Signs Economic Commentary
Donald Hunt
July 11, 2005
The U.S. dollar closed at 0.8357 euros on Friday, down 0.5% from last week’s close of 0.8397. The euro, then, went from 1.1908 dollars on July 1 to 1.1966 on July 8. Gold closed at 424.90 dollars an ounce, down 1% compared to $429.30 an ounce a week earlier. Gold in euros would be 355.09 an ounce, down 1.5% compared to 360.51 euros an ounce at the previous week’s close. Oil closed at $59.04 up 0.5% compared to $58.75 a barrel on July 1. Oil in euros was unchanged this week at 49.34. The gold/oil ratio was 7.20, down 1.5% compared to 7.31 a week ago.In the U.S. stock market, the Dow closed at 10,449.14 up 1.4% from last week’s 10,303.44, shaking off any terrorism effects even before the end of Thursday. The NASDAQ closed at 2112.18 up 2.7% from the previous Friday’s close of 2057.37. The yield on the ten-year U.S. Treasury bond closed at 4.10 percent up six basis points from 4.04 on July 1.
The market reaction to the London bombings showed that “normal” terrorist events are now already factored into world market prices:
World economy defies new terror onslaught
Fri Jul 8 6:44 PM ET AFP
Global terrorism is now such a tragic fact of life that major economies will prove more resilient to the attacks on London than to the shock of 9/11, analysts said. Compared to the pandemonium that broke out on financial markets after the attacks in the United States of September 11, 2001, markets this time have quickly got back in their stride after Thursday’s rush-hour carnage in London. Major European stock markets rose Friday with London’s FTSE 100 index closing up 1.43 percent at 5,232.2 points. New York stocks also rallied strongly. “Unfortunately, western societies have come to expect some type of terror attack somewhere from time to time,” US broker Ryan Beck and Co. said in a research note. “As a result, terror risk premiums already exist in all financial markets,” it said. Analysts at Claymore Research played down the wider impact of the four bomb blasts on London’s public transport system Thursday morning, which killed at least 50 people and injured more than 700. “Many worry that terrorism threatens both the US recovery and the global economy,” they said.
“But, if we look to 9/11 as an example, overall spending in the US economy was actually higher in November 2001 than it was in August.
“While airlines and hotels suffered for years, other spending accelerated, and the US consumer rebounded quickly.” On that reading, the British and other European economies will be barely affected as a whole by the carnage in London.
Indeed, there has been an upswing of economic optimism in the United States in the past week. This has come from some water-treading employment figures, strong retail sales (meaning a continued housing bubble) and, I believe, a reorienting of public attention away from probable felony indictments of Bush’s top advisor, Karl Rove, away from a rapidly deteriorating situation in Iraq and Afghanistan for the U.S., and away from a collapse of support for Bush personally (below 40% approval ratings) which usually means political turmoil and uncertainty, towards the “war on terrorism” on Bush terms after the London bombing. The political boost given to Bush and Blair by the bombing (a godsend for them, really) and by the G8 summit where they could pretend to care about Africa on human terms and not on the next destroyed region ripe for predatory capitalist exploitation can only be good news for the capitalist system, still dominated by the Anglo-American axis (Axis of Mammon?). However, the problems we have been following here this year have not changed, and it is hard to see a bombing of the transit system of the center of the world finance system, no matter who did it, as in any way being good news.
So, first the good news:
Is the economy accelerating?
by Chad Hudson July 6, 2005
Throughout the first half of the year, the economic data has been ambiguous. Growth in the manufacturing sector has moderated from the rapid growth in 2004. Consumer spending has showed signs of abating, with unseasonable weather cited as the primary reason. Over the past week, economic data indicates that economic growth has started to accelerate.
ISM manufacturing survey rose 2.4 points to 53.8. This was the first gain in six months and higher than economists expected, which was no change from May. Most of the increase was due to the jump in new orders. New orders increased 5.5 points to 57.2, the highest level this year. The prices paid component dropped 7.5 points to 50.5. While this was the lowest the prices paid component has been since February 2002, this was the 40th consecutive month that manufacturers reported that prices had increased. After contracting in May, manufacturers reported that employment held steady in June, rising 1.1 points to 49.9. The June non-manufacturing survey was also better than economists expected. Instead of a 0.2 point gain, the index increased 3.7 points in June to 62.2. Six of the components rose. The employment component increased the most, jumping 4.0 points to 57.4. This was the highest since February and the second highest level since the survey started in 1997. While manufactures said that prices stabilized in June, non-manufacturers reported that prices accelerated in June. The prices paid component increased 2.0 points to 59.8. This was the first increase this year. Factory orders jumped 2.9% in May due to a 21.1% jump in transportation orders.
Excluding transportation, factory orders declined 0.1% from April. While factory orders excluding transportation dropped 0.1% from April, orders were up 7.2% compared to last year. Orders for consumer goods rose 10.5% from last year, which was the strongest growth since November 2004.
June annualized vehicle sales reached 17.5 million units, which was better than the 17.0 million unit pace forecasted and the fastest selling pace this year. General Motors sales soared 47% after extending its employee discount to everyone. This incentive eliminated the rebates that GM had been offering and set prices at a no-haggle low price. It is interesting that this increased that average incentive by less than $500. According to Autodata, the employee discount increased the average incentive by $449 to $4,458. This week, GM announced it will extend the employee-discount pricing until August 1 and Chrysler announced that will also sell vehicles at the employee price. This forced Ford to match the offer. Last week, the Federal Reserve raised rates by 25 basis points. More importantly it said monetary policy remains accommodative and further tightening will be measured. The statement also caused traders to reassess how many more times the Federal Reserve will increase rates this year. Before the meeting, Fed Funds futures were trading at 3.78% yield, meaning that traders expected the Federal Reserve to increase rates by another 50 basis points this year. Now, the December contract is trading at 3.895%, so now traders expects three 25 basis points hikes over the next four meetings this year.
Wal-Mart announced that its same store sales rose about 4.5% in June, slightly better than its plan of 2%-4%. Additionally, throughout June the retailer said that general merchandise was stronger than its food sales, which had been stronger in May. Last week, Target said that June same store sales were running above its plan of 4%-6% growth. Some analysts attribute the recent strength to the pent-up demand after poor weather hindered purchases of seasonal items. According to the International Council of Shopping Centers, retail sales increased 3.8% during the first week of July, from last year. It also expects sales to have increased by 4.5% in June. This would be the strongest year-over-year growth since February’s 4.7% increase. The uneven economic growth over the past six-months has caused economists to forecast a weakening economy. Similar to other “soft-patches”, interest rates headed lower, which in turn ignited the already hot housing market. Recent economic reports have revealed that the economy has expanded at a faster pace than initially perceived. In the past, interest rates have moved higher on stronger economic news. While shorter-term bonds have increased, long-term interest rates remain close to two-year lows. If the employment number is stronger than the 198,000 gain economists expect, its likely that the bond market will start to price in a stronger economy.
In fact, the employment number was around 146,000, less than expected. While the unemployment rate dropped a bit in June, the June job growth numbers in the United States were still high enough to keep the economy from turning downwards.
US economy creates 146,000 jobs in June
AFP Fri Jul 8, 5:33 PM ET
The US economy created 146,000 more jobs in June, the government said, less than expected by Wall Street but still enough to reinforce evidence of healthy growth. Analysts were expecting a June rise in the closely watched “non-farms payroll” figure of 195,000. But the Labor Department also revised up the data for previous months. For May, the figure was raised to 104,000 from 78,000 given initially. The number for April was increased to 292,000 from 274,000. US Treasury Secretary John Snow said the numbers “are a reminder that the American economy is thriving”. With the revisions thrown in, the June figure reads closer to a more satisfying rise of 190,000, Nomura chief economist David Resler said. “That is amazingly close to the average of about 183,000 for the past year and a half,” he said. “Labor markets are in a steady state of growth, with wage rates offering no hint of inflation pressures.”
The US unemployment rate fell to a four-year low of 5.0 percent in June, down from 5.1 percent in May, the Labor Department said.
But economists say the total number of jobs created is a more reliable indicator of the US economy’s health than the jobless rate. They reckon that an average rise of 150,000 a month is needed to keep pace with population growth. The non-farms payroll data has been choppy of late. The May and April revisions come after February saw a big rise of 300,000.
Other data have given encouraging signs of growth in the world’s biggest economy. First-quarter gross domestic product has been revised up to 3.8 percent, while industrial and services indicators have been solid.
The health of the jobs market is crucial for economic confidence, with consumer spending remaining the biggest motor of growth. In June, average hourly earnings rose three cents, or 0.2 percent, to 16.06 dollars. Earnings are up 2.7 percent in the past year. Job creation was concentrated in professional and business services, which added 56,000 posts, in healthcare and education (up 38,000) and leisure (19,000). Construction firms added 18,000 jobs. Employment losses were concentrated in the auto sector, which lost 18,000 jobs. Among 84 manufacturing industries, 35.7 percent were hiring in June, the lowest level since October 2003. The report will feed into the Federal Reserve’s thinking on interest rates when it next meets on August 9, analysts said. The figures inspired a powerful rally on Wall Street as share traders focussed on an economic scenario that is not too hot, but not too cold. “The US economy’s performance may once again start inspiring the ‘Goldilocks’ metaphor, with growth and hiring both running at a pace that is nearly just right for the Fed,” said CIBC World Markets analyst Leslie Preston.
Now for the bad news. The following article on the real U.S. budget situation is worth quoting at length:
Federal Deficit Reality: An Update
by John Williams July 7, 2005
John Williams is publisher of “Shadow Government Statistics” which looks behind the government’s reported economic numbers.
When the U.S. Treasury reported the official 2004 federal budget deficit at a record $413 billion last October, the hisses and boos in the financial media were unrelenting. Two months later, the Treasury reported the actual 2004 deficit using generally accepted accounting principles (GAAP) to be an incredulous $11.1 trillion, up from $3.7 trillion in 2003, yet nary a word was heard in the financial media, from Wall Street or from any political denizen of that former malarial swamp on the Potomac. An exception, of course, was Treasury Secretary John Snow, who signed the government’s financial statements, but the data release was as low key as physically possible.
The silence partially reflects the financial-market terror that would accompany an effective national bankruptcy. Such is the risk when a government’s fiscal ills spin so wildly out of control that they no longer are containable within the existing system.
Consider the traditional solution of raising taxes. Putting the $11.1 trillion deficit in perspective, if the government raised individual and corporate income taxes to 100%, seizing all salaries, wages and profits, the government’s 2004 operations still would have been in deficit by trillions of dollars. The deficit has moved beyond practical fiscal control! Many in government and the markets are aware of the underlying deficit reality, but few dare to sound the alarm, for the ultimate resolutions to the situation all are political or financial nightmares.
The government’s GAAP-based accounting generally is as used by Corporate America. It includes accrual accounting for money not yet physically disbursed or received but that otherwise is committed. The largest differences come from the bookkeeping related to Social Security and Medicare, where year-to-year changes in the net present value (discounted for the time value of money) of any unfunded liabilities are counted. In contrast, traditional deficit accounting is on a cash basis. It counts the cash received from payroll taxes (social Security, etc.) as income, but it does not reflect any offsetting obligations to the Social Security system.
That type of accounting for Social Security would be fine as far as I’m concerned as long as they kept it separate from the rest of the budget, which they don’t. That means that the payroll taxes paid into Social Security are considered income for the whole budget.
For nearly four decades, officially sanctioned accounting gimmicks have masked federal deficit reality. Surpluses in trust accounts, such as Social Security, have been used to obscure the true shortfall in government spending. With less than one tenth of the actual deficit being reported each year, a cumulative negative net worth for the U.S. government has built up in stealth to a level that now tops $45 trillion, with total obligations of $47.3 trillion (more than four times annual GDP). The problem has moved beyond crisis to an uncontrollable disaster that threatens the existence of the U.S. dollar and global financial stability.
Indeed, the unfolding fiscal nightmare likely will entail a U.S. hyperinflation and a resulting collapse in the value of the world’s primary reserve currency, the dollar. With surviving politicians looking to restore public faith in the global currency system, a new system probably will be based on gold, the only monetary asset that has held public confidence for millennia.
This article updates and expands upon our original background piece on the topic, “Federal Deficit Reality”, published in September 2004, and a special economic alert, “Financial Report of the United States Government (FY 2004)”, which appeared last December. Portions of those articles are revised and incorporated herein.
Current Detail and Options
While the official cash-accounting deficit for fiscal-year 2004 (year-ended September 30) widened by 10.0% to $413 billion, the broad GAAP-based deficit (including Social Security, etc.) blew up to $11.1 trillion (96% of GDP) in 2004, triple the 2003 deficit level of $3.7 trillion.
Much of the increase in the broad GAAP-based deficit was due to a set-up charge from booking the 2004 “enhancements” to the Medicare system. Net of the $6.4 trillion one-time increase in net unfunded liabilities, the annual broad deficit was about $4.7 trillion, which still would have been a shortfall with 100% taxation.
——————————————————————–
U.S. Government - Alternate Fiscal Deficit and Debt (Source: US
Treasury; $s Are Either Billions or Trillions, as Indicated)
——————————————————————–
Formal GAAP GAAP GAAP Tot. Federal
Cash- Ex-SS With SS Federal Gross Obliga-
Fiscal Based Etc. Etc. Negative Federal tions
Year Deficit Deficit Deficit Net Worth Debt (GAAP)
——————————————————————–
(Bil) (Bil) (Tril) (Tril) (Tril) (Tril)
—— —— —— —— —— ——
2004 $412.8 $615.6 $11.1* 45.9 $7.4 $47.3
2003 374.8 667.6 3.7 34.8 6.8 36.2
2002 157.8 364.5 1.5 32.1 6.2 32.7
——————————————————————–
*$4.7 trillion, excluding one-time setup costs of the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003
(enacted December 8, 2003).
———————————————————————
Nonetheless, the total numbers reflect something close to true liability. The new Medicare charges show how quickly politicians can make an already impossible situation significantly worse. By adding features to Medicare without setting up full funding for same, the Administration and Congress helped increase the total net present value of unfunded federal government obligations by 31%, from $36.2 trillion to $47.3 trillion in just one year.
In like manner, any “fix” to Social Security, such as raising the retirement age, would result in a one-time change to the unfunded liabilities, but the ongoing annual shortfalls would be affected only minimally. An annual minimum broad GAAP-based deficit of $4.5 to $5.0 trillion appears to be in place.
Wall Street hypesters recently have been touting how the official 2005 federal deficit will narrow from 2004, and the Administration is promising ongoing deficit reductions from the official 2004 level. First, if the economy falls into recession, which it appears to be doing, all such projections are worthless. Second, even if the promised cuts came to pass, after full reductions in an about $4.5-trillion broad GAAP-based deficit, the mere billions saved would still leave the annual deficit rounded to about $4.5 trillion.
The impossibility of the current circumstance working out happily is why lame-duck Federal Reserve Chairman Alan Greenspan has been urging politicians in Washington to come clean on not being able to deliver promised Social Security and Medicare benefits already under obligation. He suggests, correctly, that there is no chance of economic or productivity growth resolving the matter. The funding shortfall projections already encompass optimistic economic assumptions.
The current circumstance also is why the Bush Administration has been pushing for Social Security reform, but the plans discussed do not come close to touching the magnitude of the problem. Most Congressional Democrats will not even admit there is a problem. Indeed, neither side of the aisle is willing even to mention the scope of the actual shortfall or talk about the Medicare problem, which is even worse than Social Security.
If the Administration and Congress were willing to address the unfolding fiscal Armageddon, only two very unpleasant general solutions are available:
* The first solution is draconian spending cuts, particularly in Social Security and Medicare, accompanied by massive tax increases. The needed spending cuts and tax increases are so large as to be political impossibilities.
* In the absence of political action, the second solution is tacit bankruptcy, with the U.S. government facing some form of insolvency within the next decade or so. Shy of Uncle Sam defaulting on debt, the most likely eventual outcome is the Fed massively monetizing the U.S. debt, triggering a hyperinflation. U.S. obligations then would be paid off in a significantly debased and devalued dollar at literally pennies on the hundred dollars.
These alternatives are politically unthinkable and unspeakable for the Administration and Congress, hence the silence. Yet, these same political bodies are responsible for the current circumstance, along with the acquiescence of the financial community and an uninformed or disinterested voting public.
Decades of Deception — Historical Perspective
Misleading accounting used by the U.S. government, both in financial and economic reporting, far exceeds the scope of corporate accounting wrongdoing that keeps making financial headlines. The bad boys of Corporate America, however, still have been subject to significant regulatory oversight and at least the appearance of the application of GAAP accounting to their books. In contrast, the government’s operations and economic reporting have been subject to oversight solely by Congress, America’s only “distinctly native criminal class.”
Nearly four decades ago, President Lyndon Johnson’s political sensitivities led him and the Congress to slough off some of the costs of an escalating Vietnam War through the use of accounting gimmicks. To mask the rapid growth in the federal government’s budget deficit, revenues from the surplus being generated by Social Security taxes were added into the general cash fund, without making any accounting allowance for the accompanying and increasing Social Security liabilities. This accounting-gimmicked reporting was dubbed “unified” budget accounting.
The government’s accounting then, as it is now, was on a cash basis, reflecting cash revenues versus cash expenditures. There were no accruals made for monies owed by or due to the government or to the government’s trust funds at some time in the future.
The bogus accounting understated the actual deficit for decades and even allowed for claims of budget surpluses in the years 1998 to 2001. While there were extensive self-congratulatory comments between the President, Congress and the Fed Chairman, at the time, all involved knew there never were any actual budget surpluses. There has not been an actual balanced budget, let alone a surplus, since before Johnson and his cronies cooked the bookkeeping.
The doctored fiscal reporting complemented the short-term political interests of both major political parties. Additionally, the ignorance and/or complicity of Pollyannaish analysts on Wall Street and in the financial media — eager to discourage negative market activity — helped to keep the fiscal crisis from arousing significant concern among a dumbed-down U.S. populace.
…Dollar, Debt and Hyperinflation
The financial-market counterpart to the federal deficit is federal debt, where gross federal debt was $7.8 trillion as of June 30, 2005. That level was $7.4 trillion at the end of fiscal 2004, of which $4.3 trillion was borrowed from the public and $3.1 trillion was borrowed from the government (i.e. Social Security). Therein lies the problem. There is and will be too much debt from the U.S. government for the financial markets to absorb and remain stable.
The burgeoning deficit means the U.S. government will be increasing its debt level significantly for years to come. Near term, the amount borrowed will increase more rapidly than the markets are expecting, with the economy slowing down and entering recession. The ultimate question is who will lend the money to the U.S. Treasury? The answer is not U.S. investors.
The Federal Reserve’s flow of funds accounts show that foreign investors, both official and private, owned 42.5% of U.S. Treasuries at the end of 2004, up from 18.2% at the end of 1994. In 2004, foreign investors bought 98.5% of new U.S. Treasury issuance. (See “A Look at Foreign Investment Behavior in the Latest Flow-of-Funds Data,” courtesy of Gillespie Research Associates.)
Part of the reason for this relates to another deficit crisis the United States faces on the trade front, where an exploding trade deficit is throwing excess dollars into global circulation. By holding dollars and investing in Treasuries, instead of converting dollars to a local currency, foreign investors have been helping to fund much of the U.S. deficit.
The combination of the rapidly deteriorating trade and budget deficits guarantee this will change. At some point, willingness among foreign investors to hold dollars will evaporate along with the reality that currency losses are more than offsetting any investment gains. When sentiment shifts away from the greenback, not only are foreign investors going to stop buying U.S. Treasuries, but also they likely will dump their holdings of existing Treasuries along with the U.S. dollar. Such actions would lead to a sharp dollar decline, a sharp spike in interest rates and a sharp sell-off in equities. The question, again, is who is going to buy the Treasuries?
With new debt continually hitting the market, eventually the Fed will have to step in to buy the Treasuries — as lender of last resort — effectively monetizing the debt. The more the Fed monetizes, the greater will be the growth in the money supply, the greater will be the weakness in the dollar, the greater will be the rate of inflation.
Where the numbers already are there for this to happen, fiscal pressures will get even worse. Already, the Pension Benefit Guaranty Corporation looks like it needs a federal bailout. As the economy deteriorates, the Congress or the Fed will step in as needed to prevent the collapse of any major financial institution that would threaten the system. Such action, though, will prove fiscally expensive.
The Fed let the banks fail in the 1930s, which helped intensify a decline in the money supply. That in turn was given major credit for deepening the Great Depression. The Fed will try to avoid the mistakes of the 1930s, but, in the process, it likely will end up triggering a hyperinflationary depression.
…Such has been the traditional cure for countries that borrowed so far beyond their means that they ended up with a choice between bankruptcy and hyperinflation. Hyperinflation seems to be the easier political route, although, for the first time, it will involve the world’s primary reserve currency.
In a hyperinflation, the currency very rapidly becomes worthless. In the classic case of the Weimar Republic of the 1920s, a 100,000-Mark note became more valuable as toilet paper than as currency; wheel barrows full of currency were needed to buy a loaf of bread; an expensive bottle of wine one night was worth even more the next morning, empty, as scrap glass. That is the eventual environment the United States faces because of its out-of-control fiscal madness.
For decades, “The deficit doesn’t matter” and “The dollar doesn’t matter” have been guiding principles in Washington. The deficit and the dollar do matter, greatly, as Washington, the U.S. public and the global markets will learn shortly.
A New Gold Standard?
The dollar, as we know it, soon will be history. Dollar inflation has been through a number of cycles since the founding of the Republic, but its current perpetual uptrend — net of some bouncing during the Great Depression — only began once the Federal Reserve was created in 1914. Now, with fiscal policy careening beyond any chance of containment, the Federal Reserve will get to oversee the U.S. currency’s demise.
It is not that the Fed wants to monetize the federal debt and trigger a hyperinflation — the U.S. Central Bank certainly will do its utmost to avoid that outcome — but it will have no politically acceptable alternative. The system otherwise would tend to right itself anyway through the economic shakeout of a hyperinflationary depression. While the Fed might hope to mitigate and to control the disaster, given the Fed’s nature, it is more likely to exacerbate conditions rather than to improve them.
When the dollar loses most of its value, through hyperinflation and/or currency dumping, the global currency system and economy will be in shambles, and a new currency system will have to be established. Those setting up the new system will need to establish its credibility, and there is only one monetary asset that can accomplish that: Gold.
Gold is the only commodity that has held up as a liquid store of wealth over the millennia. The amount of gold used to buy a loaf of bread in Ancient Rome still buys a loaf of bread today. In like manner, the amount of gold that bought a regular haircut for a man in 1914, still buys a similar haircut today. Where the public does not trust today’s politicians and central bankers, it does trust gold.
Whatever structure evolves for the new currency system, it most likely will have gold at its base. That is one reason that central banks rarely have followed through on threatened gold sales in recent years. The threats usually were nothing but jawboning aimed at depressing current market prices. Those countries holding the most gold will have the greatest advantage in any new currency system, and the central bankers know that, including Mr. Greenspan.
Timing of Related Currency and Financial Market Troubles
Central banks, OPEC, corporations and investors, both foreign and domestic — as holders of U.S. dollars — increasingly will sense or realize the greenback is headed for the dumpster. It only is a matter of when, not if.
The dumping of the U.S. dollar and/or U.S. debt by investors likely will hit quickly, with little advance notice. All the official actions that in turn could trigger hyperinflation would follow rapidly, with a full-fledged dollar collapse and developing hyperinflation possibly unfolding in a matter of weeks.
When this will happen is the tough question. It could be years; it could be next week. Without knowing the precise proximal trigger of the shift in sentiment against the U.S. currency, the timing is impossible to call. Nonetheless, some early warning signs may be evident in unusual anti-dollar activity in the currency markets, or in unusually sharp and unexplained spikes in the price of gold.
It would be extraordinarily surprising if the ultimate dollar collapse can be held off a decade, let alone three-to-five years. The pending global financial crisis conceivably could break in the immediate future, triggered possibly by one or more of the following developments: action by China to peg its currency to a basket of currencies instead of the dollar, OPEC pricing oil using a basket of currencies instead of the dollar, a sovereign credit rating downgrade on U.S. Treasuries, a major terrorist act, a very bad monthly trade report, a misstatement by an Administration official or some other event that may appear obvious in retrospect.
The dire financial straights the United States government finds itself in, after decades of bleeding the financial health of the government and the society for the enrichment of a few, helps explain the desperation of the foreign policy of the United States. It is the behavior of someone who is robbing a store to pay off huge gambling debts.
