US GDP Numbers are too high. Why is that?

ZeroHedge Notes the Fed may have been hiking into a recession after all

“These GDI/GDP revisions…could make us think differently about the US economy… especially if the Fed kept hiking even though true GDP was flat, if not outright negative”

-Jim Reid, DB

Housekeeping: Just reread a ZH post on GDI and GDP that is even more pertinent now as a major election nears. That free post is here.

If history is listening, this topic will become increasingly talked about if (when?) we get a recession for sure. It will also be relevant this election year when looking at the interest payments paid by our Federal Reserve; a good chunk of which goes to banks using the RRP facility effectively being paid to not lend money out.

Neither would we be surprised if it was also the major banks shorting bonds recently in anticipation of them having to tap that RRP to buy the new issues. But that is another issue. 

Our GDP Numbers are too high.

Authored by GoldFix ZH Edit

Sections:

1. What is the difference between GDP and GDI?
2. First a little more detail on GDP and GDI
3. Why Do We Use GDP Then?
4. The Fed is Paying Interest
5. Not the Fed’s Fault
6. Banks Aren’t Supposed to Make Money As the Fed Hikes. and Yet…
7. Bottom Line: The GDP Revision Effect

The following summarizes in somewhat reasonable terms why it has happened, how it will be reconciled, and how it changes perception (aka uncovers a harsher reality) of our economy.
It is a current event and pretty important as the data starts getting revised downward so close to an election. We thought this may also interest Founders.

What is the difference between GDP and GDI?

Bottom line: GDP (product or output) is what you make and sell. GDI (Income) is what you take in (get paid). These are supposed to be very close with easily explained legitimate discrepancies (GDP usually a little too high, GDI a little too low- see graph below). But lately their differences are widening and not so easily explained. Here, then is what is going on. First, why do we prefer GDP? 

Why Do We Use GDP?

GDP tends to be the more relied upon as it is based on fresher and more expansive data; while GDI, due to being more thorough statistically, will usually eventually be more accurate but not as timely. 

There is a historically predictable difference that is not usually suspect. Here it is.

For annual data, the correlation between GDI and GDP is historically 0.97. But this past year, the GDI has remained somewhat lower than GDP beyond the norm in scope and time. The difference is now 1.8% with GDP being high relative to GDI.

Why?

The Fed is Paying Interest

If there is a smoking gun for this, it could well be the fact that this past year, The Fed’s ballooning interest payments are not being accounted for equitably.

Pic ZH

To restate: One pattern evident is that GDP comes in higher and eventually gets revised lower towards GDI in general. But that discrepancy has gotten a lot wider than historical norms lately (1.8%) as ZeroHedge shows. Here is likely why that has happened. 

Recently, the profits of the Federal Reserve banks have rapidly deteriorated, contributing to the weakness in GDI.

This deterioration has been the result of ballooning interest payments on the Fed’s liabilities as short-term interest rates have increased

The Fed is not making money. It is in fact losing money making payments on loans, with the RRP being one relatively new example. Remember…corporations are not feeling the pain of rising interest rates this past year. That implies their counterparty is. That counterparty is the FED.

Banks Aren’t Supposed to Make Money As the Fed Hikes. and Yet…

Cynically speaking: Banks have gotten paid for their extra cash, used it to buy failing banks, and your money market is still 0.01% at those banks.

How Banking Works…

Borrow low, Lend high, hedge for the opposite.. and get free money for not lending in the RRP.

Not The Fed’s Fault (this time) 

Less cynically, the Fed is stuck in a bad place, in no small part due to the new found fiscal profligacy which underpinned inflation and thus forced them to raise rates to keep a lid in it. 

Banks, who normally suffer in a curve inversion event suffered. A few collapsed. Some, in addition to being smarter risk managers, were overpaid by the Fed to offset that pain

To “fix” this growing and persistent accounting discrepancy which is largely the manifestation of the Fed paying interest not being properly accounted for in reports— they have recently started doing just that

This inclusion would cut in half the statistical discrepancy in 2Q23, bringing it down from 1.8% of GDP to 0.9%, well within the normal discrepancy.

et voila.. Everything is fine, except for the actual economy. 

Bottom Line: The GDP Revision Effect 

GDI will get revised upward a little due to the counting of interest as profits. The bigger change will be seen in the GDP which will now account for (more properly) the costs related to Fed interest rate expenses. The numbers will almost converge again, but the GDP will likely drop more than normal to close the current gap.

Jim Reid’s Full quote on that:

"the revisions are potentially an important event and could make us think differently about the US economy in the recent past and therefore the future" especially if it is revealed that due to faulty data, the Fed kept hiking in the first half of 2023 even though true GDP was flat if not outright negative.

We may find out that the Fed was hiking into a recession already using faulty data for decisions.