Economic and Market Fantasies versus Underlying Reality. The fantasy of economic recovery received questionable support with the report of 3.2% annualized growth in real (inflation-adjusted) first-quarter GDP.  Surging inventories gave a temporary boost to the number, but underlying fundamentals still do not support the growth reported in the dominant personal consumption category. 

The signal for a renewed, major deterioration in the economic downturn (a double-dip for those buying the economic "recovery) was generated at the end of 2009. That signal not only is continuing but also is intensifying. In this "happy" environment, where the economy and systemic stability are sharply at odds with market perceptions, the rallying equity markets appear to be removed from underlying reality in the extreme. The liquidity and market circumstances are reviewed following the GDP analysis.

First-Quarter GDP Showed "Normal" Growth. First-quarter GDP growth of 3.24%, if accurate, would be about average, showing normal growth for the series, but economic circumstances are anything but normal. Looking at the major first-quarter GDP accounts that were on the plus side, personal consumption expenditures accounted for 2.55 percentage points of the reported gain, and business investment accounted for 1.67 percentage points, of which 1.57 percentage points were due to a continuing relative buildup in inventories. Such put the total growth contribution from expanding GDP accounts at 4.22 percentage points.

On the downside, with a widening trade deficit, net exports sapped away 0.61 percentage points of growth, while declining government consumption reduced growth by a further 0.37 percentage points. Total major GDP account contractions of minus 0.98 percentage points, offset against the positive 4.22 percentage points of gain, yield the official 3.24% annualized growth rate. Consider the following.

Personal Consumption Expenditure. Sustainable growth in personal consumption requires sustained growth in personal disposable income. When such is lacking, short-term consumption growth can be borrowed from the future through debt expansion or savings liquidation, but those alternative funding sources are short-term and not sustainable. In monthly reporting for January and February 2010, real disposable income was contracting versus the fourth-quarter. Today’s GDP report showed first-quarter real disposable income to be unchanged from the fourth-quarter. While such implies either an uptick in the March income numbers to be released on Monday, or upside revisions to the January and February data, the government still showed no growth in real disposable income in the first-quarter versus the fourth-quarter.

Real consumer credit, which has been reported only for January and February, also was contracting in the first-quarter versus the fourth-quarter. In combination, these numbers show no basis for sustainable growth in personal consumption and even throw into question the credibility of the government’s first-quarter consumption reporting (see Commentary No. 290).  

Inventories. Relative inventory growth, which has supported recent GDP reporting, eventually will turn to liquidation without adequate support from growing consumption. Final sales, which is GDP net of inventory change, measures the base consumption in the economy. As a result of relative increasing inventories, final sales grew at an annualized pace of 1.67% (versus 3.24% GDP) in the first-quarter, against 1.77% (versus 5.55% GDP) in the fourth-quarter.

Trade Deficit. For once, the quarterly change in net exports was in the same direction as indicated by the underlying monthly trade reports. As a cautionary note on the "advance" GDP, though, most of the estimates are guesstimates. For example, only two of three months of trade data for the first-quarter were available for this morning’s report.  

Government Spending. The decline in government spending was at the state and local levels, where, unlike the federal government, those government entities do not have the ability to print money. At the state and local levels, the quarterly contraction in spending was at an annualized pace of 14.9%. Federal spending was reported up at an annualized 3.5%.    

GDP.  The Bureau of Economic Analysis (BEA) released its "advance" or first estimate of first-quarter 2010 Gross Domestic Product (GDP) this morning, April 30th, and the report showed an annualized real growth rate of 3.24% +/- 3% (95% confidence interval). Such followed a 5.55% annualized gain reported for real fourth-quarter 2009 GDP. The year-to-year change in real first-quarter GDP rose to 2.55% from a gain of 0.06% reported for the fourth-quarter. Specifics are discussed above.

 

The graph shows official year-to-year change. The "recovery" in year-to-year growth reflects the nature of the protracted recent bottom-bouncing in the economy. The pattern should flatten out and turn negative, once again, in revision and in future quarters.  

The GDP implicit price deflator — inflation measure — showed an annualized pace of inflation in first-quarter 2010 of 0.88%, up from 0.50% in fourth-quarter 2009. In contrast, annualized inflation for the CPI-U in the first-quarter was 1.53% versus 2.62% in the fourth-quarter. The higher the inflation rate used in deflating the GDP, the weaker is the inflation-adjusted number.

The SGS Alternate-GDP estimate for first-quarter 2010 is an approximate annual contraction of 1.5% versus the official estimate of a 2.5% gain, less-negative than the annual 4.6% contraction (0.1% official gain) estimated in the fourth-quarter. While annualized real quarterly growth is not formally estimated on an alternative basis, a small quarter-to-quarter contraction likely would have been realistic. The relative upturn in annual change reflects the bottom-bouncing at low levels of activity seen for much of the last year in key underlying economic series, not an economic recovery. As discussed below, an intensified downturn appears to be in the offing.

GNP and GDI. Given the lack of meaningful data available for the "advance" estimate of first-quarter 2010 economic activity, the Bureau of Economic Analysis will not attempt even to guesstimate the Gross National Product (GNP) or Gross Domestic Income (GDI) for first-quarter 2010 until next month’s (May 27th) "second" estimate, or first revision, of the first-quarter GDP.

Pace of Money Supply Contraction Accelerates. With somewhat over two weeks of reporting in on April money supply, weekly contractions in M2, institutional money funds and large time deposits suggest that the pace of decline in the broad M3 (SGS-Ongoing M3 Estimate) is accelerating, with the nominal year-to-year change reflecting a record annual decline of roughly 4.8% in April, versus a decline of roughly 3.7% in March, if weekly reporting showed no further changes for the balance April. Real year-to-year change appears likely to deteriorate from a 5.8% contraction in March to an unprecedented reading pushing a 7% annual contraction. As discussed in numerous Commentaries (see for example Commentary No. 290), contracting annual growth in broad money supply signals contracting economic activity.

Not only is the money supply signaling worse economic times, once again the nominal contraction suggests mounting systemic difficulties in the banking system. It appears that most of what has been accomplished by the extraordinary actions of the Federal Reserve and the U.S. Treasury in the last two years or so has been tied to short-term stabilization of the system and to buying time, not to establishing long-term stability and health to the financial system or the economy. If the U.S. banking system were able to function normally, it would be lending increasing amounts of money, not contributing to a slow downward spiral in consumer and business credit outstanding and a pending renewed decline in economic activity.

The mounting sovereign solvency issues in Europe have parallels in the way the U.S. banking crisis engulfed the world. Shy of letting Lehman Brothers fail, the Fed and Treasury did everything — spent every dollar they had to — to prevent systemic collapse at the worst of the banking crisis. Such was and is irrespective of severe and mounting popular political opposition. The crisis in Europe also is one that threatens systemic collapse, but I expect that everything possible will be done to contain it, regardless of long-term costs and consequences or near-term vociferous political opposition.

U.S. fiscal instability, however, remains the primary global systemic risk. If Europe blows up in the near-term, short-term impact likely would be flight to the U.S. dollar, as seen in some of this week’s turmoil. Such should be relatively short-lived, however, as the deteriorating economic, fiscal and systemic circumstances in the United States likely will engulf the domestic and global markets in the not-too-distant future.

My outlook for a hyperinflationary great depression in the United States is unchanged; all that is unfolding now is some of the detail that should lead to that ultimate financial/economic disaster. Gold remains the best long-term hedge here, along with some silver, and cash outside the U.S. dollar and the United States. I still like the Canadian and Australian dollars and the Swiss franc. Again, the outlook is for the long haul, irrespective of any near-term extreme volatility in the various markets. As to the U.S. stock market, the term "insanity" comes to mind as I watch some of the day-to-day movements.

From an anecdotal standpoint, given the unusual level and nature of communications I have been receiving in the last several days from long-time, conservative clients — individuals who have been in these markets for decades — I would not be surprised to see a major event in the markets, soon. Again, underlying reality does not support the happy hype fueling higher equity prices.

Week Ahead. Given the underlying reality of a weaker economy (or likely re-intensifying downturn) and more serious inflation problems than generally are expected by the financial markets, risks to reporting will tend towards higher-than-expected inflation and weaker-than-expected economic reporting in the months ahead. Such is true especially for economic reporting net of prior-period revisions.

Employment and Unemployment (April 2010).  The April employment and unemployment numbers are due for release on Friday, May 7th. I have not yet seen any public, consensus estimates for the data, but I presume Wall Street will be looking for a gain in payrolls, net of census hires. The bulk of the likely monthly gain will be in temporary hiring by the government of census workers, and those numbers will be detailed in the reporting. Whatever jobs gains are seen there will be reversed — lost completely — by the end of the third-quarter. 

Census hiring impact on the unemployment rate, however, will be hard to quantify, since some of the hiring will be of people who already have part-time jobs and are not now counted as unemployed in the headline U.3 unemployment rate.

Newspaper help-wanted advertising (Conference Board) fell to 9 in March, from 10 in February. Such leads April payrolls and is the first indicator of a possible downside surprise on the non-census payroll change. As other indicators are released next week, the reporting outlook will be updated, along with consensus estimates.