John Hussman: Growth in 'Potential GDP' Shows Limited Potential

Excerpt from the Hussman Funds' Weekly Market Comment (8/17/09):

Stocks are currently overvalued, which – if the recession is indeed over – makes the present situation an outlier. Unfortunately, since valuations and subsequent returns go hand in hand, the likelihood is that the probable returns over the coming years will also be a disappointingly low outlier. In short, we should not assume, even if the recession is ending, that above average multi-year returns will follow.

That conclusion is also supported by another driver of market returns in the years following U.S. recessions: prospective GDP growth. Every quarter, the U.S. Department of Commerce releases an estimate of what is known as “potential GDP,” as well as estimates of future potential GDP for the decade ahead. These estimates are based on the U.S. capital stock, projected labor force growth, population trends, productivity, and other variables. As the Commerce Department notes, potential GDP isn't a ceiling on output, but is instead a measure of maximum sustainable output.

The comparison between actual and potential GDP is frequently referred to as the “output gap.” Generally, U.S. recessions have created a significant output gap, as the recent one has done. Combined with demographic factors like strong expected labor force growth, this output gap has resulted in above-average real GDP growth in the years following the recession.

The chart below shows the 10-year growth rates in actual and potential GDP since 1949 (the first year that data are available).

The blue line presents actual growth in real U.S. GDP in the decade following each point in time. This line ends a decade ago for obvious reasons. The red line presents the 10-year projected growth of “potential” real GDP. This line is much smoother, because the measure of potential GDP is not concerned with fluctuations in economic growth, only the amount of output that the economy is capable of producing at relatively full utilization of resources.

One of the things to notice immediately is that because of demographics and other factors, projected 10-year growth in potential GDP has never been lower. This is not based on credit conditions or other prevailing concerns related to the recent economic downturn. Rather, it is a structural feature of the U.S. economy here, and has important implications for the sort of economic growth we should expect in the decade ahead.

Comments

[Tony Petroski:]

"One of the things to notice immediately is that because of demographics and other factors, projected 10-year growth in potential GDP has never been lower. This is not based on credit conditions or other prevailing concerns related to the recent economic downturn. Rather, it is a structural feature of the U.S. economy here, and has important implications for the sort of economic growth we should expect in the decade ahead."

Yes?

Aug 17 12:10 PM

[CautiousInv...:]

As always, interesting information based upon thought and analysis as opposed to wifhful thinking.

If the Commerce Department does not include the very likley increase savings needed to liquidate personal debt, growth in potential GDP could be yet lower. And if you layer in structural and widespread underutilization of economic infrastructure, it would pull it down even further because of reduced need for investment.

I don't want to come off as arrogant, but why cannot others see what is so obviously evident and the attending challenges?







Every quarter, the U.S. Department of Commerce releases an estimate of what is known as “potential GDP,” as well as estimates of future potential GDP for the decade ahead. These estimates are based on the U.S. capital stock, projected labor force growth, population trends, productivity, and other variables. As the Commerce Department notes, potential GDP isn't a ceiling on output, but is instead a measure of maximum sustainable output.

Aug 17 12:14 PM

[John Galt:]

I'll complain as much as everybody about what's going on but this isn't really new news.

YES, I see that downward sloping potential GDP output but you'd see those slower growth rates with any of the first world economies. The developing economies grow faster than the developed economies.

If you want to look at democraphics, the USA's birthrates are higher than the rest of the developed world, 13.82 births per 1,000 people, where as you have countries like Germany, Japan, France, Italy, Spain, South Korea all in the 7, 8, 9 range per 1,000. Then consider our elevated immigration rates and the USA is the youngest developed economy. Lower media age, higher birth rates, higher immigration, more people 0-14 years old, less people 65+ etc.

This current recession/depression has also wiped away a lot of wealth. Now why does that matter? I'm not sure if your data considers it but what if Joe Public Baby Boomer was 62 years old and wanted to retire in 3 years. Well, you remember all that wealth he had tied up to the value of his home and the value of his 401K? That retirement in 3 years just got pushed back as he is forced to continue to work.

Wealth destruction for our largest and most productive producers = more worker bees for longer than they were planning.

It's some interesting stuff and I'm bearish like many, but I'm sure if you picked up the same stats for Japan, Germany, UK etc. you'd see that similar downward slope on their potential GDP.

Aug 17 02:25 PM

[enigmaman:]

You said "In short, we should not assume, even if the recession is ending, that above average multi-year returns will follow"

4 reasons why- increase in taxes, Fed fund rates, inflation and consumer frugality - strong GDP coming out of past recessions did not have these head winds, like they say " Dont fight the Fed,

Aug 17 07:00 PM

[expat in China:]

"10 Year actual" is 8 years old data?

is there an later release?

Aug 17 07:02 PM

[conceptwizard:]

For political reasons 75% of the stimulus will be spent in 2010, an election year, and some in 2011. Politics screwed up the package and we will never know if it would have been successful. The one-third devoted to tax cuts has been a loser just as the checks to citizens was. Banks seeing what is going on won’t lend easily in a depression. At the same time consumers are reluctant to borrow. Only business is in the mood to borrow and that is just to keep things going.

If you step back and look at what the Fed and government has done you will see they have spent trillions bailing out Wall Street, banking and insurance, as well as the auto sector. This is called corporate welfare. The recipients contend if they go down the system goes down and they are right. We believe they should have been allowed to fail. They were the ones lending 50 times assets while playing in a grand casino. Taxpayers will never get that money back and they will be forced to pay that principal and interest to foreign lenders over many years. You might also notice that only a few crumbs were thrown to the public.

Even if there is a second stimulus plan it won’t work. All it will do is buy more time, just as increased bank lending will. The victim is the dollar. It simply has to fall and as it does real interest rates will rise and the market will fall. Monetization will create more inflation and lending by foreigners will dry up forcing further monetization. A vicious circle that will end in hyperinflation. No one is willing to bite the bullet and that is what it takes to solve this problem. Even Joe Stiglitz wants the Keynesian solution, which will be much worse than it has to be.

As the financial “experts” continue to attempt to spend us out of depression the US financial authorities want foreign banks to do what the Fed has done, that is stuff banks with money, there is a virtual bank war going on. The Europeans are saying no and that is an impasse that will be the hot topic of discussion at the up and coming G-20 meeting in London. The ECB has already moved into a more conservative position by cutting back on the issuance of money and credit to 4.7% and by not lowering interest rates to 1%. Moving in the opposite direction are the British banks, such as HSBC, which in behalf of the black nobility is dictating what JP Morgan Chase and BoA should be doing. They have just created new market bubbles on the FTSE and the NYSE and when they break the fall will be resounding.

Aug 17 09:33 PM