Last week the
Commerce Department released its revised numbers for Quarter 2 GDP. The
results were much less than satisfactory, with annualized 'growth' coming in
at a pathetic 1.0%. Think of this as an economic stall speed. We know the GDP
deflator allows the metric to be overstated to begin with, so it is VERY
likely that America has re-entered the 'great recession' as it has been
dubbed by the media. There are some burning issues in here that need to be
discussed and they go way beyond the methodology of how GDP is calculated. I
will end with the assertion, backed with output methodology,
that is at least as reliable as what the Commerce Dept. offers that we
never left the great recession.
Ben Bernanke,
the official spokesman for Bankers, Inc. was quick to pontificate from
Jackson Hole Wyoming that the second half of the year bodes very well for GDP
and economic growth in general. This is where the shuck and jive starts. What
nearly all commentators are missing here is that USGovt
borrowing nearly ceased in the second quarter. On the surface, that might
look positive, because it would indicate that a greater percentage of that 1%
growth was real; that the economy was actually able to stand on its own, if
even in a very small way. This is where the price deflator comes in. The GDP
price index came in at a very tepid 2.4% in the second quarter of 2011 after
coming in at 2.3% in the prior quarter. This number is a complete fabrication
in that it certainly doesn't properly discount the impact of price increases
experienced on Main Street. Inflation metrics have been understating
inflation for years in order to rip off transfer payment recipients. For
example, the last SocSec cost of
living adjustment came three years ago. Does anyone believe that the cost of living
has remained unchanged in 3 years? The CPI, Core CPI and GDP price index have
been manipulated to discount inflation and by definition, to overstate
economic growth. Failing to properly discount for inflation is more than
likely responsible for all of the 1% growth experienced in Q2 – and
then some. I'll provide more substantiation for that opinion a bit later.
Now the second
part of the shuck and jive. Bernanke and everyone else knows
what happened when the debt ceiling was raised. The government went on a
borrowing binge, adding around $400 billion to the public debt within days of
the bill's signing. This bolus of new debt was pumped into the economy, and
will go right into Q3 GDP calculations. When Q3 GDP shows a boost, Bernanke
will get up in front of Congress, smile, and talk about how the Fed's
policies actually work, how government action is the best way to generate
economic growth, and, by the way, please give us more power to create even
better GDP results moving forward. Washington politicians who are hooked on
the idea of a centrally planned economy will do the same. Think I'm cynical?
Watch what happens. The overall lack of jobs will only be of minor concern,
but enough to likely justify another 'stimulus' attempt at some point before
the elections next year. They're already cooking up something to bail out
underwater homeowners, calling that a stimulus.
Let's go out a
bit further. There is now an economic kill-switch built into our economy in
the form of massive (and allegedly mandatory) spending cuts. These cuts need
to be agreed on and passed before Thanksgiving or else automatic cuts will be
triggered. So either way, some of the cookies and candy ought to be coming
out of the equation in Q4. Has anyone noticed that very little attention was
given to this reality? The debt ceiling deal has long been forgotten and we
haven't felt even a single nudge from the negative consequences yet. So we
see a boost of GDP in Q3, and likely Q4 as well from the increased borrowing.
The massive budget deficits are still firmly in place and are being built on
daily. Once the mandatory cuts take place, GDP drops, depending on the timing
of the cuts. However, it is very likely that through manipulation of the GDP
price index, that an official recession will be avoided – in governmentspeak at least.
The
Consequences of a Fraudulent GDP
The entire
notion of including government spending in economic output is tainted to
begin with. Mainline economists will argue that it must be counted since the
dollars are real and end up on Main Street where the vast majority of them
are spent into the economy. My assertion would be that if the government
butted out and left the dollars on Main Street, they would be spent anyway,
and horror of all horrors, some might actually get saved. Keynes was quick to
point out the evils of savings, though, and his followers are quick to
maintain the tradition. If mainstream economists can make a case for
including government spending in GDP, how about when half of that money is
borrowed? Count it anyway, they say! Never mind that the debt must be paid
back with interest, thereby reversing the infusion (plus a little extra for interest).
There are plenty of folks who will quickly point out that 'by accounting
definition, borrowing makes us rich since the money goes into the economy'.
You guys know who you are. You never tell anyone about what happens when the
money must be repaid though. These folks are following Keynes to the letter
– forget the long run – it doesn't matter.
Unfortunately,
GDP numbers are used in many financial activities, from capital spending
decisions to financial asset purchases. Distorted numbers lead to distorted
assumptions, which lead to bad financial decisions. Is it any wonder that
corporate debt is at an all-time high? These folks are borrowing money in anticipation
of a boom that never arrives. Granted, GDP isn't the only metric they use,
but I spent enough time in budget meetings to know that it is the biggie when
next year's budget allocations are on the table.
Those seeking
to purchase financial assets often look at GDP for an insight as to how a
particular company might fare in its quest for increased profits. A solid
economy is likely to generate better profits, thereby increasing stock
prices, etc. I don't need to lay out the rationale; everyone understands it.
Perceptions about the economy play into many other consumer decisions as
well, although one thing I am noticing is that people are paying less
attention to government numbers than they are to their own personal economic
realities these days. This is one of the reasons why consumer confidence can
be at recession levels despite the fact that the government doesn't own up to
it.
One thing a
flagging economy also tends to do is drive people out of stocks and into
bonds. This action lowers interest rates and allows the government to borrow
money more cheaply. In that regard it is certainly in Washington's interest
to keep the idea of the never-ending recession going. Phony GDP numbers
prevent accurate price discovery in the bond markets,
although, admittedly, this isn't nearly the issue it was a few years ago.
Back then there was actually a bond market, as opposed to now where we have a
group of primary dealers laundering bond market monies for the fed and little
in the way of other activity taking place.
In a normal
world, the fed wouldn't have to conduct all these illicit bond-purchasing
activities. The recession would do it for them, driving investors to grab USGovt debt in a flight to safety. However, the magnitude
of USGovt borrowing has overwhelmed the savers of
the world. Erosion of confidence in the dollar hasn't helped matters. The
realization that the US will never get its house in order has prompted savers
around the world to seek out other safe haven assets, notably commodities,
which people are learning don't come off a printing press. The recently
passed debt deal and the plan to switch to a chained-CPI are two landmark
initiatives that lay bare the intentions of the powerbrokers to keep the
Ponzi scheme going a little while longer.
An Alternative
to Traditional GDP Metrics
With these
matters in mind, one of the items of high priority should be discovering an
authentic measurement of output. There will be no perfect measurement, since
the definition of output varies depending on whom you happen to be conversing
with. So I'll frame this part of the essay by stating that my goal in seeking
an alternative was to find a measurement that allowed capital, labor, and
productivity to assume their proper roles in the determination of output. My
earlier assumption that government shouldn't be in the economics business
means that I will not count any government spending in this definition of
output. Government monies either arrive by taxation or borrowing. Taxed
dollars would have stayed in the economy anyway if they hadn't been taxed out
of it, so there is no reason to count the taxed portion of government
spending. There is definitely no sane reason to count the portion of
government spending that arises out of debt accumulation. It must be paid back
and constitutes a drag on future output. I also believe that corporate debt
and bailout dollars don't represent authentic capital and cannot be used to
determine output. These are my biases; I'm being forthright and honest about
them, rather than trying to use subterfuge to cover my motives.
That said we
could simply revise the existing GDP formula to exclude all government
spending and be done. That would be one way of doing things for sure, and
people have done it. Another way would be to take labor and capital inputs,
understanding the relationship between the two as they relate to output, then
adjusting for changes in multifactor productivity. The Cobb-Douglas output
function is a rather simplified way of doing that.
I am not going
to get into the nitty-gritty of the methodology in this article, as this is
not the forum. Frankly, we have subscribers and clients who pay good money
for this information and there is way too much work involved to just hand out
anything recent. What I will do is provide the graphic below and submit to
you that (and I have said this many times) the great recession began in late
2006 – a year before my original call of the recession on 11/25/2007 -
and has yet to end, despite what the Commerce Department has to say. This in
itself should not be an earthshattering statement; it dovetails with what so
many of you are experiencing. The real value is that we have empirical
evidence to connect with our perceptions. Better yet, we have another tool in
the toolbox for making financial and economic determinations.
There is an
old adage that figures lie and liars figure, and I am sure there are those of
you that will call me the latter because this empirical evidence doesn't
match up with your particular worldview. That is fine; the traditional
measurement of GDP certainly doesn't match up with mine – or the vast
majority of Americans.
Until Next Time,
Andrew W. Sutton, MBA
Chief Market Strategist
Sutton &
Associates, LLC
Interested in what is going on in the markets and
the economy? Read Andy Sutton's weekly market and economic commentary 'My Two
Cents' - go to www.my2centsonline.com
