 The Plug Factor
Dr. Kurt Richebächer
The
Daily Reckoning
August 23, 2004
The Daily Reckoning PRESENTS : The Good Doctor takes issue with
the "plug factor," a statistical adjustment used to
capture small-business job creation overlooked by the BLS's standard
surveys. Until 2000, it was set at 35,000 per month. Now the
plug factor regularly reaches 300,000...
At first look, the May consumer
income and outlays numbers - which we were eagerly awaiting last
month - appear excellent: Incomes are up 0.6%, and spending is
up even a full percentage point. At second look, after adjustment
for inflation, the reality is pretty ugly.
The increase in disposable
income melts to less than 0.1% in real terms, and that of spending
to 0.4%, of which well over half came from the burst in motor
vehicle promotion. Spending on nondurable goods has been flat
for two months. The whole of the extra increase accrued from
a blip in spending on services.
Amazingly, this sharp slowdown
in consumer spending, though lasting for half a year, has been
met with flat denial all around. During the five months to May,
it was up in real terms by $78 billion, or $186 billion annualized.
This is less than half of the consumer spending growth in the
second half of last year - $376 billion annualized. Meanwhile,
we know that June was another horrible month for consumer spending.
One important reason for the
general indifference to this drastic reversal in consumer spending
was apparently the fabulous job figures for the three months
March-May that the Bureau of Labor Statistics (BLS) miraculously
pulled out of the hat, reporting almost 1 million new jobs during
these three months.
It shocked us to see how readily
and uncritically research institutions, economists and media
around the world accepted these numbers at face value, even though
they came like a bolt from the blue in the face of otherwise
rather mixed economic data. For the few who wanted to see, these
numbers were bluntly suspect.
It turned out that virtually
two-thirds of the new jobs had come not from the survey, but
from a new computer model. For decades, the BLS has aimed at
small businesses when measuring job creation in times of recovery,
especially those not captured by its established monthly survey.
Until 2000, this statistical adjustment was fixed at 35,000 each
month, called the "plug factor."
The recent sudden jump in these
figures towards 300,000 each month results from a computer model
based on a calculated "net birth/death adjustment,"
which is supposed to measure how many jobs small firms have created
and shuttered. In this way, the former monthly 35,000 figure
exploded into numbers that are almost 10 times greater.
For us, the sudden statistical
spike in job creation during March-May was massively out of whack
with prior numbers and other concurrent economic data to be credible.
Then came June: 112,000 new jobs created, less than half the
expected number. We never saw it mentioned that the net birth/death
adjustment contributed 182,000 to this disappointing increase.
Without it, employment would have fallen 70,000.
What all this means for the
U.S. economy's prospects should be clear: The suddenly strong
support from job and income growth looks very much like a mirage.
To the contrary, sharply slower consumer spending is essentially
exerting the opposite effect of depressing income growth.
What, then, induced the American
consumer to his sudden retrenchment in spending in the first
quarter? Partly due to lower taxes, his nominal disposable income
grew during the quarter by $171.7 billion. Yet he raised his
spending by only $119 billion, putting fully $52.7 billion of
his higher earnings into savings. That was definitely a drastic
break with his past spending mania.
The salient point here is that
the retrenchment was plainly not forced by tight money or credit.
Oddly, consumer borrowing set a new record at the same time with
an increase by $1,008.2 billion at annual rate, after "only"
$659.9 billion in the prior fourth quarter of 2003. We have a
hard time making sense of this mixture of income growth, savings
growth and record borrowing.
The answer probably lies largely
in the fact that the "average" private household is
a statistical fiction. The other day we read that nearly a quarter
of households have to spend 40% of their current income on debt
service, as against 14% on average. On the other hand, there
are, of course, many households with net income from assets after
debt service. Higher bond yields and loan rates speak, in any
case, for sharply lower borrowing in the future.
In April, an increase in nominal
disposable household income by $52.3 billion compared with an
increase in their spending by a mere $16.3 billion. In real terms,
spending even declined slightly. No less than $36 billion went
into savings. Due to the huge promotions and rebates by the automakers,
spending in May was drastically distorted. Purchases of durable
goods were up $17.8 billion, accounting for 54% of the total
increase. News about auto sales since then has been disastrous.
Glancing over the figures for
real personal consumption expenditures, it strikes the eye that
the sudden spending weakness has gripped all sectors of consumption,
services and non-durable goods, as well as durable goods.
As mentioned earlier, lesser
consumer spending essentially means lesser income growth. If
allowed to develop, it implicitly turns into a vicious circle
where lower and lower spending leads to lower and lower incomes.
One has to wonder what Mr. Greenspan can come up with next. In
2001, he had more than 500 basis points of interest rate cuts
at his disposal to fight the economy's downturn, led by plunging
business investment.
Our view has always been clear
and unambiguous. Ultra-cheap and loose money together with fiscal
priming of unprecedented scale have provided a tremendous stimulus
to consumer spending in the United States. For the bullish consensus,
this policy stance has been most successful, as measured by recent
real GDP growth of 4% and higher at annual rates.
For us, this is a much too
simplistic and superficial a view. Lost in the celebrations are
the long-term costs of this recovery as manifested in the form
of ever-mounting structural imbalances - namely record trade
gaps, record levels of financial leveraging, record levels of
personal indebtedness, a record-high budget deficit and rock-bottom
national savings.
For any reasonable person,
it ought to be clear that this cannot be the road to healthy
economic growth.
Regards,
Kurt Richebächer
for The
Daily Reckoning
TDR note: Former Fed Chairman
Paul Volcker once said: "Sometimes I think that the job
of central bankers is to prove Kurt Richebächer wrong."
A regular contributor to The Wall Street Journal, Strategic Investment
and several other respected financial publications, Dr. Richebächer's
insightful analysis stems from the Austrian School of economics.
France's Le Figaro magazine has done a feature story on him as
"the man who predicted the Asian crisis."
This essay was adapted from
an article in the August edition of The
Richebächer Letter.
321gold
Inc Miami USA
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