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Joel Bowman, checking in briefly from Australia's
Gold Coast...
An interesting thing happened last week. On Thursday, the government
announced its "all important" GDP figures for the September quarter. The
results bettered the Street's expectations and promptly sent investors
into a buying frenzy. The S&P 500 finished the day up 2.3%.
But by Friday, investors were scratching their heads with one hand...and
hitting the "sell" button with the other. Apparently the "man on the
street" is not doing so well...despite news that the economy around him
is improving. Consumer spending was down 0.5% for the month of
September, according to the Commerce Department, and the housing market
is still floundering.
"[N]ew home construction is 74% below the peak it reached in January
2006," reports Forbes. "The drop is far more dramatic than the
46% decline in 1981 and well ahead of the 60% fall between 1986 and
1991."
There are now almost 20 million vacant homes in the United States.
That's a lot of inventory to move.
By close of trading Friday, investors had given back all of Thursday's
gains...and then some. How could this be?
"Don't believe the GDP hype," Dan Denning cautions from his post here in
Melbourne. "The big problems in the economy - too much debt, too much
leverage, too much government - are still there. They didn't go anywhere
overnight. We'd suggest that getting sucked back into stocks now because
of the US GDP figure is a very bad idea.
"Of course, we could be wrong," Dan continues. "Maybe stocks will go up
another 20% from here. Or 30%. Or 50%. But it's not likely. It's more
likely that the recession is over, but that the Depression has just
begun.
"It's begun because what the US GDP numbers actually show is a private
sector in full retreat as its income shrinks, its assets fall in value
and the cost of servicing debt rises. Into that terrible breach the
public sector has stepped, armed with an arsenal of inefficient and
stupid programs that give the illusion of economic activity, but
actually prevent the economy from liquidating excess capacity and bad
debt (the two conditions required for a real recovery)."
Your editor will be down in Melbourne this weekend...partly to lose all
his money at the Spring Carnival horse races, and partly to catch up
with Dan, who heads up the Australian version of The Daily Reckoning.
We'll keep you posted on that but, in the meantime, here are a few more
thoughts on GDP...
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The Daily Reckoning
Presents: |
America's economic "recovery" can only last as
long as the delusions that propagate it. The principal delusions of the
moment are: 1) that the rallying stock market is "anticipating" growth,
and 2) that the positive GDP numbers are signaling the end of the
recession. To the first point, the stock market may be right or wrong
about what's coming next. The stock market has been both right and wrong
before and we are certain that it will be either right or wrong this
time. To the second point, the US GDP calculation is just plain wrong,
and therefore, deceptive...
The "GDP Fraud"
by Joel Bowman
Gold Coast, Australia
If GDP is telling us that the US economy is steadily improving, how come
so many folks on Main Street feel so bad? Don't they read the papers?
Don't they know the GDP is improving?
The short answer to these questions is that the GDP calculation is a
fraud...or perhaps it's a fraud wrapped in a deception.
To understand why the GDP numbers could be so good when the economy all
around looks so bad, it is necessary to understand a few pertinent
details of the GDP calculation. It is necessary to see just what meat
and meat by-products go into this economic sausage. For one thing, GDP
includes government spending...but does not SUBTRACT any of the
borrowing the government does to fund its spending. And obviously,
government spending is in no way a reflection of private sector economic
activity.
Therefore, as Frank Shostak, an adjunct scholar of the Mises Institute,
observes, "The GDP framework gives the impression that it is not the
activities of individuals that produce goods and services, but something
else outside these activities called the 'economy.' However, at no stage
does the so-called 'economy' have a life of its own, independent of
individuals. The so-called economy is a metaphor - it doesn't exist."
Convention tells us that the GDP framework is, more or less, a tool used
to measure the size and health of this "metaphor"...ahem, the "economy."
Most often, we hear it expressed as a rate of growth - either positive
or negative. And it is this widely followed number that determines when
economic expansions end and recessions begin (two consecutive quarters
of "negative growth."). But GDP as a measurement is really just hogwash.
It can no more calculate the health of an economy than it can tell you
the time or give you a back massage.
Let us consider briefly the computation of the GDP measure. There are
three main ways to calculate GDP:
1) The expenditure method
2) The income method and
3) The value-added method.
Theoretically, all three methods should produce the same result
although, in practice, this almost never happens. For instance, when
there is a large surge in public spending, as we have seen recently with
the torrent of stimulus packages from governments around the world, the
GDP "growth" registers most prominently in the expenditure method.
Roughly speaking, this method calculates the "size" of an economy by
totaling its expenditures, minus imports. It is also the most common
method employed to determine GDP. The equation looks like this:
GDP = private consumption + gross investment + government spending +
(exports - imports).
To understand just how misleading the expenditure method can be, let us
consider briefly the case of the Australian economy. It is widely
accepted that the Aussies, under the deft stewardship of Prime Minister
Kevin Rudd, had avoided entering a technical recession during the crisis
from which we are now said to be "recovering." It's a nice
story...except that it is a lie or, at best, a "one-third truth."
Australia DID unquestionably fall into recession. It's just a matter of
definitions.
Like their American counterparts, Australian politicians pushed through
a series of emergency stimulus packages, now credited with having helped
the country avoid recession. Dr. Steven Kates, who lectures on economics
at RMIT University in Melbourne, provided a rare dose of clarity in a
recent article, published in The Australian. Dr. Kates concludes that by
both the income and value-added measures, Australia comfortably
satisfied the criteria for a technical recession.
"The income series... indicates a pretty minimal year all round," Dr.
Kates explains. "Both the September and December 2008 quarters showed an
actual fall in the level of output, the very definition of a technical
recession. Over the year, the level of GDP has fallen 0.4 per cent, by
no means as bad as elsewhere, but more in keeping with the general
experience across the economy.
"The third measure shows the changes in GDP according to the
production-based data," Kates continues. "Here, too, [in the value
added, or, production series] we have the ingredients for a technical
recession, with an actual reduction in the level of output in both
December 2008 and March 2009. Across the year, GDP has fallen by 0.7 per
cent.
"While the stimulus package appears to have been able to distort one of
the three sets of national accounting measures we use," Dr. Kates
concluded, "beneath it all the Australian economy, in keeping with the
rest of the developed world, has gone through a recessionary phase from
which it is only now beginning to emerge."
Therefore, the only way the Australian government could claim that it
had "avoided" a recession was by utilizing the expenditure method, or by
averaging all three measures of GDP together. Here we see that
unprecedented government stimulus spending propped up the expenditure
metric, much like a steroid injection might help prop up a cheating
athlete. Not only is stimulus spending an unsustainable and deceptive
scam, measuring it as a "+" under the expenditure GDP calculation
separates further the reality individuals experience from the fantasy
their governments serve up to them.
As the Australian example shows, this methodology simply ignores the
fact that government spending is not true production at all because it
is debt financed. Government spending, therefore, should really only be
government spending, LESS government borrowing.
You see how misleading this measurement can be, especially when huge
sums of debt-financed stimulus must be taken into account. Sound
familiar?
Murray Rothbard, the legendary Austrian economist, elaborated further
when he proposed his alternative measures: Gross Private Product (GPP)
and Private Product Remaining (PPR).
Rothbard defines the former as "gross national product less income
originating in government and government enterprises." PPR is GPP less
the higher of government expenditures and tax revenues plus interest
received. Rothbard argues that because government output is "financed
coercively" (i.e., by taxation), it is unclear what - if any - market
value may be ascribed to the end product. Simply put, both measures
place government "production" where it belongs: in the "opportunity
cost" pile.
If free market participants did not deem it worth their while to buy
something in the first place, why should it be considered a net positive
when the government uses their money (or China's) to buy it on their
behalf? This case may be brought against the "cash for clunkers"
program, the $8,000 credit for homebuyers and impending "cash for
anything" programs currently finding their way through the special-
interest-greased halls of Congress as we write. Indeed, the entire
bailout and stimulus programs fall squarely into the opportunity cost
pile. But that's not how those trillions are calculated using
conventional GDP metrics.
Measure it how you will, dear reader; true economic progress is forged
not in the crucibles of debt or coercion, but from the honest toil of
individuals seeking to better their own lot, unhindered from the
government's long, strangulating reach. No nation can spend its way out
of recession...no matter what the official GDP numbers may imply.
Regards,
Joel Bowman,
for The Daily Reckoning
P.S. What are the implications of such blatant,
government-sponsored manipulation for us individual investors? Glad you
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