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Real
GDP increased at an annual rate of 5.7% in Q4 after rising by 2.2% in Q3
— the quickest pace in more than six years. This was above Wall Street
economists' forecast for a 4.6% increase in Q4. The yearly rate of growth of real
GDP climbed to 0.1% in Q4 from −2.6% in Q3. The yearly rate of growth
of GDP at current prices, i.e., nominal GDP increased by 0.8% in Q4 from
−2.1% in the prior quarter.
The
bounce in the growth momentum of both real and nominal GDP is due to the Fed's
massive money expansion. However, a sharp fall in the growth momentum of real
AMS[1] poses a threat to the growth
momentum of GDP in quarters ahead.
 
Most
economists, including the White House chief economist Christina Romer, hailed
the Q4 GDP data as "the most positive news to date on the economy."
But
economic growth presented in terms of GDP just describes monetary expenditure.
GDP is designed along the line of Keynesian thinking, which holds that
spending equates with income — hence more spending leads to a higher
national income and in turn to higher economic growth. On this logic, a
tighter monetary stance by the Fed leads to slower economic growth while
increases in monetary pumping produce higher economic growth. (In the GDP
framework, money expansion leads to an increase in overall income in the
economy, and hence to a higher rate of growth of GDP).
In
reality the exact opposite actually takes place — printing more money
weakens wealth generators' ability to grow the economy whilst a decline in
the money supply's rate of growth strengthens their ability to grow the
economy.
Once
the central bank raises the pace of money expansion in order to lift the
economy out of a recession, it prevents the demise of various false
activities. It also gives rise to new false activities. The outcome of such
so-called economic growth is nothing more than the strengthening of wealth
consumers and renewed pressure on wealth generators. All this undermines the
process of wealth generation and weakens true economic growth.
Real Savings Fund Economic Activity
Irrespective
of whether an activity is productive or nonproductive, it must be funded. At
any point in time, the number and the size of activities that can be
undertaken is determined by the available amount of real savings.
From
this we can infer that the overall rate of increase in productive and
nonproductive activities as a whole is set by the rate of expansion in the
pool of real savings. This inference runs contrary to the GDP framework,
where the pace of money pumping sets economic growth.
After
all, individuals, whether in productive or nonproductive activities, must
have access to real savings in order to sustain their lives and well-beings.
Money cannot sustain individuals — it can only fulfill the role of the
medium of exchange.
As
long as wealth producers can generate enough real wealth to support
productive and nonproductive activities, loose-money policies will appear to
be successful.
"Neither the Fed nor
the government can grow the economy. All that stimulatory policies can do is
redistribute real savings from wealth-productive to nonproductive
activities."
Over
time a situation can emerge where, as a result of persistent loose monetary
and fiscal policies, there are not enough wealth generators left.
Consequently, generated real savings are not large enough to support an
increase in economic activity.
Once
this happens, the illusion of loose monetary and fiscal policies is
shattered; real economic growth must come under pressure. Even in terms of
GDP, it will be difficult to show economic growth. (The only way, in such an
event, that GDP could grow is through the use of misleading price deflators).
As
a rule, monetary pumping by the Fed "works" through the commercial
banks' expansion of credit — the increase in commercial bank reserves
on account of the Fed's pumping gets amplified by means of credit expansion.
At
present, banks are finding it more attractive to sit on massive piles of cash
reserves rather than lend them out. In January 2010, excess bank reserves
stood at $1.063 trillion, against $793 billion in January 2009 and $1.4
billion in January 2008.
The
banks are still in the process of trying to fix their balance sheets. Also,
they can't find many viable borrowers, i.e., wealth generators. All this
raises the likelihood that the process of wealth formation is in trouble.
Note
that if the pace of wealth generation were rising, banks would have been very
active in securing a growing slice of the expanding real wealth for
themselves. The latest data indicates that banks are still very tight.
Year-on-year, in January commercial bank lending fell by 8.8%, and in
December it fell by 7.9%. This was the 9th consecutive monthly
decline.
 
If
the supply of real savings is dwindling, the government's attempt to boost
the rate of growth of GDP by raising expenditures is also going to fail.
After all, government activities also require real savings. If the government
persists with its aggressive stance, it will only make things much worse: it
will deprive funding from wealth-generating activities.
Increasing
government outlays while the pool of real savings is declining could severely
damage the process of real-wealth formation. Those commentators who subscribe
to the view that an increase in government spending can fix things hold that
something can be created out of nothing.
There
is no such thing as a stimulus policy that can grow the economy. Neither the
Fed nor the government can grow the economy. All that stimulatory policies
can do is redistribute real savings from wealth-productive to nonproductive
activities. These policies encourage consumption that is not supported by
useful production.
The
latest data show that in Q4 the government outlays to GDP ratio stood at
0.25. Note that the ratio is on an explosive path. Also, the government
deficit as a percentage of GDP increased further in December. The 12-month
moving average of this percentage stood at 10.3% against 10.1% in November
and 4.7% in December 2008.
 
Conclusion
US
real GDP increased at an annual rate of 5.7% in Q4 — the fastest pace
in more than six years. The yearly rate of growth climbed to 0.1% in Q4 from
−2.6% in Q3. We suggest that the current bounce in the growth momentum
of real GDP is on account of the Fed's past massive money pumping. A sharp
fall in the current growth momentum of AMS poses a threat to economic growth
in terms of GDP in quarters ahead.
We
suggest that what matters for true economic growth is the pool of real
savings. There is a growing likelihood that this pool might be in trouble. An
important factor that provides support for this conclusion is the continuous
fall in bank lending.
A
further attempt by the federal government to "help" the economy
with fiscal stimulus is only likely to further weaken the pool of real
savings. This will make it much harder for the economy to stage a meaningful
recovery.
Frank Shostak
Frank
Shostak is a former professor of economics and M. F. Global's chief economist.
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