Timing Begins to Narrow, with the Broad Outlook Unchanged: Intensified Economic and Solvency Crises, Higher Inflation and Hyperinflation. The last month or so generally has seen economic reporting turn to the downside, and, importantly, the concept of an intensified economic downturn, or a "double-dip" recession, appears to be gaining broader acceptance. Weak reports on retail sales, industrial production and trade activity this week all showed that broad economic activity has slowed in the second quarter, suggesting not only a slowing of GDP growth in the second- versus first-quarter of 2010, but also an increasing the likelihood of renewed quarterly GDP contraction in the third-quarter. Consensus forecasters, though, appear at present to be looking for a stronger second-quarter, with continuing growth for the balance of the year. 

Accordingly, as the recession intensifies anew, the implications of worse-than-expected ballooning federal deficits, Treasury fundings, banking industry solvency issues, etc., increasingly will bring the issues of U.S. solvency and U.S. dollar soundness to the fore. As suggested perhaps by some recent rebound in the euro, market concerns already may be shifting from European solvency issues to those of the United States. At such time as U.S. solvency become the focus of global financial-market concerns, it is hard to imagine the U.S. dollar and the U.S. equity and credit markets not being pummeled. 

As reported today (July 16th) by the Bureau of Labor Statistics, consumer inflation appears to be contained. That should change quickly and sharply at such time as the U.S. dollar comes under heavy selling pressure, along with broad dumping of dollar-denominated paper assets. Not only will oil prices spike in response to the dollar weakness, but the Fed will find itself forced to become lender of last resort to the U.S. Treasury, with a resulting sharp jump in Fed monetization of Treasury debt and related money supply issues. Both the dollar weakness and monetization developments are of increasing probability within the next year, with the time-horizon beginning to come in. These developments should result in a rapid increase in consumer inflation, with the base then being set for a hyperinflation, as discussed in the Hyperinflation Special Report.

The general outlook for the economy and the markets is unchanged. For those with assets at risk, circumstances continue to suggest looking at actions for long-range wealth preservation. Despite any severe near-term volatility in the markets, physical gold and silver, assets outside the U.S. dollar (such as the Canadian dollar, the Australian dollar and Swiss franc) and assets outside the United States, offer long-term hedges against the severe loss looming in U.S. dollar’s purchasing power.  

 

As suggested by the above graphs, the gold market continues to look beyond short-term volatility in the financial markets and in current inflation reporting, with the upside distortions in the U.S. dollar’s exchange rate and the downside distortions to oil prices perhaps starting to reverse.

Reversal of Gasoline-Price-Depressing Seasonal Factors Should Spike July CPI. After a number of months where seasonal adjustment factors reduced reported gasoline price inflation — depressing the level of the adjusted headline CPI-U inflation — June’s seasonal factor adjustments turned neutral. Gasoline prices, though, actually fell in the month of June, dampening reported CPI inflation. 

The seasonals, however, turn sharply in the other direction in July and August, spiking reported gasoline prices and the headline inflation number, even when there is a fair monthly decline in actual gasoline costs (July gasoline prices appear to be holding relatively flat versus June). July’s CPI-U inflation rates are strong bets to pick-up on monthly (both adjusted and unadjusted) and annual bases.

CPI-U.  The BLS reported this morning that the seasonally-adjusted June CPI-U eased by 0.14% (down by a statistically-insignificant 0.10%, unadjusted) +/- 0.12% (95% confidence interval not seasonally adjusted) for the month, after a 0.16% decline (a gain of 0.08% unadjusted) in May. Seasonally-adjusted, the CPI-U annualized rate of inflation for the three months ended June 2010 (June versus March) was a decline of 1.46%, against May’s decline of 0.67%. The lack of inflation in the latest three months largely was due to seasonal adjustments. Unadjusted, the CPI-U annualized rate of inflation for the three months ended June 2010 (June versus March) was a gain of 0.62%, against May’s 2.68%.

Unadjusted, June’s year-to-year inflation was 1.05% +/- 0.20% (95% confidence interval) against a 2.02% annual increase in May.

Year-to-year inflation would increase or decrease in next month’s July 2010 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.10% adjusted monthly gain seen in July 2009. I use the adjusted change here, since that is how consensus expectations are expressed. To approximate the annual inflation rate for July 2010, the difference in July’s headline monthly change (or forecast of same) versus the year-ago monthly change should be added to or subtracted directly from June 2010’s reported annual inflation rate of 1.05%.

CPI-W. The narrower, seasonally-adjusted June CPI-W declined by 0.19% (down 0.13% unadjusted) for the month, following a decline of 0.28% (a gain of 0.08% unadjusted) in May. Seasonally-adjusted, the annualized rate of CPI-W inflation for the three months ended June 2010 (June versus March) was a contraction of 2.39%, versus a decline of 1.42% in May. As with the CPI-U, the lack of inflation in the latest three months again was due to seasonal adjustments. Unadjusted, the CPI-W annualized rate of inflation for the three months ended June 2010 (June versus March) was a gain of 0.59%, against May’s 3.01%.

Unadjusted year-to-year CPI-W inflation rose by 1.36% in June, versus a 2.56% May increase.

C-CPI-U.  The Chain-Weighted CPI-U — the fully substitution-based series that gets touted by CPI opponents and inflation apologists as the replacement for the CPI-U — is reported only on an unadjusted basis. Unadjusted, the C-CPI-U annualized rate of inflation for the three months ended June 2010 (June versus March) was 0.27%, against May’s 2.73%. Year-to-year, or annual inflation, was 0.82% in June 2010, versus 1.99% in May.

Alternative Consumer Inflation Measures. Adjusted to pre-Clinton (1990) methodology, annual CPI inflation was roughly 4.3% in June 2010, versus 5.4% in May, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, was about 8.4% (8.37% for those using the extra digit) in June, versus 9.2% in May.

The SGS-Alternate Consumer Inflation Measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS. Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept. Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact not otherwise published by the BLS.

Gold and Silver Highs Adjusted for CPI-U/SGS Inflation. Despite another recent all-time high in the price of gold in the current cycle, gold and silver prices have yet to approach their historic high prices, adjusted for inflation. Even with the June 28th historic high gold price of $1,261.00 per troy ounce, the earlier all-time high of $850.00 (London afternoon fix, per Kitco.com) of January 21, 1980 has not been breached in terms of inflation-adjusted dollars. Based on inflation through June 2010, the 1980 gold price peak would be $2,382 per troy ounce, based on not-seasonally-adjusted-CPI-U-adjusted dollars, and would be $7,689 per troy ounce in terms of SGS-Alternate-CPI-adjusted dollars. 

In like manner, the all-time high price for silver in January 1980 of $49.45 per troy ounce (London afternoon fix, per silverinstitute.org) has not been hit since, including in terms of inflation-adjusted dollars. Based on inflation through June 2010, the 1980 silver price peak would be $139 per troy ounce, based on not-seasonally-adjusted-CPI-U-adjusted dollars, and would be $447 per troy ounce in terms of SGS-Alternate-CPI-adjusted dollars.

As shown on page 22 in the Hyperinflation report, over the decades, the price of gold has more than compensated for the loss of the purchasing power of the U.S. dollar as reflected by CPI-U inflation, while it has effectively fully compensated for the loss of purchasing power of the U.S. dollar based on the SGS-Alternate CPI.

Real Money Supply M3. The signal of what now appears to be an unfolding intensification of the economic downturn, based on annual contraction in the real (inflation-adjusted) broad money supply (M3), most recently was discussed and graphed in Commentary No. 307. The annual real contraction in June M3 (SGS-Ongoing) estimated for that Commentary was 7.2%. Based on today’s CPI-U report, that annual contraction was 7.1%, narrower than May’s 7.9% contraction. The signal for a downturn or an intensified downturn is generated when annual growth in real M3 first turns negative in a given cycle; the signal is not dependent on the depth of the downturn (currently a post-World War II record) or its duration. The current downturn signal was generated in December 2009. The broad economy tends to follow in downturn roughly six to nine months after the signal.

Real Retail Sales.  Based on June 2010 CPI-U reporting, inflation- and seasonally-adjusted monthly June retail sales fell by 0.4%, where before inflation adjustment the current number was down by 0.5%, versus a revised 0.9% (was 1.0%) real retail sales contraction in May. June real retail sales rose at a 3.7% year-to-year pace — slower than in May’s revised 4.8% (was 4.9%) annual pace — versus a 4.8% gain in June, before inflation adjustment.

On a quarter-to-quarter basis, real retail sales in second-quarter 2010 expanded at a 4.8% annualized pace, down from annualized growth of 6.6% in the first-quarter. Adjusted for inflation, seasonally-adjusted monthly retail sales in May and June fell at an annualized pace of 7.6%. If that pattern continued in the current quarter, a quarterly contraction in real third-quarter 2010 GDP would be a good bet.

Since November 2008, monthly real retail sales (CPI-U deflated) have been fluctuating around an average of $162.1 billion (the deflated June number was $166.0 billion). The first graph below reflects the relatively volatile monthly levels of real retail sales, as reported.

Smoothed for the monthly volatility on a six-month moving-average basis, as shown in the second graph, the pattern of activity here has been one of bottom-bouncing in terms of the level of inflation-adjusted sales. The recent bounce from short-lived stimulus factors and warped-seasonals appears largely to have run its course, with the average close to rolling over, and with continued lower real sales levels likely in the months ahead. There has been no change in underlying fundamentals that would support a sustainable turnaround in personal consumption or in general economic activity — no recovery — just general bottom-bouncing.

 

June PPI Inflation Hit by Lower Food and Gasoline Prices. Seasonally-adjusted inflation at the wholesale and production level declined month-to-month in June, reflecting short-lived declines in food and gasoline prices.  As reported yesterday (July 15th) by the BLS, the regularly-volatile, seasonally-adjusted finished-goods producer price index (PPI) in June dropped by 0.5% (down 0.6% unadjusted), following May’s decline of 0.3% (a gain of 0.3% before seasonal adjustment).

Unadjusted and year-to-year, June’s annual PPI inflation rate eased to 2.8% from the 5.3% annual gain reported for May.

On a monthly basis, seasonally-adjusted June intermediate goods fell by 0.9% (up by 0.4% in May), with crude June goods falling by 2.4% (down by 2.8% in May). Year-to-year inflation in June intermediate goods was up by 6.4% (up by 8.5% in May), with June annual inflation in crude goods up by 13.3% (up by 21.2% in May).

June Industrial Production Boosted by Continuing Utilities Surge. The growth in seasonally-adjusted monthly industrial production flattened out in June. While the report actually was on the plus-side of flat, it would have been on the minus side of flat, except for revisions to the initial benchmark revision, which was published between the May and June reporting. More significantly, net of unseasonably-warm weather spiking utility usage again — which also spiked manufacturing production estimates imputed from electricity consumption — production contracted (manufacturing production was reported down by 0.4% for the month). 

The benchmark revision had noticeable impact on the numbers as far back as 1971. As a result of the changes, the 2001 recession now appears to have been a little more severe. In the current downturn, 2007 now is relatively stronger and 2008 relatively weaker, with a suggested stronger than previously estimated "recovery" starting in 2009. The new series was reset with the index of industrial production at 100 for 2007; the old series had been set at 100 for 2002. 

The Federal Reserve Board reported yesterday that seasonally-adjusted June 2010 industrial production rose by 0.07% (down by 0.2% against the initial benchmark revision, up by 0.45% versus pre-benchmark reporting) for the month, versus a benchmark-revised 1.3% (1.2% pre-benchmark) monthly gain reported for May.  

For the second-quarter 2010, industrial production rose at a 6.6% annualized pace, versus 7.0% in the first-quarter 2010.

The year-to-year change in June production rose to 8.22% from May’s benchmark-revised 7.90% (previously 7.62%). The spike in annual growth was due largely to the pattern of collapsing activity a year ago, which troughed in June 2009. After the benchmark revision, the deepest year-to-year decline seen in the current cycle is a year-to-year contraction of 12.86% for May 2009 (previously a decline of 13.31% in June 2009). The May 2009 drop now is the steepest annual decline in production growth since the shutdown of war-time production following World War II. 

The following two graphs reflect both new and old reporting, with the old series plotted on the new base, for comparison purposes.

 

 

The first graph shows recent monthly detail, with a fair chance that the June number will mark the turning point to renewed decline in the production series.

The "recovery" in production is shown in the second graph, where month-to-month volatility is smoothed using a six-month moving average. For the last 18 months, the production index has averaged 88.93, around which the series has been fluctuating, with June’s six-month moving average reading at 91.36 versus 92.54 for the single month. Production activity had leveled off at a low-level plateau of activity that effectively wiped out the last eight years of growth in industrial production. Despite the near-term upside gains generated by short-lived stimulus and seasonal distortions, the series likely still is bottom-bouncing and should continue to soften anew, significantly, in the next several months.  

Week Ahead. Given the unfolding reality of a weaker economy (or 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. Increasingly, that will be seen in economic reporting net of prior-period revisions.

Housing Starts (June 2010). Due for release on Tuesday, July 20th, the report on June residential construction should show continued bottom-bouncing moving towards renewed downturn. Despite a likely month-to-month contraction in June housing starts, the change may lack statistical significance.