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Recession deepens despite spin
In our last update, we discussed the ways in which the current recession (let's call a spade a spade, even if the government insists on calling it a diamond) is likely to be longer and deeper than administration officials and the mainstream media are ready to admit. In large part, as we said, this recession is being driven by the alarming disappearance of the American consumer. Much government data has been published over the last month that would seem to deny that we're in a recession at all, and much of it—like the official GDP, unemployment, and inflation figures—is rather suspect, as we'll discuss below. One report that rings true, however, is about consumer sentiment. The U.S. consumer sentiment index declined to 62.6 in April—the lowest level in 26 years—from 69.5 in March, according to the latest gauge compiled by the University of Michigan/Reuters. Economists were looking for an April result of 63.0, so it was even lower than expected and signals even greater economic weakness ahead.
"The recent acceleration in the loss in confidence indicates a longer and potentially deeper recession," according to Richard Curtin, survey director. "All households now anticipate smaller income gains and larger price increases, as just one-in-five now expect their overall finances to improve during the year ahead, the least favorable reading in more than a quarter century." (See full story.)
Tight or nonexistent credit, declining employment, and, most of all, skyrocketing (if largely unreported) inflation have combined to create an extremely chilly atmosphere for spending. And since consumer spending accounts for more than 70% of GDP, we can expect the economy to shrink further before it starts to expand. Certainly, the credit crisis is far from over. Banks continue to shut down their lending in response both to rising risks of default and to the pressures to rebuild their capital base. The Fed has flooded the banks with up to $462 billion in liquidity, in addition to the nearly unlimited funds available through the discount window and the primary credit dealer facility. It has badgered banks to resume lending to their best customers, but to almost no avail.
With reduced consumer sentiment eating into retail sales and substantially tighter credit constraining individuals and businesses, the recession is far from over. These are just a couple of reasons why the official Gross Domestic Product report released earlier this month doesn’t accurately reflect the lived experience of most Americans, who are definitely feeling recessionary pain. According to Bureau of Economic Analysis figures, GDP increased at a 0.6% annualized rate in the first quarter of 2008 after a 0.6% gain in the fourth quarter of 2007.
That's growth at a snail's pace, but does it mean recession? The government wants us to believe it doesn't. The calculation of GDP, however, is more or less an accounting gimmick and not an accurate reflection of economic reality. It includes inventory stockpiling and export growth, things that don't really increase the living standards of Americans. It also includes defense spending, which aids on paper a very limited economic sector at the cost, today, of ballooning deficits that will damage us tomorrow; and it factors in an artificially low inflation rate, which we'll discuss in a minute. So, for the first quarter, almost all of the reported expansion in GDP came from inventory growth and exports, with very little increase in either the amount of money individuals or companies earned, or in the things American households and businesses bought.
Because some people use the old rule of thumb that a recession is defined as two consecutive quarters of declining GDP, nudging the number into positive territory gives the administration technical bragging rights that a recession has been avoided. Yet the margin of error in GDP calculation is plus or minus 3%, which renders moot that bit of spin. The average person judges a recession mainly on employment. If jobs are available, then the economy is holding up. If jobs are scarce, the economy is poor. By that standard, the economy is really struggling, with payrolls down in each of the first four months of the year. But the headline figures, again, don’t reflect the lived reality of Americans. At 5.0% in April, down from 5.1% in March, the current BLS unemployment rate is relatively low by historical standards. Yet the number of jobless Americans of prime working age, that is, men aged 24 to 54, is historically high at 13.1%. Most of these people don't qualify as unemployed but they are nonetheless out of work.
Why don’t these would-be workers show up in the headline statistics? Mainly because the government's definition of the unemployed includes only people who do not have a job, have actively looked for work in the four weeks preceding the survey, and are currently available for work. But it excludes the self-employed, 1099 workers who can't get enough contracts, those working part-time or on commission only, and the under-employed (like real estate agents waiting tables or mortgage brokers bagging groceries). It also doesn't count those who've given up looking for work altogether—a category known as "discouraged workers," defined as persons not currently looking for work specifically because they believe there aren't any jobs available for them. Some analysts say this particular group of jobless Americans—who believe their prospects for finding a job are getting ever dimmer, yet who don't figure in the computation of the unemployment rate—represent the nation's dire job situation. According to John Williams' Shadow Government Statistics, the primary source for unbiased economic data, if adjusted for "discouraged workers," the actual unemployment figure for April rose to 13.1%, up from 13.0% in March. Now that's recessionary!
Inflation genie out of the bottle
Of all the incredible statistics fed to Americans recently, perhaps the most patently absurd—and the most dangerous to our future financial wellbeing—are about inflation. Until recently, inflation has not been much of an issue in U.S. policy, but that's about to change. The Fed is increasingly concerned with the uptrend in prices, especially food and energy, while the U.S. economy is slowing down. In the 1970s, we called this curse stagflation and it is back. Some of the inflationary pressure comes from abroad. For over a decade, we imported price deflation primarily from China and India in the form of cheap labor, goods, and services. Today, that very same pool of cheap labor has earning power and new money to spend, and is competing for the same goods and services we are. Growing demand in India and China, in particular, is creating strong upward price pressure on commodities, food, and natural resources. So, the cheap labor in China and India that kept prices low for so long is now having the opposite, inflationary effect.
There are 2.4 billion Chinese and Indians combined, totaling eight times the U.S. population. They're hungry, increasingly mobile, earning their way out of poverty for the first time, and helping to strain supplies of the world’s finite commodities. Pair this with global money supplies that have been gushing with new paper and you get a recipe wherein more paper chases after fewer available goods. It's no wonder prices for everything we need to consume on a daily basis are suddenly rising. This situation has been building for several years and now it's arrived in earnest. Since May of 2007, just one year ago, prices for daily necessities have jumped dramatically.
Changes in world prices since May 2007, according to Time Magazine:
Oil – up 89%
Meat – up 12%
Dairy – up 24%
Cereals – up 89%
Oils and fats – up 77%
Sugar – up 40%
With these fundamental necessities skyrocketing in price around the world, we have to ask, how can the official U.S. measurements of inflation be so benign? The answer, of course, is they cannot. According to the most recent Consumer Price Index report, April year-over-year inflation was running at 3.94%, down from 3.98% in March. While these figures are alarmingly high, and certainly higher than the Fed's target rate of around 2.2%, they are nowhere near the real figures. John Williams argues convincingly that CPI measurements have been systematically understated since the early 1990s in order to reduce the burden placed by entitlements, such as social security, on the federal the budget and bring the deficit under control. Behind this movement were financial luminaries Michael Boskin, then chief economist to the first Bush Administration, and Alan Greenspan. According to Williams:
"The Boskin/Greenspan argument was that when steak got too expensive, the consumer would substitute hamburger for the steak, and that the inflation measure should reflect the costs tied to buying hamburger versus steak, instead of steak versus steak. Of course, replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that" (The Consumer Price Index).
As one of the original architects of the CPI, Williams is in a position to know how it has morphed from its original structure, and his illuminating website tracks it and many other government statistics according to their original measures. If we return to the pre-Clinton standards of measuring CPI, Williams says, the alternative calculations show April inflation running at roughly 11.5%, versus 11.6% in March! That means the difference between reported inflation and "real" inflation is around 7.6%!
These numbers are alarming but they make a lot more sense to real people, especially when the IMF says food prices rose 43% last year while the BLS says U.S. food costs were up only 5.1%. Gasoline prices rose 5.6% in April, according to BLS numbers, and 20.9% compared to a year ago. But the seasonally-adjusted gasoline prices used in calculating the official headline CPI number supposedly declined by 2.0% for the month. Of course, the financial media and markets concentrate on the seasonally-adjusted aggregate series, which minimized energy inflation thanks to this reported weakness in gasoline.
Increasingly, the mainstream media is waking up to the unreality of official inflation numbers. USA Today ran a story about the CPI with the revealing headline, "Inflation May Be Worse than Consumer Price Index Shows," citing this comment from the Wachovia Economics Group on the seasonally adjusted drop in the price of gasoline: "The drop makes absolutely no sense. Where does the BLS buy their gas?" (See full story.) And the L.A. Times cited the assertion from Scott Anderson, senior economist with Wells Fargo & Co., that the data released by the Labor Department "weren't worth the paper they were printed on." (See full story.) We think he has a point! And as reported by MarketWatch's Paul B. Farrell earlier this week, Harper's Magazine recently publish an article by Kevin Phillips entitled: "Numbers Racket: Why the Economy is Worse than We Know." A former Republican strategist for Nixon, and today one of America's leading political historians, Phillips states: "Based on the criteria in place a quarter century ago, today's U.S. unemployment rate is somewhere between 9% and 12%; the inflation rate is as high as 7% or even 10%; economics growth since the recession of 2001 has been mediocre, despite the surge in wealth and incomes of the superrich, and we are falling back into recession." (See full story.)
So the chickens are starting to come home to roost, the roosters in the media are finally starting to crow about it, and gold will be the primary beneficiary. The questions now are whether the dollar will rally from its all-time lows, and whether precious metals and oil will slump with a rising dollar, as we would normally expect. We believe the answers are no. In the short run, we may see oil and precious metals fall with a rebounding dollar; but the dollar can only rebound so far, even behind future rate increases, until the fundamental financial imbalances—budget deficits, massive debt, trade imbalances, and unreported inflation—in the U.S. economy are dealt with, and that will take years.
Instead, we expect the gold market to enter a powerful new phase driven by the mega-inflation that is already rampant, if unreported, in our economy. We believe we are on the cusp of this transition now. And those of you who remember what happened to gold during the 1978 to 1980 period of super-high inflation will understand how explosive this part of the bull market in precious metals can become. The lull we are experiencing now may be the last one before prices break sharply higher into a full-blown, inflation-driven bull market that could easily propel the gold price into the $1,500 to $2,000 range, if not higher. We urge you to stock up now while prices are still low.
As always, thanks for you time!
Sincerely,
Dana Samuelson, President
Dr. Bill Musgrave, Vice President
