Is the GDP report really all that good?

The wire services and the stock market are both taking the revised 2006Q3 US GDP report as an overall good sign that the US economy is on track for the fabled "soft landing". Mark Zandi sums up the general sentiment well:

"It was a tough quarter, but not as tough as previously estimated," said Mark Zandi, chief economist at Moody's Economy.com. "But there's reason to be optimistic that the expansion will remain intact. With businesses so flush with profits, they will continue to invest and hire and the economy will continue to move forward," he predicted.

A close look at the revised numbers does indeed show that nonresidential investment surged ahead in the third quarter at an annualized 9.6% rate. Of course, this only just balanced out the rather stunning -19.4% annual change in residential investment. Overall, gross private domestic investment rose in the third quarter a microscopic 0.04% annualized, and over the last two quarter a meagre 0.5% annualized.

With overall investment at a standstill thanks to the housing market collapse, the economy has unfortunately become ever more dependent on consumer spending, which motivates the title of this posting. From 1983 to 1999, personal consumption expenditures as a percentage of GDP reguarly hit a ceiling of 68%. The big shift came during the bursting tech bubble in 2000 and the investment-led recession of 2001. Once the dust settled in 2002, the US economy found itself profoundly reliant on consumer spending as never before. Ever since 2001Q4, consumer spending has been at least 70% of US GDP as the below graph shows.

The result? A tremendously falling savings rate both in households and government, and a concomitant reliance on external savers to fund US investment (and consumption), producing current account deficits of 6.6% of GDP and tremendous pressure on the US dollar, which has fallen (on the major currencies index) some 3% in just 7 weeks.

From its peak in 2005Q2, the US economy's reliance on consumer spending began to relax. The percentage of GDP composed of personal consumption expenditures fell or remained steady each quarter after that -- until now. 2006Q3 saw this figure rise yet again, to 70.84%. The personal savings rate for 2006Q3 rang in at -1.3%, only slightly better [sic] than last quarter's -1.4%.

Quite frankly, the US economy needs to be shifting into saving, not yet more consumption. If it doesn't, the chances of a dollar crash becoming increasingly likely. In 2004 Paul Volcker claimed there was a 75% chance of a "dollar crisis" within five years. In the wake of this quickly declining dollar, it's about time we did something to avoid that most unpleasant of scenarios.

Under pressure

“The dollar is coming under real pressure and this looks like the beginning of a sustained move,” said Ian Stannard, strategist at BNP Paribas.

Productivity is as productivity does

One of my students recently wrote a paper on international labor standards. The primary foundation of his claim that they are not only unnecessary but actually harmful was that there is a very tight relationship between productivity and wages (or more broadly, labor compensation). Thus labor standards will only drive up wages higher than productivity levels will allow, forcing capital to abandon this now higher-cost labor and harm workers' interests overall. In short, there's just no escaping the laws handed down by productivity -- either by labor or capital.

Our measurement of the relationship between productivity and compensation is heavily influenced by the price indexes we use. While poking around the web, I found this on the blog of the esteemed Greg Mankiw (you remember him, don't you? Greg "Former Chair of Dubya's Council of Economic Advisors" Mankiw? Greg "Outsourcing is just a new way of doing international trade" Mankiw? Ah, now you remember . . .):

The price index is important. Productivity is calculated from output data. From the standpoint of testing basic theory, the right deflator to use to calculate real wages is the price deflator for output. Sometimes, however, real wages are deflated using a consumption deflator, rather than an output deflator. To see why this matters, suppose (hypothetically) the price of an imported good such as oil were to rise significantly. A consumption price index would rise relative to an output price index. Real wages computed with a consumption price index would fall compared with productivity. But this does not disprove the theory: It just means the wrong price index has been used in evaluating the theory.

And hence the broad claim from the right that there is not a compensation-productivity gap in the US (or anywhere else for that matter) because those claiming to find it are using the wrong price index -- the CPI -- when they should be using "an output deflator". Douglas "Disciple of Jagdish Bhagwati" Irwin uses the PPI in his book Free Trade Under Fire to show that there is no compensation-productivity gap at all in the US -- something my student seized upon with glee.

But hold on a minute. Productivity is defined as output per hour. So what's the price index for output? A fine question indeed.

It took some digging, but here is what the Bureau of Labor Statistics itself said back in 1999. The "deflation method" is used to calculate 93.3% of real business output (almost all the rest is by "extrapolation"). And what is the business output deflator, you ask? Well, it's a hodge-podge of several price indexes, but the largest component -- 55.9% -- is the Consumer Price Index! Yes, over half of the "output deflator" used to calculate business output per hour (which you can find right here) is actually a "consumption deflator". Well, according to Greg Mankiw that's just a great big no-no! This is despite the fact that, if we search down to little 'ol footnote 12 in the BLS document, we find out that "Based on 1997 current-dollar data, personal consumption expenditures account for about . . . 73 percent of business sector output". Only 15.1% of the business sector output price index is made up by the Producer Price Index -- you remember, the one which Douglas Irwin used to impress my student and "prove" that labor compensation closely and faithfully tracks productivity levels. Another 10.6% is made up of "BEA input-based indexes" -- which sounds like another Mankiw-banned procedure. Then we've got export and import price indexes as well as a slew of other bits and pieces to round out the family.

So what's the upshot? When Mankiw says "the right deflator to use to calculate real wages is the price deflator for output" he's talking past how output data itself is actually measured -- a majority of it using price deflators for consumption.

And the upshot of the upshot? Since 1973 there has been a significant divergence in the US between productivity growth and compensation growth when real compensation growth is deflated even by the PCE index (which understates inflation notably in comparison to the CPI). The only exceptions have been a couple of years in the late 1990s, and 2006. Don't get fooled by the likes of Mankiw, Irwin and the other apologists for capital who want to tell you otherwise.

Rampant out-of-control inflation!

You know you've fallen down the rabbit hole when you read something like this:

Eleven million homeowners are facing higher bills after the Bank of England raised interest rates to their highest for five years.

The Bank said the quarter-point hike in the base rate to 5 per cent was necessary to combat above-target inflation swollen by record increases in fuel bills. . . .

Economists warned that rates might have to rise several times - and as soon as February - to prevent inflation running out of control.

And what exactly is this terribly worrisome British inflation rate, you ask? Nearly the 11% of 1990? The 22% of 1980?! The 27% of 1975?!?! No. It is the haunting and ominous 3.6% of September 2006.


And note that this is by the Retail Prices Index (RPI) which tallies inflation significantly higher than the current favorite measure, the Consumer Price Index (CPI). Per the British CPI, inflation is running at a dangerous 2.4%. Never mind that there is not a scrap of evidence to indicate that inflation rates as high as 8% actually damage real economic growth. Yet the wise old Bank of England wants us to believe that anything over 2% CPI growth is somehow sinister and perilous.

And this is exactly the kind of crazy thinking that Ben Bernanke wants to bring to the United States.

3% as "high" inflation? Well, in Wonderland, you know, when I use a word, it means just what I choose it to mean, neither more nor less.

Is the trade deficit finally catching up with the dollar?

By now you've all heard the September 2006 US trade figures: a $64.3bn deficit, nearly 7% smaller than that of August and the smallest tally since April. Still, the 13 largest monthly trade deficits of all time have occurred during the last 13 months -- but perhaps we should concentrate on the positive.

Rather than talk about petroleum vs. non-petroleum imports or the deficit with China, I'd like to highlight something different. The United States has been running a trade deficit in the 5-6% of GDP range and a balance of payments deficit in the 6-7% of GDP range for two years now with little to no impact on the value of the dollar. Despite the tremendous downward pressure on the USD from these deficits, the ol' greenback (well, at least the $1 bill is still green) has declined nary a whit. Over the past 22 months (December 2004 to October 2006) the broad dollar index is actually up 2% in real terms and the major currencies index is up an incredible 7% in real terms.

But perhaps now, finally, this is starting to turn around.

Through the 8th of this month, the real dollar in November as measured by the broad dollar index is at its lowest point since December 2004, and current trends are likely to push it to its lowest point since October 1997. The dollar has a lot further to fall on the real major currencies index, but a further 5% slide would take the dollar per this measure down to its pre-Asian financial crisis level as well.



With the booming stock market, one would think that foreign capital would be plowing money into the US and supporting the dollar. Yet the declining dollar suggests that foreigners appetite for those juicy US Agency bonds (read: Fannie Mae and Freddie Mac mortgage-backed securities) and even treasury bonds is quickly dissipating. That and some higher-than-OECD-average US inflation suggests that perhaps now, finally, the dollar is feeling gravity's pull.

Lonely crank!

If for no other reason than this, I'm coming out of retirement (yes, again -- you'd think I was Bill Parcells or something):

For a long time there we were told not to attack the fake centrists because at least they attacked Bush, too. But that position is now untenable because it became obvious that fake centrists only attacked Bush’s means, not his ends. Fake centrist economic schemes, which were and are merely slight variances on the corporate-whoring of wingnut policies, used to only be attacked by lonely cranks like General Glut. Now Duncan Black and Thomas Frank and others attack economic Technocrat ‘Centrism’ on grounds of principle as well as on the obvious point that such policies have lost the working class for the Democrats.

That's high praise indeed. If the blogosphere doesn't need another lonely crank, I don't know what it needs!

Data update

In light of the Associated Press' (and others') strangely rosy depiction of the latest employment figures from the BLS, let's take a look at the updated employment numbers for working-age men:



As of 2006Q3, the four-quarter moving average is 83.3%, i.e. 83.3% of men age 25-64 have jobs. Not only is the four-quarter moving average apparently reaching a plateau, but the post-2001 peak is just a smidge above the 1992 nadir of 83.1% -- and far, far away from the employment levels reached in the late 80s and again in late 90s.

Apparently, however, the Fed now believes that men in their 50s and early 60s don't really need jobs anymore as so many of them are enjoying their investment largesse and spending all day golfing. Of course, they've got to sell that kind of snake oil to make these sorts of numbers look good.