My Two Cents - "Pass out the 3D Glasses"

07/31/2009

It doesn’t take long these days to find an economic bull that’s for sure. Whether you turn on the television, radio, or pick up a newspaper, they’re everywhere. The most popular phrase to date has obviously been Bernanke’s ‘Green Shoots’ comment made several months ago now. Boy have we gotten some mileage out of that one.

San Francisco Fed President Janet Yellen became the latest to don the well-worn 3D glasses early this week at the Oregon and Idaho Banker’s Association convention. The following are some of her comments:

“We glimpse the first solid signs since the recession started more than a year and a half ago that economic growth may be poised to resume… indeed, I expect that to happen sometime this year.”

Again, it all comes back to one’s definition of growth. Yellen, like most mainstream Keynesian policymakers believes in the idea that if GDP rises and that increase is subsequently discounted by some arbitrary deflator, then the balance is ‘growth’. There is a lot more to it than just that unfortunately.

GDP has a number of components and is calculated by the formula below:

GDP = C + I + G +(X-M)

C is classified as private consumption. It is the spending done by consumers on final goods and services. Virtually all consumer spending is counted excluding home purchases. However this component does include rents paid.

I is the investment portion of GDP. However, as one would typically assume, it does not include purchases of stock and/or bonds since such transactions are essentially just changes of title and do not involve capital goods and/or services. Components of I are business investment in capital goods, and purchases of new housing units by consumers.

G represents the government spending portion of GDP. It represents the government’s purchases of final goods, payment of government employees, and investment in capital goods. Transfer payments such as Social Security and Medicare are not included in the GDP calculation.

(X-M) is essentially our trade balance. If we run a trade surplus, then this component contributes to GDP. If we run a deficit, then it is deleterious to GDP. Imported goods are subtracted here because they have already been counted once in C, I, or G since the goods/services came into the country and were purchased in some manner be it as final goods or capital goods.

It is easy to see that there are many factors affecting GDP, and this is where Mrs. Yellen’s comments border on ludicrous. Even those folks who still use two tin cans connected by a piece of string for their communication know the government is borrowing and spending huge sums of money in an attempt to ‘stimulate’ the economy. Much of this spending goes right into GDP. What we have is a situation where the government is trying to pick up where consumers have left off. So if for example consumer spending drops by $200 billion but the government spends an extra $300 billion, we can now advertise (all else equal) that we have economic growth by way of a $100 Billion increase in GDP.

Consider this confirmation of the above from the Bureau of Economic Analysis’ report on GDP released this morning:

“The much smaller decrease in real GDP in the second quarter than in the first primarily reflected much smaller decreases in nonresidential fixed investment, in exports, and in private inventory investment, upturns in federal government spending and in state and local government spending, and a smaller decrease in residential fixed investment that were partly offset by a much smaller decrease in imports and a downturn in personal consumption expenditures.”

As a side note, BEA has released their comprehensive revision, which generally happens every five years. While the details of the methodological changes are outside the scope of this article, they must be mentioned and considered in the analysis of GDP. Perhaps the most important factor is that BEA is now using 2005 dollars versus 2000 dollars in their calculations, which will tend to overstate GDP since the 2005 version of the greenback was considerably weaker than its predecessor. Consequently, purchasing the same amount of goods required more greenbacks thanks to the diluted value.

If one were interested in calculating a more honest version of GDP, any government borrowing (for starters) would be subtracted. Sure the money is spent on goods, but it is not money that is free and clear. It represents a future burden on growth, and should be treated as such. Just as an example, in FY 2008, the Federal Government ran a deficit of over $400 billion. Taking that off 2008 GDP lops another 2.8% off GDP. Imagine what deduction nearly $2 Trillion worth of borrowing would do to 2009 GDP if it were counted.

I am sure this position will bring argument that debt should not count against GDP, but if the GDP is being used to measure growth and debt constitutes a drag on future growth, then we need to be accounting for it. By the same token, we should also be counting consumer debt against the consumer’s contribution to GDP as well.

When one looks at Ben Bernanke or Janet Yellen’s remarks through the lens constructed above, their comments take on a totally different meaning. Essentially what they are saying is that growth can always be achieved at will by printing money, lending it to the government and having the government spend it. Are we really that far off here?

And true to form, Mr. Bernanke issued some well-couched comments last week regarding the economy. It is remarkable to watch him climb the learning curve of how to speak without really saying anything. A man that was easily pinned down early in his tenure because he was specific has now plunged headlong into ambiguity:

“The economy is showing tentative signs of stabilization.”

And the classic ‘green shoots’ comment:

“I do. I do see green shoots. And not everywhere, but certainly in some of the markets that we've been functioning in. And we've seen some improvement in the banks, as well, certainly in some key cases.”

The first part of this quote says it all. Bernanke is basically admitting that those markets which include the mortgage-backed and GSE securities market would still be in shambles if the Fed weren’t in there with its helicopters providing liquidity. How can such an unsustainable path be considered as positive?

Somehow the idea that government, by stepping in and putting trillions of dollars on the taxpayers’ tab – without any invitation to do so – then spending the money and calling it growth defies common sense. The idea of the Fed ostensibly rigging key markets to create even more phony low interest rates for the purposes of continuing a binge that never should have happened in the first place is equally absurd.

It is becoming rather clear that if you want to do well in the land of green shoots that you’d better have a pair of 3D glasses. Hopefully those glasses come with a helmet because we’re going to need it.