Submitted by David Stockman via Contra Corner blog [17],
During the heyday of post-war prosperity between 1953 and 1971, real final sales - a better measure of economic growth than GDP because it filters out inventory fluctuations - grew at a 3.6% annual rate. That is exactly double the 1.8% CAGR recorded for 2000-2014.
And after yesterday’s punk GDP report in which growth stayed above the flat-line by a hair only due to a massive inventory build, the contrast is even more dramatic. Real final sales actually declined by 0.5% during Q1 and, more importantly, reflected a mere 1.1.% annual growth rate since the pre-crisis peak in the winter of 2007-2008.
The long and short of it, therefore, is that there has been a dramatic downshift in the trend rate of economic growth during an era in which central bank intervention and stimulus has been immeasurably enlarged. In this regard, the size of the fed’s balance sheet is the telltale measure of its policy intrusion. That’s because the only mechanism by which the Fed can actually impact the real economy is through open market purchases of treasury bills, bonds and other existing securities for the purpose of raising their price and lowering their interest rate or yield. And it doesn’t matter whether the Fed is buying short term T-bills to peg the federal funds rate or 10-year notes to drive down long-term interest rates and flatten the yield curve.
Thus, the old-fashioned business of pegging the Federal funds rate and the new-fangled intrusion of massive bond buying under QE are all the same maneuver. They both involve expansion of the central bank balance sheet and, therefore, the systematic injection of fraud into the financial system.
That is to say, growth on the asset side of the Fed’s balance sheet involves the acquisition of financial claims that arise from the utilization of real labor and capital resources. This happens, for example, when the Fed buys treasury notes that were issued to fund the purchase of concrete and bulldozer operators under the highway program or when new homes embodying carpenters’ wages and lumber are financed with Fannie Mae guaranteed mortgages purchased by the Fed.
That contrasts with the liability side of the Fed’s balance sheet, which expands dollar for dollar with the asset side, but represents nothing more than bottled monetary air confected from its digital printing press. Stated differently, the Fed’s fundamental tool of open market purchases of public debt and other securities, and thereby the expansion of its balance sheet, embodies the exchange of claims based on something for credits made from nothing.
The Fed’s current $4.5 trillion balance sheet, in fact, could be expanded to sport liabilities of $10 trillion or even $100 trillion by a few keystrokes on the Fed’s computers—–if the open market desk could find enough public debt, private debt, equities and even seashells to buy and stash on the asset side. But questions of practicality or likelihood aside, the basic principle is that the liability side of the Fed’s balance sheets represents spending power made out of nothing. Accordingly, the greater the size of the Fed’s balance sheet, the greater is the amount of fraud released into the financial system and the more intrusive is its deforming and distorting impact on the capital and money markets and ultimately the real main street economy.
Self-evidently, the Fed’s 5X balance sheet expansion since December 2008, which has resulted in 77 straight months of zero money market interest rates, has massively subsidized carry trade speculators. The latter use this free short-term money to fund (i.e.”carry”) their stock, bond and other asset positions, and thereby bid the market for these assets to higher and higher levels. So doing, they are not bringing new savings into the investment market and thereby augmenting honest demand for stocks, but are merely enlarging their bids with zero cost credit made from nothing.
Needless to say, there has been a sweeping change of monetary regime since the golden era of growth and prosperity in the 1950s and 1960s. During the former period, the Fed was run by the sobered survivors of the Great Crash of 1929 and the traumatic depression which followed. They deeply feared financial speculation, and most especially this was true for the Fed’s leader during this period, William McChesney Martin.
Accordingly, during the entire period between the end of the Korean War in 1953 and Nixon’s striking down of the Bretton Woods system in 1971, the Fed’s balance sheet grew by just $42 billion or 5.7% per year. And after adjusting for GDP deflator growth during the same 18-year interval, the constant dollar size of the Fed’s balance sheet grew at 3.0% per year. In point of fact, this means that the Fed’s real dollar balance sheet grew more slowly than the real economy during this 18-year period—-that is, at just 0.8X the growth rate of real final sales (3.6% per year).
By contrast, the Fed’s balance sheet soared by $4 trillion—–100X more—-during 2000-2014 or by 17% annually. That amounted to a 15% CAGR after adjusting for the 1.9% per year rise in the GDP deflator. In sum, during the current century to date, the constant dollar growth rate of the Fed’s balance sheet represents 8.3X the growth rate of real final sales (1.8% per year).
In metaphorical terms, the central bank was using a pop-gun during the 1953-1971 era versus a nuclear weapon since the year 2000. Yet not only has the reported trend rate of real growth fallen by 50% since the era of William McChesney Martin, but the periodic economic setbacks (i.e. recessions) were also much shallower back then.
To wit, there were four recessions certified by the National Bureau of Economic Research (NBER) during the earlier period, but only the 1957-1958 downturn, when real final sales dropped by 2.4%, was serious. Overall, however, the average real sales decline during the four recessions of the golden growth era averaged just 1.0%.
The implication is straight-forward. The nation’s capitalist economy exhibited no suicidal tendency toward deep plunges and depressionary spirals during Fed’s “light touch” policy regime over 1953-1971. In fact, the officially designated recessions were primarily short-lived inventory corrections that reflected the wind-down of a war economy in two of the four cases, and mild cutback of credit growth in the other two.
In any event, the Fed’s mild tweaking of money market rates during that era was more than enough to keep the economy moving steadily higher—-and even that was not really necessary as I will demonstrate in a subsequent post. As shown in the graph below, the dips in activity were shallow and short-lived and the real economy nearly doubled in size during the period.
By contrast, during the most recent 14-year period not only has the trend rate of growth dropped by half, but one of the two recessions was quite deep by historical standards. Between the Q4 2007 peak and the Great Recession bottom (Q2 2009), real final sales declined by 3%—–the deepest drop of all post-war business cycles.
In light of this evidence, it goes without saying that the Great Moderation ballyhooed by Bernanke and the Greenspan Fed in the early years of this century was just self-serving poppycock. In the process of its massive financial intrusion and manipulation of virtually all interest rates and financial market prices, the Fed has not eliminated the business cycle at all.
And despite all its prodigious money printing, the thing that really matters—-the trend rate of real economic growth—-has fallen sharply, but relative to its post war average. In fact, the 1.8% real growth rate during the last 14 years is well less than the 2.9% growth rate achieved during the Great Depression years between the 1929 crash and the war economy triggered by Pearl Harbor.
And even then, the historically tepid rate of real final sales growth since the turn of the century may not capture the whole story. The reason is that the national income and products accounts (NIPA) have serious quality and conceptual defects and these factors have intensified over time.
Real final sales, for example, include the national defense spending accounts of NIPA, which currently amount to $750 billion. But defense spending generates pure economic waste—even if it does arguably provide for the intangible good called “national security”. That’s relevant because between 1953 and 1971 there was zero real growth in the defense component of GDP.
By contrast, between 2000 and 2014, the real defense spending component grew by 37%. So the quality and sustainability of the 3.6% real final sales growth number for 1953-1971 was far better than the 1.8% rate posted during the most recent 14 years. The latter period was inflated by wasteful defense outlays, reflecting the Bush wars of invasion and occupation that are now being rolled-back owing to the abysmal failure of these imperial adventures and to the belated fiscal constraints of the sequester.
Moreover, comparability issues go far beyond the dubious economic value of defense spending. During recent decades massive credit expansion and increasingly overt government fiddling with its own economic statistics has created further disconnects.
For example, the figures for real final sales and the other GDP components depend upon the measures of inflation the Commerce Department uses to compute real output and spending. Yet during the years since 1980, the Washington statistical agencies have fiddled so heavily with the inflation indices that it is virtually certain that today’s deflators capture far less of the cumulative increase in the price level than they did a half-century ago. That means, of course, that they tend to overstate real growth relative to earlier periods.
Here is just one example. Since the 1980s, fully 24% of the CPI has been accounted for by “owners equivalent rent”(OER). The latter is a purely theoretical “price” that 78 million homeowners would purportedly pay for their lodging costs if they rented their own homes to themselves!
And how does the BLS arrive at this big chunk of the inflation index? Why, by asking a few thousand people each month what they think they might charge if they were renting out their castle to a stranger.
You can’t make this stuff up. Its what they do all day inside Washington’s statistical agency puzzle palaces. But even then, this whole “imputed homeowners rent” gambit—-which is a completely made-up number but accounts for $1.5 trillion of the current GDP total—-could be worked around by using the government’s index of rental price inflation. The latter is obtained via the standard surveys by which the BLS collects prices for apples, hamburger and ladies handbags.
Not surprisingly, during the last 14 years this market based index of shelter costs, as reflected in the residential housing rental sector, has risen at a 3.5% annual rate or by one full percentage point per annum faster than the made-up OER. This means that the OER understates the cumulative 14-year rise in shelter prices by 30%.
Also, not surprisingly, the rental price index accounts for only 6% of the weight in the CPI or just one-fourth of the weight of the OER. Thus, were the BLS to use the market price of shelter rather than its whacky OER confection, the annual CPI gain since the year 2000 would be 2.5%, not the 2.2% figure reported.
[18]Owner’s Equivalent Rent Vs. Actual Rent – Click to enlarge
Needless to say, there is a lot more where that came from. The most notorious of these downward biases, of course, is the “hedonic” adjustment factor which purports to adjust for quality improvements in products and services. It doesn’t take much examination, however, to see that hedonics amounts to a bunch of bureaucratic guestimates and arbitrary theories that systematically bias the rate of inflation downward.
The fact is, within the multi-thousand item basket of products and services included in the CPI, and in the deflators which are derived from it, there is a constant flux of both quality improvements and quality deteriorations, and a continuous blizzard of subtle changes in product function, size and specifications that cannot possibly be accurately captured by the crude instrument of the Census Bureau/BLS surveys and the tinkerings upon the resulting raw data by in-house civil service theoreticians.
The truth of the matter is that the BLS has been under constant pressure from the top of the Washington hierarchy to dilute the inflation numbers ever since social security and other cash pension programs were put on annual COLA adjustments during the inflation-ridden 1970s. Thus, during 2015 upwards of $1.3 trillion of transfer payments will receive CPI-based COLA adjustments. After 15 years, the cumulative difference between an inflation rate of 2.5% versus 2.2%, per the above example, would amount to $100 billion per year.
So you better believe that the statistical agency bureaucrats troll the data for ways to “disappear” small bits of real world inflation wherever the chance presents itself. The most blatant and telling example is evident in the manner in which they have tortured new car prices.
According to the BLS index, new car prices have risen by only 1% since 1997! That’s right, back when Bill Clinton was being sworn in for his second term, the new car price index stood at 145 and according to the BLS, its just 147 today.
Well, now. According to readily available public information, the average new car price in 1997 was $17,000 compared to about $33,000 today. Most assuredly, the average worker needing a car to get to his job and to transport his family to Wal-Mart would recognize the real world gain of 95% during the last two decades, not the BLS fiction of 1%. Just because today’s new cars have eight air bags, navigation systems and run-flat tires—- it doesn’t mean that new car price inflation has vanished. This is hedonics gone haywire.
In fact, it gets even worse. Not only is the CPI artificially suppressed, but then when it gets translated into the NIPA accounts in the form of the GDP deflator, the government statistical wizards gut the index even more. Thus, for the 15 years ending in the just reported data for Q1 2015, the GDP deflator is alleged to have risen by only 1.9% annually—-or by 25% less than the reported CPI, as adjusted only for the dopey OER distortion.
At the end of the day, there is every reason to believe that inflation has averaged between 2.5-3.0% since the turn of the century. Accordingly, real final sales, which hit another air pocket in Q1, have actually been struggling to stay above the 1% annual growth marker since the turn of the century when deflated by a more realistic index of cumulative price gains.
The obvious question from all of the above thus recurs. And when the cycles have gotten deeper? And especially, when financial markets have self-evidently become unstable and bubble-prone owing to massive central bank intrusion in financial market price discovery?
Actually, there is an even more pointed question in the face of still another repudiation embodied in today’s GDP release of the “escape velocity” promise that was the basis for $3.5 trillion of fraudulent bond-buying by the Fed over the past six years. Namely, is there any justification for the FOMC’s intrusion in the financial markets at all? Does market capitalism really have a death wish and therefore need for an external agency of the state to smooth its cyclical undulations least it tumble down an economic black hole?
Well, actually, it is all about a wish. That is, the Fed and all other central banks have a power wish; a rank ambition to operate as masters of the financial universe—-unrestrained by either political authority or the discipline of honest free markets.
So motivated, they have bamboozled the political class and the public alike into the false belief that they are the indispensable element—the very mainspring—-of modern economic life. Without their expert ministrations, they claim, we would be faced with a Hobbesian world in which economic life would be poor, nasty, brutish and short.
Not true! On the one hand, market capitalism can function without state management of the business cycle. On the other, it desperately requires honest money and capital markets where savers are rewarded, gamblers disciplined and entrepreneurs are allocated capital for productive investment based on criteria of efficiency and risk-adjusted returns.
Such a world existed before 1914. During the prior 50 years real living standards rose at the highest compound rate for an equivalent duration in recorded history(@4%)—-and without any help from a central bank whatsoever.
There is no reason that benign era could not be revived under Carter Glass’ original design of the Fed as a “bankers bank”. The latter was given a narrow mandate to operate a passive discount window at which it would liquefy sound collateral at a penalty spread above the free market rate for short-term money.
Under that arrangement, the FOMC would be abolished and the destructive fraud of massive bond-buying with credits made from nothing would be eliminated.
The Fed would have no need for economists, Keynesian policy apparatchiks or Yellen and her power-drunk band of money printers. A few green eyeshade loan officers randomly picked from the community banks of America could more than adequately perform the task of examining self-liquidating collateral (i.e. loans against finished inventory and receivables) brought to the discount window by true commercial depository lenders.
In future installments we will delve deeper into the foundational myth that the Fed has deployed in justifying its sweeping seizure of power. Namely, that market capitalism would have crashed over and over during the last 60 years without its interventions.
That proposition, however, is not even remotely true.
