U.S. Dollar Remains Key Driver of What Lies Ahead. The U.S. economy and systemic-solvency issues are getting worse, and so are Federal Reserve efforts to debase the U.S. Dollar. Inflation fears appear to be surfacing anew, with the U.S. dollar under selling pressure, with oil prices (and related gasoline prices) spiking partially in response to the dollar, with gold prices rising (partially dollar and safe-haven effect), and with mounting global concerns over the credit worthiness of the United States.

Irrespective of any near-term volatility or short-lived central bank interventions or market manipulations in the pricing of the U.S. currency, oil and gold, the long-term outlook remains for a much weaker dollar, and much higher oil and gold prices. Mr. Bernanke’s dollar-debasement program is helping to fuel the near-term pressure on the greenback, and the resulting higher oil prices are setting the stage for serious non-demand-driven inflation in the United States.

For the two weeks ended May 20th, the St. Louis Fed’s adjusted monetary base was up a record 113.4% from the same period last year, versus a 102.8% gain in the prior two-week period. The monetary base –basically currency plus bank reserves — is the Fed’s primary tool for affecting growth in the money supply. The weekly pace of growth in the still-published components of M3 (M2, institutional money funds, partial large time deposits) has slowed since the comments were published in the May 20th Flash Update, but it has remained strong enough for the year-to-year change in the SGS-Ongoing M3 estimate for May 2009 to have a fair shot at increasing from the 7.1% pace estimated for April.

The U.S. dollar and U.S. Treasuries effectively are the benchmarks against which sovereign ratings are determined. So long as this remains the case, and so long as the U.S. issues its debt in U.S. dollars, a rating downgrade from "AAA" status is not likely. Ratings usually reflect the risk of default, and so long as the government can run the printing presses to pay its debts, risks of formal default are nil.

Nonetheless, investors increasingly will not want to purchase or hold U.S. Treasuries as federal debt explodes and the hyperinflation threat nears. Ultimately, the Fed will serve as the lender of last resort to the U.S. government, monetizing government debt at an accelerating pace, which in turn will accelerate the pace of decline in the greenback and the pace of increase in U.S. inflation.

Less-Negative GDP Reporting Is Mixed. Gross national product (GNP) is the broadest measure of U.S. economic activity (GNP is GDP plus trade in factor income, or interest and dividend payments). For decades, GNP was the common measure followed on the U.S. economy, until the United States gained the dubious stature of a net debtor. Net-debtor nations tend to show stronger growth in GDP than in GNP, since net payments to creditors do not subtract from reported economic activity. This morning’s (May 29th) initial reporting of first-quarter GNP showed a relative deepening of the recession fourth-quarter 2008 to first-quarter 2009 (annualized GNP contraction deepened from 5.59% to 5.78%), rather than the relative improvement indicated in GDP (annualized GDP contraction narrowed from 6.34% to 5.72%). While magnitudes of the quarterly declines are subject to horrendously large confidence intervals, relative changes have some meaning. Similar assumptions underlie both the GNP and GDP series, but the GDP is the most heavily politicized series, since it is the headline number. In terms of year-to-year change, both GNP and GDP show a deepening recession.    

GDP Reporting Still Underestimates the Economic Downturn. The Bureau of Economic Analysis (BEA) reported the "preliminary" estimate revision of first-quarter 2009 gross domestic product (GDP) showing an annualized quarterly real (inflation-adjusted) contraction of 5.72% +/- 3% (95% confidence interval), narrowed from the "advance" estimate of a 6.14% contraction. Year-to-year change revised to a decline of 2.51% versus an initial estimate of a 2.62% drop. The latest first-quarter contraction rate followed a reported annualized decline of 6.34% in fourth-quarter 2008 and a 0.51% contraction in the third quarter. In terms of year-to-year change, the fourth-quarter saw a contraction of 0.84%, following a gain of 0.75% in the third quarter. The first quarter’s annual contraction was the deepest since the third quarter of 1982, while the third-consecutive quarterly contraction was the longest string of consecutive quarterly declines since the 1973/1975 recession. 

The largest revision to the data was an increase (less-negative change) in business inventories. Higher than expected inventories often are unwanted and usually lead to production cutbacks and lower future GDP growth, although the changes and revisions here were not that large. As with the "advance" estimate, today’s revision understated the depth of the downturn. Current reporting likely will suffer negative revisions in the grand benchmark revision due the end of July. Lowered estimates of personal consumption expenditure and business investment would be consistent with the recent showings of more-reliable underlying economic series such as retail sales, industrial production and new orders for durable goods.

The first-quarter GDP inflation rate (GDP deflator) eased back in revision to an annualized 2.80%, versus 2.85% in initial reporting. Such contrasted with a 0.61% increase in the fourth quarter and a 3.88% inflation rate in the third quarter.

Based on removal of the effects of some reporting gimmicks and unfortunate methodological changes of recent decades, the SGS-Alternate GDP estimate for first-quarter 2009 is for an annual (not annualized) contraction of roughly 5.1% versus a 4.1% contraction in the fourth quarter, against official respective annual estimated declines of 2.5% and 0.8%. Against reporting of underlying economic series, the annualized quarterly contraction likely was in excess of 8% for the first quarter. Nonetheless, GDP reporting remains virtually worthless and is little more than political propaganda.

Nominal GDP Also Improved Slightly in Revision. The annualized decline in nominal GDP — GDP not adjusted for inflation, reflective of the way companies book actual sales volume — revised to 3.08%, versus initial reporting of 3.47%. Such followed a 5.77% annualized contraction in the fourth quarter (the relative improvement reflected higher inflation — see deflator comments above). As noted in prior comments, for the first time since the severe impact of a steel strike in 1957 and 1958, nominal GDP declined for a second consecutive quarter. Year-to-year change in nominal GDP turned negative in the first quarter, down a revised 0.43% (previously down 0.53%). Such was the first annual contraction since the second quarter of 1958. Annual growth in fourth-quarter 2008 was a positive 1.21%.     

GDP-Like Measures Reported.  Initial estimates of the BEA’s GDP-like measures for first-quarter 2009, GNP (see above) and Gross Domestic Income (GDI) — the income-side equivalent of the GDP’s consumption estimate — were released along with the "preliminary" GDP estimate.

Running contrary in direction to the reported pattern of quarterly GDP changes, first-quarter GNP was reported showing an annualized real quarterly contraction of 5.72%, deepening slightly versus the fourth-quarter estimate of a 5.59% contraction. Year-to-year, first-quarter GNP declined by 2.42%, versus a 0.93% contraction in the fourth quarter.

Reflecting a sharp reversal in "statistical discrepancy," likely as part of the preparation for the upcoming benchmark revision, first-quarter GDI was reported showing an annualized real quarterly contraction of 3.64% (3.90% net of revisions), versus a revised fourth-quarter estimated contraction of 7.78% (previously 7.54%). Year-to-year, first-quarter GDI declined by 2.94%, versus a revised 2.16% (was 2.10%) contraction in the fourth quarter.

Pending Benchmark Revision.  As previously noted, the BEA plans a grand benchmark revision on July 31st, along with the "advance" estimate of second-quarter GDP. The revisions will include the introduction of new methodologies. The pending changes will be assessed in a separate update. What is likely is that recent economic history — as reported for the GDP — should appear to have been relatively weaker than initially published. Minimally, the new data should reflect quarterly GDP contractions that go back to at least first-quarter 2008, consistent with the National Bureau of Economic Research’s recession timing. Further back in time, however, prior history from 1929 through the late-1990s likely will be revised higher, reflecting the "benefits" of new methodologies. 

Hype and Revisions Distract from Ongoing Annual Deterioration in New Orders for Durable Goods. Continuing a pattern of downside revisions to prior reporting by the Census Bureau, the regularly-volatile new orders for durable goods rose by 1.9% (up just 0.2% net of revisions) month-to-month in April. Such followed a revised 2.1% (previously 0.8%) monthly decline in March. In terms of year-to-year change, before any accounting for inflation, April’s new orders were down by a great-depression-like 26.6%, following March’s revised annual decline of 24.7% (previously 23.6%). Adjusted for inflation the series would have shown even sharper contractions.

The widely followed new orders for nondefense capital goods fell by 2.0% (down 4.8% net of revisions) in April, following a revised 0.9% contraction (previously a 1.9% increase) in March. Year-to-year, April orders were down by 35.5%, versus a March decline of 30.8% (previously down by 29.4%).

Home Sales Also Are in Annual Deterioration. Following last week’s reporting of a record 54.2% annual contraction in April housing starts, home sales are not presenting a much happier picture, despite mixed or qualified reporting.

The National Association of Realtors estimated that 45% of existing home sales in April (down from somewhat more than 50% in March) were distressed (in foreclosure). Such makes the reported 2.9% monthly gain and 3.5% annual decline in the April sales difficult to relate to underlying economic activity. There is no easy way to estimate what portion of the foreclosed properties would have otherwise translated into normal home sales, had the forced sales not been present in the market. Safely, the net annual pace of decline would have been much steeper.

The Census Bureau and HUD reported that April new home sales were up by a statistically insignificant 0.3% (down by 1.1% net of revisions) +/- 17% (95% confidence interval) for the month, following a revised 3.0% (previously 0.6%) decline in March. April homes sales declined by 34.0%, following a revised 31.0% (previously 32.1%) decline in March   

Consumer Confidence Rallies on Positive Financial Media.  As discussed in the last newsletter, reported consumer confidence easily is swayed by the tone of the popular media towards the state of economy and the financial markets. Such was established some years back by David Fan of the University of Minnesota. Accordingly, recent happy spins out of Washington and Wall Street, which have been reflected widely in the popular media, placed upside pressures on both the April and May consumer confidence numbers. Keep in mind that these measures usually are lagging, not leading indicators of economic activity. As the talk of economic recovery begins to wear thin with the public, and the stock market falters anew, these series should turn sharply lower again.

May consumer confidence numbers bounced sharply, but at a slightly slower pace than in April. The Conference Board’s May 2009 Consumer Confidence measure rose by 34.6%, versus a revised 51.7% (was 45.7%) month-to-month increase. Year-to-year decline in the three-month moving average as of May narrowed sharply to 34.4% from a decline of 54.7% in April.

The Reuters/University of Michigan’s Consumer Sentiment measure rose by 5.5% for the month of May, versus a 13.6% gain in April.  Year-to-year decline in the Sentiment three-month moving average also narrowed sharply to a drop of 0.4% from April’s 11.9% contraction.

Week Ahead. Employment/Unemployment for May: Due for release on Friday, June 5th, May payrolls are expected to fall by 550,000, following a 539,000 monthly decline in April, with May’s U.3 unemployment rate rising to 9.2% from 8.9% in April, per Briefing.com. Such expectations are not unreasonable, although the better quality indicators below remain weak enough to support a monthly payroll contraction well in excess of 600,000, as well as a higher unemployment rate. From the standpoint of political/financial market needs, after revisions and other reporting gimmicks, the headline payroll number is more likely to come in on the sunny side of expectations, with the annual year-to-year contraction continuing to deepen.

Keep in mind that these data are coincident indicators of broad economic activity, not lagging indicators as hyped by Wall Street. The next month’s June payroll data should show the worst annual contraction since the shutdown of production at the end of World War II.

Employment Environment. Significant weakness and deterioration has continued in the better-quality employment-environment indicators, which not only lead the May report, but also are leading indicators to the June report:

April newspaper help-wanted advertising held at its record-low reading of 10 for the second consecutive month, down by 44.8% year-to-year change on a three-month moving average basis. The annual decline in March was a record 45.2%. Similar, deepening annual fall-offs were seen in the nascent online help-wanted advertising measures for April.

Annual growth (positive growth is an economic negative) in new claims for unemployment insurance has continued to surge, with the 17-week moving average up by 76.8% as of May 23rd, still shy of the historical peak growth rate of 78.8% in March 1975. A month ago, annual growth was 75.8%; a year ago growth was 14.8%.

Although stronger than in March, employment readings continued deep in recession territory for the April manufacturing and non-manufacturing purchasing managers surveys.