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Q3 GDP Is A Head Fake
This article originally appeared on the Daily Capitalist.
The news on the latest GDP report said "recession fears recede." Now, a few days later, it's "red flags." So which is it?
I think it is still "red flags." But then we have most of mainstream economists/analysts who disagree with us. The difference is that they have been mostly wrong and we have been mostly right.
There are several things to understand about gross domestic product before analyzing the numbers:
1. Spending Isn't Everything
One is GDP measures spending in the economy as an indicator of what the entire U.S. economy is doing. In other words it is concerned only with demand and consumption of goods, not with the production of goods. As a statistic it tells you nothing about how all those goods got there. This is an interesting topic going way back in Austrian theory economics and which distinguishes it from other economic theories. We Austrians are more concerned with what individuals are doing not some aggregate "national" output that economists make up. It's complicated. (This article makes it easy.)
But think about this: if the Fed injects more dollars into the economy it will show up as increased final demand/consumption and boost GDP. Since printing more money doesn't create wealth, that doesn't tell us much about our economic health (e.g., spending boomed during the Weimar Republic and in Zimbabwe).
Since we Austrians are, if nothing else, realists, we understand that everyone pays attention to GDP, including the Fed, so we pay attention to it as well.
2. This Report Will Be "Revised"
So assuming GDP is important to follow, the next thing to understand about this Q3 report is "a". "a" is the letter attached to this report and means "advance estimate". These GDP reports are revised as better data comes in, so next we will get the "second estimate" and then the "third (final) estimate." More often than not these reports have been revised downward lately more than upward.
3. They Fudge The Deflator
Lastly these numbers are what are called "real", or inflation-adjusted numbers. This gives rise to the question of what is the actual rate of price inflation. They don't use the CPI ratio put out by the Census Bureau. They use what is called a "chained" price deflator from the GDP report which means they take prices as they were in 2005 and figure how much they have gone up since then. Then they adjust the gross spending numbers by this ("deflator"). This is good for the government because it is lower than what we believe to be the actual price inflation rate and makes GDP look better than it really is. Let's face it, 2005 isn't very long ago and if you go back farther in time this inflation indicator would make GDP look worse. Why not 1995 or 1985 or 1975?
Also, they keep changing their calculation methodologies. My preferred price inflation source is Shadowstats which uses methodologies the government used in 1990 or from 1980. Their 1980 chart is showing price inflation at about 12%. The BEA (which puts out the GDP report) is using a 2.5% rate of price inflation. In other words, if you adjusted current GDP by the 1980 deflator GDP would be in the negative. And, if that were the case, which I believe it is, we would be seeing flat to declining growth and high unemployment, which we are.
The Q3 Report
GDP was up 2.5% for Q3 2011. This is almost double the Q2 report (1.3%). Spending by businesses centered on equipment, especially computer and software related goods (up 17.4%). Consumer spending was up (2.4%) and auto sales were healthy. Durable goods were up 4.1% and fixed investment (nonresidential) was up 16.3% (vs. 10.3 Q2).
Negative signs were that inventories have been increasing. Another very negative indicator was real disposable personal income (-1.7%), which confirms that income/wages are going backwards. Another negative trend was that the personal savings rate declined one full percentage point to 4.1% from 5.1%. While the report suggests that cutting back in state and local government spending is a negative, we need to see this as a positive in economic terms.
A look at the BEA's report on Personal Income and Outlays for September shows that real disposable personal income (i.e., inflation adjusted) decreased 0.1% in September (vs. -0.4% in August). And real personal consumption outlays (spending) increased 0.5% (vs. a decrease of 0.1% in August). This mirrors the Q3 GDP report.
The fact that auto sales are up is a positive, but much of this is related to pent-up demand, "improving availability of product, lower pricing and this year's late-starting model-year-end clearance activity. But pricing still has not fully returned to normal and there are still inventory shortages. This suggests there may be a small upside to near-term sales."
“October’s sales numbers are certainly a bright spot in a sluggish economy, but it would be a mistake to believe that this momentum is the ‘new normal,’ said Jessica Caldwell, senior analyst at Edmunds.com. “Unless early holiday incentives inspire droves of buyers in November, we don’t expect sales to increase on the same trajectory as we have seen in the last two months.”
Remember that most people in America are fully employed (about 84% of the workforce) and they are buying cars because of dealer incentives and the availability of desirable models. This may be analogous to Cash for Clunkers, where future demand was pulled into the present and when the incentives were gone, sales dived. A better indicator of economic health is the fact that people have cut back on driving because of higher gas prices.
Business spending is also up, but other data suggests that companies are replacing equipment in order to create efficiencies in operations, but they are not hiring because of a lack of demand.
What does all this tell us?
It tells us that consumers are spending by almost the same amount that they are drawing down savings (savings down $116.2 billion from prior month, yet personal outlays were up $133.1 billion). These are rough statistics to be sure—we would need to see the Fed's Flow of Funds report when it comes out to get more accurate data. But it illustrates the reality that since people are earning less and spending more, the money must come from somewhere and that somewhere is savings.
This is not healthy.
In an economic recovery we would be seeing wages grow and consumption increase. That is not happening:
What is really happening is that consumers are being squeezed and spending is modest and declining; this is the trend:
When you see economists exultant about a minor blip in spending you can be assured that they are high on hopium.
We fervently hope that the economy would recover, but for that to occur the Fed needs to raise interest rates and wind down excess reserves. Then real savings would increase, and ultimately as capital is accumulated, production would increase, debt loads would be reduced at the personal level, housing would bottom and start to turn around, banks would resolve their balance sheets, and employment would increase. But that isn't the likely case.
All the attention on GDP—demand and consumption—is misplaced. This quarter's report is a false signal, a head fake if you will, that is an artifact of two rounds of quantitative easing (QE), which cannot be sustained when you have wages declining and debt loads still historically high.
In my article, "Winners and Losers: The New Economy", I pointed out that the top 5% of earners account for 37% of all consumer spending and it they who are supporting consumer spending. It is our opinion that the über rich have been the main beneficiaries of QE and that it hasn't "trickled down" to the middle income earners. As the Fed's fiat money is distributed throughout the economy it has been causing prices to rise, perhaps modestly, but then QE is not a very efficient way to inflate. It hasn't created real wealth and has been rewarding financial players rather than producers. Without another round of QE we should see a continued economic decline and then a gradual recovery as outlined two paragraphs above. Because of all of the government interference in the recovery process, this will take some time.
The probable scenario in the near term is that the financial markets will decline, corporate profits will flatten or decline, exports will decline because of a worldwide slowdown and a rise in the dollar, unemployment will remain high, and prices will continue to rise. That certainly doesn't add up to an increase in future real economic growth. That will alarm the Street, the Obama Administration, and the Fed and we can expect another round of quantitative easing, continued ZIRP, higher prices, and calls for more fiscal stimulus. This will kick off another round of market euphoria, a further decline in the formation of real capital required to fuel a new recovery, more price inflation, continued high unemployment, and economic stagnation.
The further implications of these events will be spelled out in another article coming soon.
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I'm not quite sure I get some of the points in the article. For example, point 2 describes how nominal GDP may not be a good guide because of inflation. Point 3, however, describes how they fudge the deflator. Although I agree that deflators may not reflect our reality and, as Austrian economists would point out, deny that some things are going down while others are going up, if you use GDP deflator as in point 3 you won't have much of an impact from point 2.
Additionally, I think you misinterpreted in point 1 what Shostak was saying in the mises.org link. This is not surprising because it is a muddled, unfocused attempt at explaining ... something, although I'm not sure it adequately explains anything. He's saying that GDP fails to measure intermediate goods production (true) and that GDP doesn't adequately measure demand (it measures output). I'm not sure why anyone (except a Keynesian) would think that GDP was designed to somehow match up with demand; it was designed to measure economic OUTPUT. Of course, Keynesians then go on to believe that government planning can somehow hope to erase the mismatch that occurs between demand and final output when it's not just final output they should be looking at because intermediate production also gives rise to economic activity.
Insider, thanks for the comment. Perhaps I'm not getting your first criticism, but I think I explain that, regardless of it's meaninglessness, the numbers aren't that accurate based on the methodology they use.
The next critique I don't understand. I thought Shostak was VERY clear about his analysis. The part you mention says:
Because the GDP framework completely disregards the intermediate stages of production, it can be of little help in the assessment of boom-bust cycles. It is little wonder then that mainstream economists are forced to conclude that recessions are a response to a sudden fall in consumer spending. Consequently, it is quite logical within the GDP framework to advocate loose monetary policies to revive the "economy."
Thus he is discussing the boom-bust business cycle, not that it has to match up with demand. Final demand, as he says is not relevant in explaining economic phenomena, especially output. In Austrian theory it is real capital that matters, primarily being reflected in the initial stages of production.
But thanks anyway. We differ that's all.
I don't care about the GDP anymore, it is not an indicator of any revelance to a regular working stiff. The fate of regular folks is pretty much unhinged from GDP.
Once upon a time, if the US GDP increased, regular folks benefitted. This is no longer the case. Corporations may have more cash reserves, and smart/lucky//talented/whatever rich get richer. Some people manage to make and make it big, but it's turning to winner take all.
Thus we see economists say we are out of a rescission, but someone laid off in 2011 has no more hope of finding a job than in 2009. We see most major corporations not giving raises , promotions, not filling iopemed positions in 2011 after having often cut pay in 2009. And at least in 2009 some things got real cheap like cars, gas, vacations, rent etc, so a even a stagnan wage could mean a slightly better lifestyle.
Of all the regular working people I know, college friends, working class people I grew up with, family members etc all over the country I know of one person that is doing better than 2009, and he lives in boomtown in ND gas fields. Everyone else is worse off or treading water.
Even the ones with same jobs and salary in 2011 as 2009 are looking at their house values that continue to drop so that even long time homebuyers are ending up underwater, they are seeing increasing costs of health insurance and health care costs because bigger insurance co pays, bigger bills. They are paying more for food and more for gas because their food is gas(ethanol). And the price of education, practically a pre req for a hope for middle class, is still going up. And if not in a house, rents are up even while homeowners are underwater.
They think consumers are loosening up on spending because their savings are down, however, I think consumers are spending their savings because they are desperate. How many people lived off their 401k the last few years, between job? How many people are ripping thru savings because some one got sick. How many retired people are living off savings because they can't get any interest/returns on their investments?
I could have bought a car three years ago, but I waited until my 9 year old car was starting to cost me and had about $1500 in known repairs coming up. So I bought a car this fall, that will show up in GDP in fourth quarter, but I'll have $300 less a month to spend on anything else for the next three years, and I didn't buy due to more confidence in 2011 than in 2009.
When the GDP works for the common wealth, when my 50 year brother in manufacturing can find a job again, when my employers stops laying off a few people every year, starts giving raises to keep workers, and when my everyday expenses decrease compared to my wages because GDP went, I'll star paying attention to it.
I agree with the fudged numbers.
All one has to do is look at the housing market especially construction and new homes sales today compared with 2006. Now think of all the services and products that go into building and furnishing a home. Most of that has vanished yet the GDP is still positive. How can that be?
Could it be the $1.5 trillion in deficit (borrowing) spending?Seems to me if you have a $15 trillion economy and the gov't borrows and spends $1.5 trillion then the real GDP should be 10% lower than is reported.
The deficit in 2007 was 4-500 billion. What created the need for an additional $trillion plus deficit spending? A reported drop in taxes/gov't revenue of 200 billion?
Someoone please shine a light on me.
I just got back from a wedding where the unemployed relatives were all showing off their new iPhones. ??? It sucks to be them and sucks to be us. I think the spending binge figures are probably real but don't show much more than there's been some mighty fine fire sales recently. Bauble deflation is upon us.
In other words, if you adjusted current GDP by the 1980 deflator GDP would be in the negative. And, if that were the case, which I believe it is, we would be seeing flat to declining growth and high unemployment, which we are.
This says it all.
All these fudged numbers are to take the heat off the govt. to cut deficit spending. Remember how much the 1st quarter was revised down to after about 4 months after the initial release? I can't remember the exact numbers but I think it was revised from 1.9 down to 0.4.
Couple the third quarter fudged GDP with the Fed buying up our treasuries so the interest rates will stay artificially low, and look, they don't have to cut spending after all. GDP is good and people are buying our treasuries and we pay very little interest on it. So lets cut nothing!
And another thing. If the govt. makes the economy look good with their fudged numbers, it makes them look good also. Tell all those people who can't find jobs that the economy is improving. And if it weren't for record number of people receiving entitlements we'd really be in a great depression. Entitlements in the US have replaced jobs, since there aren't very many jobs out there today.