The Plug Factor

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.

Job Creation Spike: Suspect Numbers

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.

Job Creation Spike: A Drastic Break with the Past

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.

Job Creation Spike: Vicious Circle

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.


Dr. Kurt Richebächer
for The Daily Reckoning
August 18, 2004

More and more, we Americans depend on the kindness of strangers.

The record U.S. trade deficit of June – $54.8 billion – had to be financed by strangers in strange places. Like Japan. And China.

The U.S. federal deficit for June – nearly $70 billion – also had to be financed by someone. Thanks again to strangers in strange places.

Any other country that ran such huge and chronic deficits would be an immediate "sell!" You’d want to get rid of its currency and its bonds as fast as you could. But Americans think their country is special; the rules, principles and constraints that apply to the strangers don’t apply to us, they say – we’re exceptional!

Besides, the strangers seem to think so too. They save; we spend – currently, it takes nearly 80% of the entire world’s available savings just to keep us spending in the style to which we’ve become accustomed. They produce; we consume – nobody does it better. They build factories and production facilities; we build too – houses and shopping malls.

This relationship – between America and strangers, notably the Chinese – is thought to be "symbiotic." It allows both parties to get what they want. Win-win, in other words.

Let’s see…the Chinese get new factories, jobs, wages, profits, technology, assets, savings, capital, know-how. We Americans LOSE jobs, assets, savings, capital, factories, profits and so forth. But we get…hmmm…big-screen TVs, Game Boys, electronic gizmos, toys and everything else you find on the shelves of Wal-Mart. And debt. Lots of debt. $32 trillion last time we looked.

Well, that seems like a pretty good deal to us. What do you think, dear reader?

The foreigners own more and more of what used to be American wealth-producing assets. When Ronald Reagan arrived at the White House, foreign-owned U.S. assets were less than 15% of GDP. Now, they’re over 78%. And they’re growing rapidly. Net purchases of U.S. assets by foreigners rose to $71.8 billion in June, up from $65.2 billion in May. Most of that was in U.S. Treasury bonds. And most of those were purchased by Japan and China.

This puts the U.S. economy – and even its elections – largely in foreign hands. If the Chinese or Japanese should decide to sell Treasurys, for example, it would certainly boost interest rates, pop the housing bubble and likely cost George W. Bush the White House.

Fortunately for us, the foreigners are such nice people.

More news from the newshounds in Baltimore:


Tom Dyson, tucked away behind Lovegrove Alley, in Mount Vernon…

– In 1953, two geologists traveled to Lituya Bay, in Alaska, to survey for oil. They didn’t find any oil, though. Instead, they found evidence of a cataclysmic natural disaster, the likes of which had never before been documented.

– The scientists noticed massive scarring in the trees, some of which grew hundreds of feet from the water. It appeared as if a massive wave, at least 450 feet high, had pummeled the bay’s shoreline.

– It was all pure conjecture until, in 1958, the scientists got the proof they were looking for…an entire cliff collapsed into Lituya Bay, producing a wave a third of a mile in height, higher than any skyscraper on earth.

– "I had 40 fathoms of anchor chain," said Howard Ulrich, who was in a boat when the cliff disintegrated, "and it started running out off the boat – came to the end of the 40 fathoms, just snapped it like a string and then we were free and – but we were still on the front of the wave. We were swept up over the land and up above the trees. That’s where I assumed that we were going to end up."

– Now a British scientist is attacking the government inaction over an infinitely greater threat of the same nature in the Atlantic. "A block of rock approximately twice the volume of the Isle of Man would break off, traveling into the sea at a speed of up to 350 km [220 miles] per hour," claims the Benfield Hazard Research Centre. "The disintegration of the rockundefinedwould produce a debris avalanche deposit extending 60 km [40 miles] from the island. The energy released by the collapse would be equal to the electricity consumption of the entire United States in half a year."

– The island in question is an active volcano called Cumbre Vieja on La Palma, part of the Canary Islands. A large fault runs for 1.3 miles along the western flank of the volcano and would become unstable during an eruption. The 10-foot-wide fissure opened in 1949, when the volcano last erupted. "We found that the relatively small rising temperature in the core of the volcano due to the injection of magma could result in very large changes in water pressures. These water pressures are large enough to produce strength in the flank and result in collapse of the volcano. What this of course means is that the next collapse will ultimately be tied to a future eruption."

– This natural phenomenon is called a mega-tsunami. They are caused when massive volumes of rock slide into a body of water. Scientists are concerned that the greatest mega- tsunami ever imagined could be heading for the East Coast of the United States in the near future.

– "Their [experts at University College London] research suggests the Caribbean and the East Coast of the United States would take the brunt of the devastation," reports the BBC, "but high water could also submerge large parts of the west coast of Britain."

– Wonks in Switzerland created complex models to analyze this phenomenon. Erring on the side of caution, they envisaged an initial wave height of 2,000 feet and a wavelength of 20-28 miles traveling towards America at 450 miles per hour.

– Cumbre Vieja has erupted three times since 1646. No one knows when the next eruption might occur…"Tourists in America and the Canaries shouldn’t cancel their holidays," advises the BBC. "The next summit eruption is unlikely to happen for decades and it may take many more eruptions before the flank of the volcano is pushed into the Atlantic. The problem is scientists cannot tell."

– Here at The Daily Reckoning, we don’t plan to take any immediate action…and we won’t be canceling our holidays to the Canaries. As regular readers already know, we’re more focused on the mega-tsunami heading for Wall Street.

– No sign of any financial tsunami yesterday – stocks continued to bounce. The Dow added 18 points, closing in on the 10,000 mark again. By the bell, it had reached 9,973. The Nasdaq gained too; it added 0.7% or 12 points, closing at 1,795. Gold liked the news that the CPI fell by 0.1% in July and took the opportunity to put some daylight between itself and the $400 mark. It gained $1.50 to $404.50.

– If we do get wind of an eruption on La Palma, we may have to reassess our situation here in Baltimore. But rest assured – readers will continue to receive The Daily Reckoning regardless. And one more thing – we would politely ask readers to refrain from telling bin Laden about the fissure…


Bill Bonner, back in Paris…

We’re back in France…but still ruminating on our long trip through North America. We began on the east coast of Canada and finished on Canada’s west coast, after looping through southern USA.

What did we learn from our trip?

The raw country is stunning. Magnificent. Beautiful. And mostly empty.

There, Americans have built a style of life that is alternately trashy and refined…exuberant and dull…appealing and incomprehensible.

We never understood why anyone would want to stop at Hog’s Restaurant (with a picture of a pig on the advertisement) in Aztec, New Mexico, for example. Nor why anyone would want to live in the typical American suburb. Nor how Americans could work so hard and have too little to show for it; they get poorer each year. They have a standard of living that few people in the world can afford – not even Americans themselves.

Americans are "a decent people caught up in an indecent conceit," we quote ourselves, finding no better reference.

They believe they are not subject to the ordinary laws of economics…or fair play. If any other country tried to spend so much, or live so far above its means, we would say it was headed for trouble. Americans forgive themselves; for they believe that they are blessed by such good fortune that they will never have to pay their debts.

Or imagine that Germany decided that "regime change" was what South Africa needed? Or that Morocco decided to attack Tunisia on the pretext that the Tunisians were up to something? We would find it unforgivably arrogant and unpardonably aggressive.

Yet we Americans pardon our own aggression, as well as our own extravagance. We are the guardians of the world’s peace, we believe, and are endowed by our Creator with some special duty to spend the world’s money as well as tell others what to do.

"For the first time in human history," wrote Michael A. Ledeen, "a singularly diverse people has been given the chance to experiment with a new kind of society, inhabited by a new kind of man, driven by a new kind of ethos…

"No longer impeded by our youthful weakness, we can continue our national mission beyond the boundaries of our national frontier…There is no one to stop us except ourselves."

We are surely up to the job.

*** "I came here after the war," said an old man we met in Los Angeles. "It was great. But it was different then. You could drive down the freeways at 50 mph. Now they’re all clogged up with cars.

"America was the land of opportunity. Well, maybe it still is the land of opportunity. I’m not sure. But if I were a young man again, I think I’d go to Russia or Brazil. They’re wide open."

*** "Even in difficult conditions, there are opportunities to make money [in Asia]," writes old friend Martin Spring:

Real estate "is a no-brainer." Tens of millions of people are moving from the rural areas to the cities every year, creating enormous demand for housing. What’s more, unlike in the manufacturing sectors, there is in other Asian countries no competition from China. In India, in particular, the property market is very underdeveloped, so there are "huge opportunities."

Tourism is Asia’s most promising growth industry. As the middle classes burgeon and become richer, they have the time and resources for leisure activities. Over the past five years, the number of Chinese holidaying abroad has doubled to 16 million. Marc Faber foresees up to 100 million Chinese visiting other Asian countries.

Commodities. When you have a nation that is industrializing rapidly, the need for natural resources explodes. China’s steel industry is already larger than those of Japan and America combined, while its share of the world’s copper demand has soared from 6-27% over a decade.

Asia’s oil consumption is likely to double, from 20 to 40 million barrels a day, over the next 10 years. That extra demand is equivalent to two-and-a-half Saudi Arabias.

Rising living standards will also generate exploding demand for food imports, especially from China, where agricultural production is declining. As an example of the potential, Faber says, Taiwan consumes 81 kg (180 lbs) of meat per person each year, compared to China’s 15 kg (35 lbs).

Services. The middle-class explosion will also generate fast-growing demand throughout developing Asia for financial services, advertising, distribution, health and personal care services, entertainment and media.

Local business giants will emerge to challenge the existing multinationals, just as happened in Japan during its "miracle" years and has been happening more recently in Korea.

This is not necessarily the right time to rush in, as the U.S. central bank has created a colossal worldwide bubble in Asia as much as elsewhere, and it’s conceivable that this bubble will burst this year or the next.

However, that should not undermine the long-term case for investing in Asian themes.

American growth has been driven by consumption, which has been artificially high because of the transitory phenomenon of cheap, abundant credit instead of growth in employment and earnings.

By contrast, Asian growth is being driven by industrialization and related development in China and India as dramatic as the transformation of the United States in the 19th century from a small colonial economy of 4 million people to the world’s largest economic power."

The Daily Reckoning