U.S. Economic Growth Deconstructed

I had planned a review of the UK economy and stock market, but I was overtaken by the news that the US economy ‘grew’ by 0.9 percent in the third quarter. A fairly typical explanation for the growth can be found in a Telegraph article as follows:

The primary reason US economic output has rebounded so strongly is the slug of growth contributed by state programmes, including "cash-for-clunkers" and similar stimulus schemes.

As such, I thought it might be worthwhile to return to the well worn subject of GDP growth. What we are seeing is the mirage and magic of statistics. I will explain this as clearly and simply as I am able through an analogy, and show why this is all 'magic' growth.

Imagine that I am a farmer, and that my output of food is not quite enough to feed my family. As a result, I have frequently turned to my neighbour, who has each year lent me enough food to make up for the shortfall. As each year goes by, I am borrowing more and more from my neighbour, and I am starting to owe him a great amount of food overall. Finally, one year, a river floods and damages many of my crops and drowns some of my animals. My output is reduced to an even lower level, and I am going to struggle to meet my family’s needs.

Once again, I turn to my neighbour, and ask to borrow even more food to take my family through the next year. He agrees and loans even more food than on previous occasions, and I add the borrowed food to the store of my own farm’s output in the barn. At the same time, I also do something to address the problem of the shortage. I decide to change the systems of measuring the output of my farm. For example, instead of counting my units of corn in whole kilograms, I change the units so that one unit becomes three quarters of a kilogram. With my new system, I now measure my output from the current year as all of the food in the barn, and find that I have increased my output of units of food overall for the year.

I look at the large pile of food in the barn and behold that despite the problems of my lack of output of food I have actually achieved an increase in output. There are more units of food in the barn than in comparison with the previous year.

As my generous neighbour is lending me so much food, he comes around to visit my barn, and see how I am running things. As reassurance, I count out my units of output, and show him how much my output has increased. I am very pleased with myself, and I smile with pleasure as I count the units. Then I note that my neighbour is frowning and I am puzzled to find that my neighbour does not share my pleasure.

He asks whether I am going to repay him in the old units of kilograms or the new units of three quarter kilograms. Now I start to frown, and suggest that he does not understand the situation. For every unit he has lent me I will, of course, return one unit as a repayment. I am a little grumpy. Can he not see that my output has grown? Can he not see that, if I can keep up this rate of growth, I will achieve a level of output that will allow me to easily pay him his food back? I wonder at his lack of confidence in me when I have demonstrably improved my output.

I am left wondering that my neighbour simply does not understand output. My neighbour is left wondering how much longer he will continue to lend me food.

Note:

I finally got around to reading this week's copy of the Economist magazine. On reading the magazine, I was struck how many of my views which were previously considered radical (if not barking mad), are now mainstream. There was even one section where they contrasted financial wealth with 'real' wealth, which is almost a perfect mirror of my first article, 'A Funny View of Wealth' (which predicted the economic crisis in the UK). The Economist also addressed the relationship between the US and China, and much of their analysis mirrors the analysis I offered a long time ago (though with different outcomes), and the same applies to the prospects for the $US (again with different outcomes).

I should also mention that I predicted a $US collapse for April of this year and got it wrong. However, the possibility of a $US collapse is now being discussed in the mainstream. What I am really saying is that, in about 6 months time (a wild guess), expect to be reading that the growth in the US economy was not genuine growth at all.

Comments

[TradingHelpDesk]

Good article.

The US GDP data was better than expected but I couldn't see much real sustainble economic growth in there. Just froth and stimulus. Neither of which bodes well for 2010 and beyond with the US carrying $11 trillion of debt.

The UK is even worse shape and didn't even post positive GDP despite the BoE and Labour government chucking hundreds of billions in printed money at the banks.

www.dukascopy.com/iben...

2009 Nov 01 09:30 AM

[Dave Wrixon]

"What I am really saying is that, in about 6 months time (a wild guess), expect to be reading that the growth in the US economy was not genuine growth at all."

I think some of us actually concluded that a couple of years back. But rather than admit being in trouble, they have simply maxed out their sovereign credit card.

2009 Nov 01 11:22 AM

[Dave Wrixon]

Of course the moral to the story is that if you endlessly extend your lines of credit, eventually your lenders come to the conclusion you are a complete tosser, which adversely affects your credit rating.

2009 Nov 01 11:28 AM

[Cynicus Economicus]

Dave and Trading Help: I agree that many of us have been concerned about the real wealth generated in the UK and US economies, and 'yes', the UK is truly frightening. If there is no 'growth' with this level of borrowing, what is the true state of the UK economy?

2009 Nov 01 11:39 PM

[Salacious]

Enjoyed your metaphor you introduced here, it does put things into a frightening clarity. Just another reason I'm glad my money is invested all over the place, not just domestically.

2009 Nov 02 09:29 PM

[W.D.]

I would like to correlate your comment about the U.S. dollar to your "farmer" analogy. Let's suppose that you borrowed money to buy the food that you gave to the needy farmer and your own families' well being now depends upon his repayment of his "food debt" to you. Now suppose that when you visited your friend you discovered that part or all of his surplus food had been used as collateral to borrow money from the same bank that he had used to borrow his money from. Now your dilemma has become glaringly apparent. Repaying your loan has become dependent upon his ability to repay his; not just to you but to the bank as well. Furthermore, your bank (who also incidentally keeps your money as well) has agreed to accept his "new accounting" so it can maintain it's solvency. Now all of it's clients are insisting upon their share in the 'new accounting' rules. The only way the bank can hope to recoup it's losses under such a scenario is to increase the interest rate for the repayment of the loans or to increase the value of the currency. An interest rate increase would force some of the farmers into bankruptcy and create losses that might force the bank to go out of business. Now you, as the farmer, have a choice as to what you will do. Will you go along with the new accounting rules, insist on the old rules, agree to pay a higher interest rate on all loans or borrow your money using a different currency. Oh, one more thing, ALL FOOD UNITS are valued under the currency that your bank uses now. This is a much closer analogy to what we now have facing us in today's Global Economy.

2009 Nov 22 07:00 PM