WASHINGTON, Dec. 10 (UPI) -- The Federal Open Market Committee's decision Tuesday to keep the federal funds rate at 1 percent is symptomatic of the Fed's current problem with prices: it's looking in the wrong direction, worrying about deflation, not inflation. The Bureau of Economic Analysis' long-awaited revision of economic data to 2002 also tells us much about where we've been. Conclusion: they're right, it's not currently 1929. But it is 1973!
"The probability of an unwelcome fall in inflation has diminished in recent months, and now appears almost equal to that of a rise in inflation," said the official statement from the FOMC meeting. Almost equal is an interesting view -- with gold up 60 percent from its low at $406.60 per ounce at Wednesday's close, the market appears to be taking the view that inflation is very much more likely than deflation. Other commodities, too have risen sharply during 2003 while even the oil price, which was expected to drop following the partial return of Iraq production, has remained close to the levels prevailing before the Iraq war. In this context, a sharp drop in U.S. crude oil supplies to 275.7 million barrels, reported Wednesday morning, is a further indicator that the era of cheap oil is not about to return soon.
Of course, the decline in the U.S. dollar, to a level where the euro sold for more than $1.22 Wednesday, is part of the reason for the rise in commodity prices. The law of supply and demand operates for commodities worldwide, so that a decline in the dollar against the euro, ceteris paribus, is likely to raise the dollar price of a commodity and equivalently depress the euro price. When the euro was around $0.84, in early 2002, and oil was around $20 per barrel, its euro price was 24 euros. Today, with the euro at $1.22 and oil around $32 per barrel, its price in euros is just 26.20, a rise of less than 10 percent.
Nevertheless, taking a trade-weighted average of the oil price in dollars, euros, yen and the currencies of the other major consuming countries, oil is up around 30 percent since mid 2002, and other commodities are up an equivalent amount.
Part of the reason for this of course is world economic recovery. China is growing at almost 10 percent per annum, and sucking in raw materials, particularly oil, as it does so. Japan is enjoying its first sustained economic upturn since 1990, and importing commodities accordingly. India, too, enjoyed an excellent harvest in 2003 and is also an importer of oil and perhaps most notably gold, still considered the primary store of value in rural India. The United States economy appears at first sight to have made a remarkable turnaround from its depressed state early in the year. Demand for commodities is thus sharply up from its level of a year ago, and indeed even higher than at the U.S. and European economic peak of 1999, at which time the major Asian economies were depressed.
The overall unhealthiness of this position, at least in the United States, is demonstrated by the Bureau of Economic Analysis' revised gross domestic product data for the years to 2002. This is very difficult to interpret, because the BEA has made so many changes to the basis on which figures are calculated that it is impossible for analysts to determine the true picture. For example, a "statistical adjustment," modest in the late 1990s, balloons to $80 billion in 2001 and $120 billion in 2002, and, if deducted would wipe out the modest economic growth of 2001 and approximately halve that of 2002.
Even if we take the BEA's figures at face value, economic growth in 2002 has been revised down significantly from the figure first announced, and the recession has been significantly prolonged, with the first quarter of negative GDP growth having occurred as early as the third quarter of 2000. The size of the revisions produced by the BEA is indeed shown by that quarter; the figure initially announced for its growth, in October 2000, on which market reaction was based, was a sturdy 2.7 percent. A figure that is initially announced at 2.7 percent and finally (?) revised to MINUS 0.5 percent is needless to say NOT particularly useful in making coherent investment decisions. The third quarter 2003 growth, so loudly trumpeted by the administration at 8.2 percent, may similarly be revised down; indeed, it is likely to be so, since it is notable in the BEA's current revisions that it is the quarters of exuberant growth, such as the first quarter of 2002, that disappear when the arithmetic is done properly.
A definitive picture of the U.S. economy will become clearer Jan. 7, when the Bureau of Labor Statistics announces updated figures for 2002 productivity growth. Currently, the stock market and Fed Chairman Alan Greenspan believe that the U.S. is undergoing a "productivity miracle" in which output per labor manhour is rising considerably faster than has been common throughout U.S. history. The "miracle" for 1995-2001 was exploded by figures announced in August 2002 (and, for multifactor productivity, March 2003.) However, the Fed and market bulls are currently claiming that, after a dip with the recession in 2000-2001, productivity has risen very sharply since 2001, so that current stock market valuations are justified and the danger of inflation is minimal. We shall see in January, and in March with the publication of multifactor productivity data.
One particular noteworthy feature of today's GDP revisions is their downward revision to the U.S. savings rate. Over time, the downtrend in this is quite remarkable. Personal saving, $366 billion of a current-price personal income of $5,362 billion in 1992, had declined by 2001 to $127 billion of a personal income of $8,713 billion, before recovering somewhat to $183 billion of $8,910 billion in 2002. The savings rate declined from 7.7 percent of personal income to 1.7 percent, before recovering marginally to 2.3 percent.
Previous figures had shown a much higher savings rate, in the 3.5-4 percent range, in 2002, so this further downward revision in the savings rate is highly significant. It suggests that consumption, held up for so long in 2002-2003 by the proceeds from home mortgage refinancing, may be about to drop sharply, as American consumers run out of credit card capacity and attempt to rebuild their financial position.
Certainly the volume of refinancing, down again by 15.5 percent in the week to December 5, and now 82 percent below its May 2003 peak, is no longer sufficient to sustain current levels of spending. It is likely that retail sales for Christmas 2003 will surprise on the downside, with the outlook for 2004 being gloomier yet.
There is another period in U.S. history when retail sales dropped sharply, while commodity prices soared, and the dollar weakened; it is not 1929 but 1973. In the years following 1973, the U.S. went through quite a severe recession, accompanied by very substantial inflation, a sharp decline in productivity, a collapse in inflation-adjusted terms in the stock market, a rise in unemployment that did not begin to reverse for a decade and a sharp retraction in U.S. power and influence worldwide.
If 2003 looked like 1973, then 2004 must have every likelihood of looking like 1974. Adjust your strategies accordingly.
