its renewed and ongoing plunge has signaled a new and rapid contraction in economic activity. Continued deterioration remains likely in the months ahead.
Housing Starts -- As discussed again in this month's Opening Comments, ongoing weakness in the housing starts remains in place, with an updated graph showing annual growth on a three-month moving-average basis.
July's seasonally-adjusted housing starts fell by 6.1% +/- 10% (95% confidence interval) for the month, after a revised 2.1% (previously 2.3%) monthly gain in June. Year-to-year, July starts were down by 20.9% (+/- 7.1%), versus a drop of 19.4%% in June.
Confirming ongoing weakness in the housing sector, July building permits were down 2.8% for the month and 22.6% for the year. In June reporting, new home sales were down 22.3% year-to-year, while June existing home sales were down 11.4% at an annual rate.
Inflation Indicators
Money Supply -- The money supply comments move into the Inflation Indicators section this month, given their import in that area. The SGS Ongoing M3 estimate of annual growth for the July average came in at 13.0%, the same as in June. That pace of growth remains uncomfortably high in terms of its inflationary implications.

General background note: Historical annual growth data for the money supply series, including the SGS Ongoing M3 estimates, are available for download on the Alternate Data page of www.shadowstats.com. See the August 2006 SGS for methodology. The indicated M3 levels below are our best estimate and are provided at specific subscriber request. Keep in mind that regular revisions in the related Fed series affect historical M3. Usually, annual growth rates hold, although levels may shift a little. We have not attempted, nor do we plan to recreate a revised historical series for an M3 monthly-average level going back in time. The purpose of the SGS series was and is to provide monthly estimates of ongoing annual M3 growth. We are comfortable with those numbers and that our estimated monthly growth rates are reasonably close to what the Fed would be reporting, if it still reported M3. With those caveats on the table, here are the monthly-average levels for M3:
Shadow Government Statistics Ongoing M3 (Estimated seasonally-adjusted monthly average)
Current Yr Before Month $ Tril $ Tril % Yr/Yr
Mar 07 11.541 10.347 11.6% Apr 11.722 (r) 10.417 12.5% May 11.864 (r) 10.490 13.1% Jun 11.919 10.547 13.0% Jul 12.004 10.624 13.0%
(p) July's preliminary estimate is based on full-month reporting. (r) Revised.
NOTE OF CAUTION: The estimates of monthly levels best are used for comparisons with other dollar amounts, such as nominal GDP. While the estimates are based on seasonally- adjusted Federal Reserve data, great significance cannot be read into the month-to-month changes, as was the case when the Fed published the series. The most meaningful way to view the data is in terms of year-to-year change.
Based on the July data, annual growth for monthly M1 fell by 0.28%, versus a 0.70% contraction in June, while July M2 annual growth held at 6.15%, the same as in June.
Purchasing Managers Surveys: Prices Paid Indices -- The July prices paid indices were slightly softer, again, still not reflecting the recent surge in oil prices. The levels, however, remain high and in inflation territory, suggestive of ongoing inflation issues in both purchasing managers surveys.
On the manufacturing side, the July price index eased to 65.0 from June's 68.0. On a three-month moving average basis, July's annual change was down by 12.1%, following June's 5.8% drop. The manufacturing price indicator is not seasonally adjusted and, therefore, is a generally better indicator of pricing activity. Keep in mind that the oil market was particularly strong at this time last year.
On the non-manufacturing side, the seasonally-adjusted July prices diffusion index softened again, to 61.3 from June's 65.5. On a three-month moving-average basis July's annual change was a decline of 11.2% following June's decrease of 9.2%.
General background note: Published by the Institute for Supply Management (ISM), the prices paid components of the purchasing managers surveys are reliable leading indicators of inflationary pressure. The measures are diffusion indices, where a reading above 50.0 indicates rising prices.
Oil Prices -- For the month of July, the monthly-average West Texas Intermediate spot price (Department of Energy) rose 9.9% to $74.18 per barrel from $67.48 in June. Against last year's record high oil price, July's year-to-year decline in average monthly price was just 0.3%, narrowed from June's 4.9% contraction. Price movement remains highly volatile, but generally is trending higher, and shortly should settle above the new daily record high price level set in the last month.
Meaningful upside risks to oil prices remain in play, both from the looming peak in the hurricane season and ever-volatile Middle Eastern political tensions. Hurricane Dean, the first major storm of the season, is in striking range of Gulf of Mexico energy infrastructure. As we go to press, forecasts have the storm moving well south of Houston, but storms can shift quickly and unexpectedly. Other storms, and attendant increased financial market speculation of risk, are likely in the next month or so.
General background note: Global political conditions continue to favor a further sharp spike in oil prices in the months ahead, irrespective of any ongoing games-playing by the Administration and OPEC. Overhanging the market remains the potential for a change in the dollar-based pricing of oil, particularly as dollar selling intensifies. Where dollar weakness is the equivalent of an oil price cut for oil purchasers denominated in an appreciating currency, market forces tend to push dollar-based oil prices higher, and that exacerbates inflation problems in the United States. Even worse, if oil pricing were shifted to something other than the U.S. currency, as appears to be happening between Iran and Japan (see U.S. Dollar section), U.S. inflationary pressures would be even more intense, since any drop in the dollar would be reflected directly as an increase in the price of foreign oil for U.S. consumption.
General background note: Whether from supply and demand, geo-political or currency pressures, oil prices will remain at highly inflationary levels and will continue as a major contributing factor to U.S. inflation woes. Historically high oil prices still are working their way through all levels of U.S. economic activity, ranging from transportation and energy costs, to material costs in the plastics, pharmaceutical, fertilizer, chemical industries, etc. These broad inflationary pressures will remain intact despite any near-term oil price volatility. Although these pressures may be slow to surface in government reporting of the so-called "core" inflation measures, they will surface.
Once again, and as estimated by SGS, annual GDP revisions have shown that previously reported GDP growth was overstated meaningfully. The current revisions out of the Bureau of Economic Analysis (BEA) reflect some of the downside benchmark revisions made to such series as retail sales, industrial production and housing. This continuing pattern of successive downward revisions over the years also tends to show some of the regular upside growth bias built into the GDP series.
Nonetheless, current and historical reported U.S. economic growth rates of recent years still remain heavily overstated, due largely to methodological "innovations" that have generated these and other upside biases in the official series. The Shadow Government Statistics Alternate GDP measure continues to approximate historical annual GDP with those biases removed (see the "Alternate Realities" section and Alternate Data Series tab at www.shadowstats.com for the latest plot and data, and the August 2006 SGS Newsletter for methodology). Given that the official 2007 annual revisions were in the normal scope of the previous SGS analysis, the SGS alternate growth estimates are unrevised.
The first set of graphs are as shown in the July 29th Alert. Prior GDP reporting is shown as the thin red lines, and the revisions, as well as the new "advance" second-quarter GDP estimate, as the thick blue lines. The first graph shows GDP growth on a year-to-year basis, the second graph shows it on an annualized quarterly basis.


The third graph shows the regular pattern of downward revision to GDP annual growth from initial reporting to the latest revision or estimate.

The successive annual GDP revisions are represented by the bars for each quarter, moving left to right in chronological order. With few exceptions, each revision has resulted in lowered growth than previously reported or previously revised.
The current annual revision only starts with first-quarter 2004. The revision patterns suggest downside surprises await the period of GDP growth during the now almost defunct 2000 recession. Those revisions have to wait for the five-year benchmark revisions, when the base inflation year is revised. At that time, all the accounts will be updated back to 1929. The next such revision is scheduled for 2009, when the base inflation adjustment year will be changed from 2000 to 2005. At that time, the 2000 recession should be recognized as having been much longer and deeper than previously reported. Full reporting of the current downturn may wait until 2014 or 2019, at which point newly reported quarterly contractions in 2006 and 2007 would be considered ancient history.
The "good" news out of the most revision is that the much-ballyhooed negative U.S. saving rate disappeared. While economic growth was revised lower, income generally, and quite questionably, was revised higher. Lower consumption and higher income lead to a higher saving rate. Such indeed would be good news if the series, which is the residual of two worthless series, was not meaningless itself, even in revision.
A final note, in terms of revisions that were not made: Included in that area are contentions in a recent Business Week article "The Real Cost of Offshoring" (June 18, 2007, page 29). I was asked by several subscribers to look at the analysis. Author Michael Mandel contended that inflation reported on U.S. imports of offshore products from Communist China, etc. was overstated and should be reduced. Since imports are subtracted from GDP, and lowering inflation inflates real growth, real GDP growth would be revised downward, perhaps significantly.
As best I can figure it, there is an offset in the BEA's bookkeeping, double-entry and otherwise. A downward revision to import inflation, by itself, indeed would reduce reported real GDP growth. Yet, cheaper imported goods also would reduce the cost of those goods either in inventories or in personal consumption expenditure numbers, etc., which get added into GDP. Those changes largely would offset the effects of the cheaper imports. Aggregate real GDP growth would hold about the same, unchanged in net revision.
The extreme variance in the current distribution of U.S. income and wealth has received considerable press, recently. The government's annual estimate of this long-range indicator of economic and financial activity is due for late-August release in conjunction with the annual Poverty Report. The latest data and implications of same will be examined. Last year's report showed income distribution at its most extreme since before the 1929 stock market crash and the Great Depression. It is not likely that the situation has improved.
PLEASE NOTE: The Hyperinflation Summary Report still is pending and will follow soon. The September "Shadow Government Statistics" newsletter is targeted for the week of September 10th. Postings on the Web site of monthly newsletters, interim Flash Updates and Alerts are advised immediately by e-mail.
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