Inflationary Recession Remains Intact and Intensifies

Federal Debt Jumps $1.25 Trillion Year/Year, $650 Billion in Six Weeks

Inflation Holds Despite Oil Sell-Off

3rd-Quarter Real Retail Sales Plunge
Annualized 10.1%, 4.2% Year/Year

3rd-Quarter Industrial Production Down
for Second Consecutive Quarter, Year/Year 

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In response to reader requests, this Special Update provides a preliminary but brief assessment of the impact from the financial system solvency crisis and ongoing turmoil in the global financial markets on the outlook for the continuing inflationary recession and my prediction of a hyperinflationary great depression. These comments are provided in advance of more detailed analysis in the next full SGS Newsletter, targeted for publication over the weekend of October 25th. In general, the economic and inflation outlooks — other than intensified — are little changed.

– Best wishes to all, John Williams  

Fed/Treasury Actions Should Stabilize Banking System
U.S. Equities, U.S. Dollar and U.S. Economy Face Significant Downsides

With the partial nationalization of the banking system, full FDIC backing to demand deposits and various other bank liabilities, extraordinary liquidity facilities offered by the Federal Reserve and indications of further flexibility as needed, the federal government and the Federal Reserve have taken actions or otherwise should have the ability to stabilize the functioning of financial services industry. As discussed previously, however, those actions will not prevent an already ongoing and deepening recession and will not provide a long term-prop to U.S. equities or to the U.S. dollar.  The ultimate cost of systemic salvation remains inflation, driven by excessive monetary creation, irrespective of the short-term collapse in oil prices.

It is important to keep in mind that the current recession has been in place for some time, since before the systemic solvency crisis broke in August of 2007. It reflects a structural impairment in the U.S. economy that has prevented sustainable income growth from exceeding that of inflation (see the Hyperinflation Report of April 8, 2008 for further detail). The recent systemic and market turmoil only have exacerbated the downturn, they did not trigger it. As discussed below, reporting of retail sales and industrial production show an ongoing and deepening recession.  

While those underlying economic numbers would be consistent with a third-quarter real (inflation-adjusted) GDP contraction, the Bureau of Economic Analysis so far has masked most of the GDP’s contraction in the current recession with heavily politicized reporting. The BEA has the ability to do so, again, in the upcoming "advance" estimate of the third-quarter GDP, due out on October 30th, the Thursday before the election. On the other hand, the concept of the U.S. economy being in recession is now so widespread that further obfuscation could just intensify the public’s distrust of government reporting, with little if any political gain. If consensus forecasts coming into the end of next week are for a GDP contraction, such would enhance the odds of an actual contraction being reported.

In recent weeks, the government and Wall Street talked up the "collapsing" economy in an effort to gain public support for the "bailout" package.   The fear mongering has had its impact in hitting the economy harder than would have been seen otherwise from the liquidity crisis, accelerating the fall into an economic depression (see the Hyperinflation Report of April 8, 2008 for further definitions).

From the standpoint of inflation, the current level of oil prices, below $90 per barrel, has and will ease some of the immediate-term commodity-driven inflation pressures. Such will be more than offset in the next six-to-nine months as the impact from increased money supply growth starts to surface in inflation reporting. I still look for double-digit official CPI reporting in early 2009.

As to recent strength in the dollar, weakness in oil prices, and softness in gold prices, much has been distorted by the systemic solvency crisis, where forced liquidations of related financial instruments have caused prices movements well beyond or counter to underlying fundamentals. In particular, as the markets begin to stabilize, the U.S. dollar should come under intense selling pressures. Regardless of the global nature of some actions taken to stabilize the system, the primary solvency crisis and the fiscally and monetarily destructive corrective actions are predominantly U.S. issues, ones that materially have weakened the already miserable underlying fundamentals for the U.S. dollar.

When dollar selling resumes, eventually evolving into a massive flight-to-safety outside the dollar, that should put upside pressure on the prices of precious metals. Oil prices should surge in dollar terms, too, irrespective of any softening oil demand due to slower U.S. or global economic activity.

The hyperinflation forecast remains intact, but it may be moved closer to the present, depending on developments with the U.S. dollar. This shall be discussed in further detail in the upcoming SGS Newsletter.

Federal Debt and Deficit Explode. Quick impact from the solvency crisis has been seen in the U.S. government’s deteriorating fiscal condition. Against official expectations two months ago of a $389 billion deficit, the official fiscal 2008 (year-ended September 30th) shortfall came in at $454.8 billion, up from $161.5 billion in 2007. These are the officially-gimmicked numbers, not GAAP reporting, which will show a much larger deficit. Reflecting the recession that was in place long before the solvency crisis exploded, government revenues in 2008 fell by 15.3% versus 2007.

As of October 14, 2008, gross federal debt stood at $10.294 trillion, up by $1.250 trillion or 13.8% year-to-year, and up by $650 billion or 8.8% since the first of September.    

CPI Continued to Absorb Oil Sell-Off Shock.  Reported September consumer inflation eased back again on both a monthly and annual basis, as the CPI continued to absorb the impact of an ongoing tumble in oil prices. Yet, "core" inflation also eased (CPI-U core up by 0.1% in September, 0.2% in August, and 0.3% in July) despite significant anecdotal evidence of surging non-energy and food inflation.

CPI-U.  The Bureau of Labor Statistics (BLS) reported seasonally-adjusted September CPI-U eased by 0.03% (down by 0.14% unadjusted) +/- 0.12% for the month, versus a 0.14% (0.40% unadjusted) decline in August.  Year-to-year or annual inflation in September backed off to 4.94% from 5.37% in August.  

Annual inflation would increase in October 2008 reporting, dependent on the seasonally-adjusted monthly gain exceeding the 0.26% monthly increase seen in October 2007.  The difference in growth would directly add to or subtract from September’s annual inflation rate of 4.94%.

CPI-W. Annual inflation for the narrower CPI-W — targeted at the wage-earners category where gasoline takes a bigger proportionate bite out of spending — eased to 5.4% in September from 5.9% in August and 6.2% in July.  The CPI-W is used for making the annual cost of living adjustments to Social Security payments, and the 2009 adjustment — based on the July to September 2008 period — should be about 5.8%, two-and-a-half times the 2.3% adjustment for 2008.  Such is not good news for federal budget deficit, discussed elsewhere.

C-CPI-U.  Year-to-year or annual inflation for the Chain Weighted CPI-U — the fully substitution-based series that increasingly gets touted by CPI opponents and inflation apologists as the replacement for the CPI-U — eased to 4.34% in September from 4.70% in August.

Alternate Consumer Inflation Measures.  Adjusted to pre-Clinton (1990) methodology, annual CPI growth declined to roughly 8.3% in September from 8.7% in August, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, eased back to roughly 12.9% in September from 13.2% in August.  The alternate numbers are not adjusted for any near-term manipulations of the data.

PPI Also Absorbed Oil Selling. The regularly volatile Producer Price Index (PPI) for finished goods contracted by a seasonally-adjusted 0.4% (0.1% unadjusted) in September, versus 0.9% (1.6% unadjusted) in August, as reported by the Bureau of Labor Statistics. The decline largely reflected the continued sharp decline in oil prices.  Year-to-year PPI inflation in September eased to 8.7% from 9.6% in August.

Retail Sales Plunge Month-to-Month and Year-to-Year, Before Inflation Adjustment. September retail sales showed a still-deepening economic contraction. The Census Bureau reported that seasonally-adjusted sales fell for the month by 1.16% (down 1.49% net of revisions) +/- 0.6% (95% confidence interval), following a revised 0.45% (previously 0.27%) decline in August.  On a year-to-year basis, September retail sales growth turned negative, down by 1.03%, versus a revised gain of 1.50% (previously 1.56%) in August.  

Real Retail Sales. Deflated by the September CPI-U, seasonally-adjusted real (inflation-adjusted) retail sales contracted by 1.13% for the month of September (down 1.16% before inflation adjustment), following a 0.31% decline in the month of August (down 0.45% before inflation adjustment).  On a year-to-year basis, September retail sales fell by 5.69% (down 1.03% before inflation adjustment), versus a 3.66% decline in August (up by 1.50% before inflation adjustment). The series now has suffered its fourth consecutive quarter-to-quarter real contraction (an annualized decline of 10.1% in the third quarter versus a 1.2% drop in the second quarter) and the third consecutive quarter of annual contraction (down 4.2% for the third quarter versus a 1.6% decline for the second quarter).  Such ongoing negative growth patterns never have been seen outside of formal recessions. 

Core Retail Sales.  Consistent with the Federal Reserve’s predilection for ignoring food and energy prices, "core" retail sales — retail sales net of grocery store and gasoline station revenues — fell by 1.47% (down 1.76% net of revisions) in September, versus a revised 0.21% (was 0.06%) decline in August.  Those numbers contrasted with the official aggregate drop of 1.16% in September and the revised 0.45% decline in August.  On an annual basis, September "core" retail sales fell by 4.26% versus a revised August decline of 1.67% (previously down by 1.73%).

Industrial Production Contracts in 3rd Quarter, Net of Strike and Hurricane Impacts. The Federal Reserve reported a 2.8% monthly contraction in September industrial production, following a revised 1.0% (previously 1.1%) drop in August.  September’s weakness was attributable to a strike at Boeing and to oil and gas related shutdowns in the Gulf of Mexico region due to hurricanes.  September year-to-year change plunged by 4.5%, after a 1.4% annual contraction in August. Adjusting for strike and hurricane impacts, however, third-quarter production still was down on both a quarterly and an annual basis.

Not adjusted for the special factors, following a 3.1% annualized quarter-to-quarter contraction reported in the second quarter, industrial production suffered its second consecutive quarterly downturn in the third quarter at an annualized 6.0% rate of decline.  In conjunction with a 2.7% contraction in year-to-year growth for the third quarter, the series is showing growth patterns not seen outside of recessions.

Trade Deficit Reportedly Narrowed in August. Still showing likely paperwork flow distortions as discussed in the last newsletter, the Census Bureau and the Bureau of Economic Analysis reported the seasonally-adjusted August trade deficit narrowed to $59.8 billion from a revised $61.3 (previously $62.2) billion in July. With apparent renewed games-playing in reported oil imports, these data could be used to help keep the "advance" third-quarter GDP estimate in positive territory for its pre-election debut.

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