Fallacy of recovery

A one-time skeptic of fiscal stimulus, [German chancellor] Ms Merkel plans what amounts to a third stimulus package worth about € 7 billion ($10.4 billion), starting on January 1st.

– The Economist, Oct. 31, 2009

The mainstream media is full of reports of economic recovery and an end to the recession of 2008, even though the Business Cycle Dating Committee of the National Bureau of Economic Research has not yet spoken its official word on the matter. The significant rise in the stock markets and a single advance GDP report has been enough to convince nearly every economist and financial analyst that the worst is past, that 10.2 percent unemployment is a lagging indicator, and that the primary concern at hand is now too much monetary and fiscal stimulus leading to inflation.

And yet, the actions of the monetary and fiscal authorities clearly belie their cheerful words. If the global economy is recovering, then why is Germany, whose 0.7 percent growth in the third quarter was widely cited last week as another proof of recovery, planning to embark on a third round of fiscal stimulus two quarters after the recovery arrived? Why is Paul Krugman declaring the need for the U.S. government to provide what he calls "a second stimulus," especially when those who can both recollect ancient history and count to two will recall that this would actually be the third U.S. stimulus package after George Bush's $168 billion stimulus plan of 2008 and Barack Obama's $787 billion stimulus plan of 2009. And why is the Federal Reserve still targeting an interest rate below 1 percent?

If the economy has recovered, then no further stimulus would be needed. Since further stimulus is required, it is therefore clear that the economy has not recovered.

TRENDING: All the bad news to which my friend is oblivious

True believers in the recovery theme will naturally point to the estimated 3.5 percent GDP growth reported in the third quarter of 2009 for the U.S. economy. But this doesn't actually prove anything. It only raises questions about the way GDP growth is calculated and the reliability of the measure's relationship to the actual economy. For example, if we ignore the estimates of government spending in the GDP report and look at the actual amount of money that the government has reported spending, it is quite clear that the relevant numbers do not add up.

In the second quarter, nominal U.S. GDP was reported at $14,151.2 billion. The second stimulus package was $787 billion, which represents an additional 5.6 percent of GDP being spent. This appears to indicate that instead of growing by 3.5 percent, the economy was actually continuing to contract by 2.1 percent, but that the contraction was masked by huge federal expenditures. Of course, economists and politicians will hastily point out that this analysis is too simple because it does not account for the fact that not all of the $787 billion had been spent by the end of the third quarter of 2009. And they would be correct to do so, because it does not.

ProPublica estimates that only 21.3 percent of what they calculate as a $792 billion stimulus has been spent, for a total expenditure of $168.7 billion. However, one must recall that to this must be added 78.7 percent of the 2008 stimulus, $132.2 billion, for a cumulative stimulus-to-date total of $301 billion, since if the 2009 stimulus is being spent in 2010, then obviously the 2008 stimulus was spent in 2009. This equals 2.1 percent of GDP; note that neither the 2008 nor the 2009 stimulus plans included the separate CARS bill, better known as Cash for Clunkers, which was passed four months after the $787 Obama stimulus. The Bureau of Economic Analysis estimated "added 1.66 percentage points to the third-quarter change in real GDP," so the net effect of these combined government stimuli comes to around 3.8 percent of GDP.

I expect even professional economists are capable of noticing that 3.8 percent is greater than 3.5 percent. Throw in the customary Keynesian "multiplier," and the situation looks even worse.

This is just an ad hoc analysis, of course, and there is no shortage of complicated theoretical models which purport to explain why a larger number is actually a smaller one, why spending more is really spending less, and why more debt is the answer to too much debt. But the salient point is that most of these models were wrong before the shocking economic contraction began and they remain wrong today. As you watch the news, remember that there are two possibilities with every economic report. The first is that the models used to produce the estimates are correct and accurately reflect the current state of the economy. The second is that they are incorrect and the increasing divergence between the reports and your observations indicates their increasing irrelevance with regards to the state of the economy.

As Steve Keen of Debtwatch has shown in detail, the two best leading indicators of reported economic growth are debt and government spending, and changes in debt are a more reliable indicator than changes in government spending. Since the amount of debt in the U.S. economy is continuing to contract at a rapid pace, this is a strong indication that the reported GDP growth is merely a temporary artifact of increased government spending, the economy has not recovered, and the desperate attempts to conceal its continued contraction will eventually fail at some point in the future, most likely before the end of 2010.