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...
THE PLUG FACTOR
by Dr. Kurt Richeb�cher
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,
Dr. Kurt Richeb�cher
for The Daily Reckoning
This essay was adapted from an article in the August
edition of:
The Richeb�cher Letter.
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