Inside The GDP Report –——Not What It’s Cracked-Up To Be


On the Uselessness of Aggregate Economic Statistics

We actually hate talking about GDP. It mainly measures consumption and leaves out the bulk of the economy’s production structure – which has led to the completely erroneous, but often repeated notion that “the consumer represents 70% of economic activity”. In reality, consumption represents somewhere between 35% and 40% of all economic activity. The manufacturing sector is actually not the “smallest sector of the economy”. It is still the by far largest sector in terms of total output.

Moreover, “GDP growth” is really not informative with respect to whether or not the activity measured is profitable and therefore indicating that wealth is created. Given that government consumption is a major component of GDP, there is obviously a lot of wasteful spending that is counted as “growth”.


Lake Wobegone 600

“Well, that’s the news from Lake Wobegon, where all the women are strong, all the men are good looking, and all the children are above average.” Waaay above average! (h/t BC)

Image credit: Garrison Keillor



Furthermore, in a bubble era, when credit expansion ex nihilo is running wild, a lot of investment in fixed assets will eventually be discovered to have been malinvestment. Such spending is also added to “growth” while it occurs, but in reality, it is just a waste of scarce capital. Simply put, there isn’t much worth measuring, because the truly important things cannot really be measured anyway. Even so, it makes a lot more sense to occasionally look at the gross output tables per industry rather than GDP.

Now let us think for a moment about Wednesday’s quarterly GDP report. What does it even mean that the economy has allegedly grown by “0.2%”? This strikes us as a completely absurd number. Given that it actually represents quarterly growth annualized, it means that “real growth” last quarter was 0.05%. Really? Someone has measured the economic output of the entire country and found out it grew by 5 basis points? This sounds like a tiny fraction of the margin for error rather than a meaningful number.

Real growth is determined by discounting nominal growth by the so-called “GDP deflator”. This is a magical number if ever there was one. Almost like God, it moves in exceedingly mysterious ways. One reason the deflator (which is currently declining, and hence boosting real GDP) is often so hard to believe for many people, is its partly self-referential nature.

Let’s think about this for a moment: the Fed inflates the money supply, and relative prices in the economy inevitably begin to shift. This means that the prices of some goods will rise faster than those of others, and some prices may even fall slightly. The deflator is calculated by weighing these price changes by actual spending patterns. Sounds sensible, right? It isn’t really. Consider a hypothetical example. A housewife of modest means enters the supermarket with the intention to buy beef. But then she notices that the price of beef has gone up by 50% and decides to buy chicken instead, the price of which has only risen by 10%. She isn’t doing this because she suddenly likes chicken better, she is doing it because a particular effect of monetary inflation has left her with no other choice.

Since more chicken than beef is now bought everywhere by people in a similar situation, the price deflator will give greater weight to the cheaper product and smaller weight to the more expensive one. In the end it is saying: inflation hasn’t impoverished you as much as you think. So the Fed inflates, which affects prices and artificially influences buying patterns, in the process lowering the living standard of everyone who isn’t in society’s top strata of income and wealth. These patterns are then used to claim that prices have actually increased a lot less than everybody thinks. Thereafter, the result of these calculations is used to flatter “real GDP”!


Price deflatorThe PCE index, which is the implicit price deflator used to calculate real GDP – click to enlarge.


Essentially economic statistics gathered by governments have two functions. Firstly, they are used for propaganda, by usually indicating that things are better than they really are. It’s just your bad luck citizen, that the economy feels crappy to you. It’s great for everybody else! Look at these numbers, they prove that statism is working!

Secondly, they serve as a justification for government intervention in the economy. If the Fed couldn’t point to the unemployment rate, it would have no reason to print money to “fight unemployment”. Not to mention that institutional, non-voluntary (or non-catallactic) unemployment exists for one reason only: government intervention in the economy!

Finally, the deflator, like every other “inflation” measure, measures something that is inherently unmeasurable. If both the supply of money and the demand for money were utterly fixed, then we would have a constant by which we could “measure” prices (even though we would still not be able to overcome the problem that calculating the “general level of prices” requires us to add up the prices of countless disparate goods and services. What does it mean to calculate the average of two haircuts, a bag of potatoes and 1/30000 of a car?).

Such constants don’t exist in the real world of human action. Human beings are not inanimate objects. They have volition and act with purpose. The logical structure of the human mind and the fact that humans act with purpose allow us to construct an economic theory based on logical deduction. However, the only “constant” that exists in the economy of the real world is “constant change”. There are simply no fixed yardsticks. Models of an economy in equilibrium – the state the economy always tends toward but never reaches – are useful in order to elucidate and comprehend economic laws. But these models do not represent the real world. Economics is not physics.


If Wishes Were Horses …

Let us get back to Wednesday’s GDP report. The report as such, weak as it was (in spite of being greatly improved by the weakness in the deflator), is not really worth talking about much. It certainly shouldn’t have surprised anyone, but it did. It was blindingly obvious for weeks that the report would be weak, except to mainstream economists taking part in the Bloomberg survey (or any other survey for that matter). Their consensus estimate was bound to “miss” by a few metaphorical light years. This perennial overoptimism is par for the course, but it still leaves us stumped. Virtually all economic data points have been weakening sharply in recent months. It wasn’t really difficult to guess that the number would be very weak, especially with the Atlanta Fed’s “GDP Now” data showing the way. We have no idea what these economists were looking at.


real GDPReal GDP growth (quarterly annualized) as reported by the department of commerce.


As an side to this, the science of economics has absolutely nothing to do with making “predictions” anyway, except in the most generalized, constrained by economic laws manner. Forecasting next month’s retail sales growth, or GDP, or any other government statistic to within a decimal point isn’t the task of economists, it is the task of soothsayers. The only people in the world who are able – and predestined – to occasionally make useful predictions are successful entrepreneurs and speculators. However, they need to have no knowledge of economics for this purpose, they only need talent and a willingness to put in some effort.

With that out of the way, what is there worth talking about in connection with yesterday’s report? We have been careful not to go overboard with a bearish economic outlook, in light of the sharp growth in commercial bank credit in recent months. This has offset the end of “QE” and has kept money supply growth at fairly bubbly levels. There have been two previous occasions since 2009 when it looked like the economy might tip into recession, but in both instances activity was boosted in the nick of time by more money printing. It matters not whether the Fed or the commercial banks are doing it (well, it does matter in some ways). What matters most is whether bubble activities are kept on artificial life support or not.

Anyway, what we find so astonishing is that a great many economists are now insisting that everything will be copacetic from here on out. How do they know? Since none of them ever mention the money supply, they are just guessers in our opinion, and usually not very good ones. One of the economists quoted below at least admits that they got it totally wrong in their previous round of guessing.

As Marketwatch reports:


“Here are reactions from economists to news that growth slumped to a disappointing 0.2% annual rate in the first quarter.

  • Despite the sharp deceleration in Q1, we remain upbeat about the outlook for growth in the US. We expect the economy will rebound in Q2 and beyond, similar to last year. Underscoring the risks of extrapolating the Q1 weakness forward, we note that, excluding trade, inventories, and government spending, the private domestic economy grew 1.1% annualized in Q1. In 2014, that metric rose similarly in the first quarter (+1.0% annualized) and then advanced by an average of 4.1% annualized over the remaining three quarters of the year.” —Michelle Girard, RBS Securities
  • “For now this is a huge negative for a Fed that is looking to normalize rates. The economy is not in a period of acceleration as previously thought. Now it is hard to pin down where growth will settle, let alone when the Fed can consider rate hikes again.”— Robert Brusca, FAO Economics.
  • Our research suggests GDP is likely to rebound in the second quarter led by a pick-up in consumer spending. However, inflationary pressures remain modest and core price indexes are expected to remain below Fed targets for the next few quarters. Fed policy is likely on hold until well into the second half given the slow pace of economic activity and below-target increases in prices.”— Bob Hughes, American Institute for Economic Research.
  • You were forewarned, first quarter economic activity was not pretty. But that was pretty ugly. But the positive takeaway is that all of the temporary factors that held activity back were just that…temporary.” — Jennifer Lee, BMO Capital Markets


(emphasis added)

Everybody has blamed the allegedly extremely cold winter weather for the economy’s poor performance again this year (one of those ”temporary factors”), but except for one month, the winter seemed pretty normal – in fact, overall, it was probably warmer than the average winter. As an aside to this, one David Burge recently made this not unreasonable comment in a tweet:


Screen-Shot-2015-04-29-at-4.08.26-PMA case of trying to have it both ways …


We are struck by the nonchalance with which economists – including those working for the Fed judging from yesterday’s FOMC statement – are assuming that this year will be an exact replay of last year. Again, how would they know? What if there is no rebound from the weakness this time? We are not saying that this will be the case – but we do know one thing: this year is not like last year at all.

Let us count the ways: oil prices have collapsed, leaving the “shale states” which have delivered the bulk of capital spending and employment growth in dire straits. The financial market bubble is a good sight bigger than a year ago. In Europe, some €3 trillion in government bonds trade at negative yields to maturity. The S&P 500 CAPE has reached the third highest level since 1870. Corporate earnings growth has just turned negative (in spite of many companies “beating the Street”, which has lowered the hurdle countless times). One seventh of the junk bond market consists of bonds issued by energy companies. Once their hedges run off, a wave of defaults is likely to hit unless oil prices recover sharply in the meantime (however, oil inventories keep growing day in day out – prices might recover anyway, but there seems to be a limit to this for the moment).

So why would anyone assume that this year’s economic trends will be an exact replica of last year’s? It simply makes no sense. It seems however definitely possible that the above mentioned nonchalance exhibited by mainstream economists will turn out to be a contrary indicator.



One should watch very closely what happens with some of the more reliable economic indicators, such as certain components of the PMI indexes (e.g. new orders to name a very important one), non-residential fixed investment, and above all the growth of the supply of money and credit. After years of unprecedented monetary pumping, the economy is undoubtedly structurally much weaker than seems to be widely assumed. Perhaps the time for a strong cyclical downturn is now finally at hand as well.


TMS-2US money supply TMS-2: Approaching the $11 trillion mark as of the end of March 2015, more than double the $5.3 trn. at the beginning of 2008. Since the year 2000, it is up about 265% – click to enlarge.


Charts by: Marketwatch, St. Louis Federal Reserve Research