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<TR><TD ALIGN=left><FONT FACE="Arial, Helvetica" SIZE=4><B><A HREF="july98_rates.stm">Prospective Fed Policy</A></B></FONT></TD>
<TD ALIGN=center><FONT FACE="Arial, Helvetica" SIZE=4><B><A HREF="july98_outlook.stm">Executive Summary</A></B></FONT></TD>
<TD ALIGN=right><FONT FACE="Arial, Helvetica" SIZE=4><B><A HREF="archive/archives.asp">Archives</A></B></FONT></TD></TR>
<TR><TD COLSPAN=3> <BR><H2><TABLE WIDTH=100%><TR BGCOLOR="#000060"><TD><FONT FACE="Verdana,Arial" COLOR="#FFFFFF" SIZE=2><B>July U.S. Economy: Economic Performance</B></TD></TR></TABLE></H2>
<I>Analysis by <A HREF="/thoughts/archive/bios.asp?Author=Gary+Ciminero">Gary L. Ciminero</A>, Independent Economic Advisory<BR>
Posted July 20, 1998 </I><P>
<P>
<P>Evidence of the past month shows the mid-year economy stricken by two new furies and an angrier old one. Their combined impact may even briefly halt the economy in its tracks. The new furies include the sudden onset of an acute correction of bloated <A HREF="/economy/releases/inventories.asp">inventories</A> and the prolonged and spreading strike at <A HREF="gm.stm">General Motors</A>. The third fury, a hemorrhaging <A HREF="/economy/releases/trade.asp">trade deficit</A>, results from the ongoing economic typhoon in <A HREF="asia_summary.stm">Asia</A> that contributed to an outright collapse in our <A HREF="/economy/releases/trade.asp">foreign trade</A> accounts in May.
<P>In short, latest events cause us to alter my forecast that has long foreseen markedly slower growth, contained <A HREF="/economy/releases/cpi.asp">inflation</A>, and eventual <A HREF="/economy/releases/fomc_meeting.asp">Fed</A> ease. While the updated forecast affirms my prior position, it sharpens and speeds up its negative aspects, moving me even further away from the consensus outlook.
<P>The Indepenent Economic Advisory has long assumed an inventory correction would curtail economic growth. What has changed is the suddenness and force with which it has struck. Exacerbating the inventory situation are the rippling harmful effects of a prolonged <A HREF="gm.stm">GM</A> strike.
<P>Evidence for an immediate inventory correction came from two releases of the past month: revised <A HREF="/economy/releases/gdp.asp">GDP</A> for the first quarter and May business <A HREF="/economy/releases/inventories.asp">inventories</A>. The first evidence was the late-June revision of first quarter <A HREF="/economy/releases/gdp.asp">GDP</A> that increased real growth from 4.8% to 5.4%. But this upward revision to last quarter's <A HREF="/economy/releases/gdp.asp">GDP</A> rang hollow, since much of it was due to an even worse pile-up of <A HREF="/economy/releases/inventories.asp">inventories</A>, the correction of which will drag down <A HREF="/economy/releases/gdp.asp">GDP</A> growth: inventory investment alone accounted for about 2 percentage points of last quarter's 5.4% growth pace.
<P>The second piece of evidence of inventory troubles came with this week's news that business <A HREF="/economy/releases/inventories.asp">inventories</A> actually declined in May. This marked both the first monthly retreat in nearly two years and the onset of the awaited inventory correction. Led downward by a big 1% plunge in retail stocks, total business <A HREF="/economy/releases/inventories.asp">inventories</A> fell 0.1%. This followed a string of big monthly rises that had persisted into the first quarter.
<P>I look for this inventory correction to play out through next quarter, adding to the drag on <A HREF="/economy/releases/gdp.asp">GDP</A> growth ahead.
<P>Besides, the <A HREF="gm.stm">GM</A> strike also began to show up in June statistics, affecting the National Association of Purchasing Management <A HREF="/economy/releases/napm.asp">(NAPM)</A> index, industrial production, and employment. Last month's <A HREF="/economy/releases/napm.asp">NAPM</A> index recorded the first monthly decline in over two years. (See the <A HREF="july98_outlook.stm">graph</A> on page 1.) Dropping below the critical 50 mark, the index implied that manufacturing activity began to fall last month.
<P>Blameworthy were the deepening declines in <A HREF="/economy/releases/trade.asp">export</A> orders, as collapsed Asian demand reduced the export index for the sixth consecutive month (see <A HREF="july98_outlook.stm">graph</A>). Also to blame were further inventory liquidations, falling domestic order backlogs and factory <A HREF="/economy/releases/employ.asp">employment</A>, and stalled production.
<P>According to latest industrial production data, not only did output stall last month, it outright crashed. With widespread declines in May <A HREF="/economy/releases/factory.asp">factory orders</A> that are under severe import competition, production in June followed suit, its steep 0.6% fall the worse in over five years.
<P>Sure, the <A HREF="gm.stm">GM</A> strike was partly the cause: auto production fell 11% last month. But declining production was evident far beyond autos.
<P>Besides, the big production decline eliminated any remaining inflationary thrust coming from the industrial sector: falling production cut <A HREF="/economy/releases/industry.asp">capacity</A> use to just 81.6%, lowest in 4-1/2 years. The reduced level of capacity use undercuts pricing power, a factor underscored in the June <A HREF="/economy/releases/napm.asp">NAPM</A> price index that registered falling prices for the sixth consecutive month.
<P>Turning to employment trends, though June <A HREF="/economy/releases/employ.asp">payrolls</A> still expanded by a healthy 205,000 jobs, yet the <A HREF="gm.stm">GM</A> work stoppage had just gotten underway, subtracting only 9,400 strikers from the total. Nevertheless, the depredations of the <A HREF="/economy/releases/trade.asp">trade</A> deficit dragged down employment elsewhere in manufacturing, where total factory <A HREF="/economy/releases/employ.asp">jobs</A> fell 29,000 last month.
<P>Exacerbating the drag of our tumbling foreign <A HREF="/economy/releases/trade.asp">trade</A> accounts, the ongoing strike has the potential to idle a quarter-million <A HREF="gm.stm">GM</A> workers this month. And its ripple effects could reduce employment and output in the auto parts/supply sectors into September, assuming a settlement is delayed beyond next month. Accordingly, as the <A HREF="gm.stm">GM</A> strike thrusts its way into employment statistics this month and next, I expect much bigger declines in factory jobs are in the offing. This will at once undercut economic growth this quarter even as it reduces wage pressures in the labor market.
<P>Even the "Superman Consumer" seems lulled by the hot summer weather. Not that <A HREF="/economy/releases/consumer.asp">confidence</A> levels or house-buying ardor have slipped--consumer <A HREF="/economy/releases/consumer.asp">confidence</A> hit a 29-year high last month and <A HREF="/economy/releases/housing.asp">home construction</A> and <A HREF="/economy/releases/existhome.asp">sales</A> continued quite strong through latest (May) statistics.
<P>But June <A HREF="/economy/releases/retail.asp">retail sales</A> paused with a scant rise, as both the auto and nonauto components each rose just 0.1%. It is unlikely that this portends a static consumer pattern ahead since it comes after very big gains the month before: May auto sales leaped 2.5% and nonauto stores recorded a 0.9% rise.
<P>Yet, the suddenly slack consumer trend bears watching since strength in consumption is one of the economy's only supporting sectors, now that an inventory correction, strike, and slumping foreign <A HREF="/economy/releases/trade.asp">trade</A> are simultaneously braking the economic growth.
<P>Finally, and most bleakly, today's release of May foreign <A HREF="/economy/releases/trade.asp">trade</A> accounts signaled a severe and ongoing slide, as our <A HREF="/economy/releases/trade.asp">trade</A> deficit hit another record high of $15.75 billion including goods and services. In goods alone, May registered a disastrous $21.55 billion deficit. This reflects both the fallout of the soaring dollar and the worsening Asian crisis. These forces combine to harm our <A HREF="/economy/releases/trade.asp">trade</A> accounts with fallen export demand and intense import competition from the soaring dollar.
<P>And as bad as it was, the May nominal deficit understates the true harm done to our economy in real terms since the rising dollar masks the rise in real imports. For in real terms, our foreign <A HREF="/economy/releases/trade.asp">trade</A> accounts are veritably collapsing, with worse yet to come: May's nominal deficit of $21.55 billion translates into a record real deficit of $29.56 billion (in 1992 dollars).
<P>Accordingly, with two months in, I now estimate that last quarter's real goods deficit is running at an annual rate of $345 billion, or nearly $70 billion worse than the first quarter and some $44 billion worse than I had been estimating for last quarter.
<P>Accounting for this deeper plunge in the goods deficit in May, atop a worse inventory cycle, means that <A HREF="/economy/releases/gdp.asp">GDP</A> likely recorded no growth at all last quarter. (Second quarter <A HREF="/economy/releases/gdp.asp">GDP</A> data is due out next week, together with a three-year revision of prior <A HREF="/economy/releases/gdp.asp">GDP</A> statistics.)
<P>Besides, the current quarter will suffer from a further plunge in the <A HREF="/economy/releases/trade.asp">trade</A> sector. In the face of no recovery in the inventory cycle, the deepening <A HREF="/economy/releases/trade.asp">trade</A> deficit will curtail <A HREF="/economy/releases/gdp.asp">GDP</A> growth to about 1.5% for the rest of the year, assuming the consumer and housing sectors hold up.
<P>Turning to <A HREF="/economy/releases/employ.asp">unemployment</A> and recent wage trends, June recorded an increase in the <A HREF="/economy/releases/employ.asp">unemployment rate</A>, from May's 4.3% rate to 4.5%, even as hourly wages stagnated for the month, steadying the twelve-month rise to just 4.1%.
<P>Besides, the good news on wage inflation continues to ally with the strong dollar, beckoning continued low inflation in overall <A HREF="/economy/releases/employ.asp">price indices</A>.
<P>The strong dollar pushed down <A HREF="/economy/releases/impex.asp">import prices</A> for the eighth consecutive month in June, to a level 5.6% below June 1997. As I anticipated in last month's <A HREF="june98_performance.stm">Indepenent Economic Advisory</A>, the soaring dollar frustrated recent OPEC attempts to increase crude oil prices. Accordingly, petroleum import prices resumed their decline. Moreover, nonpetroleum import prices fell again; not having risen in the past twelve months, deflating <A HREF="/economy/releases/impex.asp">import prices</A> impose strict price competition for our domestic producers.
<P>And, sure enough, domestic <A HREF="/economy/releases/ppi.asp">producer prices</A> also resumed declining, the overall index down 0.1% last month when a 1.7% plunge in energy prices overcame another big monthly gain in drug prices. Core producer prices continued quiescent, rising 0.2% last month to a level just 0.8% above June 1997.
<P>Finally, latest readings on consumer price inflation showed that there just wasn't any: <A HREF="/economy/releases/cpi.asp">consumer prices</A> rose just 0.1% for both the total and core price indices last month. Energy prices slumped 0.7% after a one-month rise in May, food prices steadied after bumping up 0.6%. Over the past twelve months, the CPI is up just 1.7%, with core prices up just 2.2%.
<P>In this environment of falling import prices I expect little or no increase in inflation even as wages continue to rise at 4.5% or more. This will tighten profit margins further that, in the face of a slower economy, will cause a deeper fall in corporate profit this year followed by a flattish performance in 1999.
<P>
<FONT SIZE=2>The articles and opinions in this publication are for general information only and are not intended to
provide specific advice or recommendations for any individual. Readers should consult an attorney, accountant, or
financial or tax advisor with regard to their individual financial situation.</FONT>
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<H6><FONT COLOR="#FFFFFE">"Mid-Year Economy Stalls on Foreign Trade Collapse, Inventory Correction, GM Strike; Chronic Asian Woes to Stunt Growth and Inflation, Curbing Interest Rates and the Fed; Economy, NAPM, unemployment, consumer prices, producer prices, slowdown, inflation, industrial production, Foreign Trade, Inventory Correction, GM Strike, Asian Crisis, Slow Growth, Diminished Inflation, Interest Rates, Fed Policy"</FONT>
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