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Stephen Graves
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Writer, filmmaker, citizen.
  • The Future of US GDP Growth 0 comments
    Jan 13, 2011 2:07 PM
         While forecasting economic growth is inherently hypothetical there is one tool which is far more valuable than all the others, even when combined, in this admittedly precarious endeavor. It’s not the latest quarterly GDP estimate, the impact of private inventories or the trade deficit, nor even the most recent trends in industrial capacity utilization and/or intermodal traffic shipments. While these are each commendable measures in their own right, they pale in comparison to the most neglected tool in our economic growth forecasting arsenal: THE PAST. Predicting the growth of an economy, it turns out, is much like predicting the behavior of any other complex system. The most effective strategy is to identify patterns within the historical data which we can then project as trends into the future. The more distinctive the pattern, the more accurate our trend line projection generally becomes. It’s not rocket science, and it’s definitely far from perfect – the future remains uncertain for the obvious reason that it has yet to occur - but utilizing the historical record to predict a future outcome is usually as good as it gets.  
        If our objective, for example, was to predict the average annual rate of US GDP growth for the current decade (ending 2019), our first task would be to select a sufficient quantity of data from previous decades. Since the Great Depression was arguably anomalous - growth in the 1930s averaged a meager 1.3 percent - while the Second World War was clearly anomalous in the opposite sense – US GDP grew at more than ten times that rate between 1940 and 1945 - a reasonable point to begin our analysis might be with the first full decade of the post-war era. The 1950s through the 2000s, six consecutive decades, should provide an adequate period to divulge any significant trend in US economic growth.
         Our next task would be to establish the average annual growth rates for each decade prior to the decade we're endeavoring to forecast. This is achieved by simply adding together each decade’s annually recorded growth rates (GDP figures compiled by the Department of Commerce's Bureau of Economic Analysis) then dividing their sums by ten:
    1950s (1950-1959):              4.17 percent
    1960s (1960-1969):              4.44 percent
    1970s (1970-1979):              3.26 percent
    1980s (1980-1989):              3.05 percent
    1990s (1990-1999):              3.2   percent
    2000s (2000-2009):              1.82 percent
         The rationale for averaging growth rates per decade is two-fold. First, it enables us to smooth out the short-term effects of recessions in order to provide a more comprehensive impression of each decade’s growth. And second, averaging per decade anticipates our objective of estimating the present decade’s average growth rate. A crude visual representation of the data would look something like this:
          The red trend line above suggests that the average annual rate of US GDP growth from 2010 to 2019 will be in the range of 1.75 percent. This may seem like a paltry figure, especially considering the well publicized predictions of three to four percent – America’s so-called ‘historical average’ – and yet this is clearly what the data seems to indicate. But why would such a flagrant discrepancy exist between the body of actual data and the general consensus of expert opinion? Are the experts simply missing something, or is the data somehow misleading? Or – and this is where we shall expend the balance of our inquiry – is the answer in both instances an unflinching albeit paradoxical yes?
    I. What the experts are missing
        Despite their obsession with statistics and their obvious fondness of leading indicators, most of our economic experts are miraculously oblivious to history as an actual living, breathing process. Their predictions for GDP growth reflect an almost mystical conviction that the US is the greatest economic power in the history of the world, unique among nations. To be sure, they counsel, we face the same challenges from China and other emerging nations that all aging democracies share, but America is special. If we can merely summon the political will to establish the right programs, find the proper balance between tax cuts and spending reductions, stimulate the private sector until it sufficiently revives, etc., then the American economic juggernaut will invariably rise again. However vehemently they may disagree over the appropriate formula for renewal – i.e., the endless squabble between Keynesians and conservatives – they share a faith in the outcome providing their formula is duly embraced. It's a swaggering consensus which gives lip service to history (the experts are basically saying that America will be great in the future simply because it has been great in the past) while ignoring the profound changes that the passage of time tends to yield.
         Consider the US at the conclusion of the Second World War: 
    1.) As a result of the enormous arms build up, approximately half of the world’s industrial capacity resided on US soil.
    2.) We possessed two-thirds of the known gold reserves on the planet (as opposed to approximately 5 percent today).
    3.) To help fund the war effort 85 million Americans had “saved” $185.7 billion by purchasing bonds (equivalent to Americans saving $2.26 trillion today).
    4.) A half decade of rationing, not to mention the Great Depression which preceded it, had pent up an overwhelming reservoir of consumer demand.
    5.) Our primary economic competitors had all been ravaged by warfare while US infrastructure had survived the conflict unscathed.
           When had any nation, since the dawn of the industrial age, enjoyed such a staggering advantage over every other nation? It had never happened before and almost certainly never will again, so it is little surprise that such an unprecedented advantage would subsequently translate into an era of unparalleled growth and prosperity. By the 1970s, however, the world was catching up. US economic hegemony was being directly challenged by rival powers and US industries, many of which had slackened into complacent oligopolies, were often slow to adapt to foreign competition. For their part, US workers, whose wages and benefits had soared during the boom years, were increasingly forced to compete with cheap foreign labor. Add to this the unfortunate fact that America’s oil supply had peaked in 1970 as domestic energy needs soared and the colonial grip on the Middle East waned, and the vine was ripe for stagflation as President Carter urged his reluctant fellow Americans to “face the truth” in his infamous Malaise Speech of 1979. 
          The point is that the declining US economic growth which began in the 1970s and continued into the late twentieth century was to a large extent the natural consequence of an evolving global dynamic. It was more or less unavoidable after such an astounding period of growth. For experts today to predict that growth in the current decade will be roughly the same as those in the post-war period – we averaged 3.85 percent between 1950 and 1975 - is therefore borderline delusional. The US isn’t the same, the world isn’t the same, literally nothing is the same. In terms of predicting US growth, in other words, our much celebrated historical average is relatively meaningless compared to the actual historical processes which have led directly to the present moment. Yesterday's success is no guarantee of tomorrow's prosperity. 
    II. Why the data is also misleading 
           With the post-war boom a mere memory, the US economy embarked upon a new era. The following graph, courtesy of the Federal Reserve, perhaps illustrates this era as effectively as anything else.
          The four lines above tell the tale of US debt - federal (black), household (blue), financial (red) and non-financial business (green) – from 1950 to 2010. Until the 1970s these lines had hardly diverged from the zero point, but by the early 1980s they were all off and running. Their conjoined spree is dramatically summarized by a second chart, also courtesy of the Federal Reserve.

         Not surprisingly, the level of debt in the US began rising on the heels of the mid-1970s recession and the rate of this rise
    accelerated following each recession thereafter; note how the curve in the chart above turns especially steep in the late 1990s and steeper still in the frothy 2000s. By mid-2010, the most recent point for which comparative records exist, the ratio of total US debt ($52.28 trillion) to GDP ($14.58 trillion) had risen to an alarming 359 percent. For purposes of comparison, in 1933, amidst the punishing depths of the Great Depression, this figure had peaked at around 300 percent and it was only half of where it stands today at the conclusion of the Second World War. Even the recent decline in private sector debt on the heels of the financial crisis of 2008 has been largely offset by the elevated rise in public sector debt (the black line from the previous chart). The US economy is behaving much like an addict; remove the steady infusion of debt and the addict risks collapse. And while our lawmakers and pundits debate whether or not this mountain of debt threatens to eventually undermine the US economy, virtually none of them are willing to acknowledge the elephant in the room: the obvious fact that this same mountain of debt is what has sustained US economic growth for decades. Since the post-war boom began to fizzle in the 1970s the US has been bankrolled by the relentless accumulation of debt. 
         We’re beginning to see how the data, which is theoretically objective, might ultimately mislead. The U.S. boomed after the Second World War, endured a challenging decade as the economy globalized and then, instead of adapting - perhaps cutting back, modifying its expectations, etc. - the nation opted for business as usual. The only way to achieve business as usual, however, was to rely increasingly on credit. Remember that last full decade of growth, 2000-2009, which official statistics recorded at 1.82 percent? It turns out that Mortgage Equity Withdrawals (MEWs) represented the lion’s share of that growth, as the following chart makes abundantly clear.

         The largest housing bubble in US history was wildly inflating home values and the American people were happily extracting hundreds of billions in home equity cash that was veritably gushing from these wildly inflated values. In 2006, at the peak of the bubble, MEWs were equivalent to an alarming 70 percent of US GDP growth. Then of course the bubble burst. According to the Federal Reserve, from the beginning of 2006 to the end of 2008 owners' equity in household real estate plunged by over $7.5 trillion - an astounding $2.7 trillion more than the US economy would grow in the entire decade. And while owners' equity has recovered somewhat from that low (but is once again beginning to fall) the same cannot be said for MEWs, which had turned distinctly negative by mid-2008 (see the graph above). In just the first three quarters of 2010, as Americans were paying off some of the debt they had amassed during the boom years, MEWs had metastasized into a $348 billion drag on the US economy. This could be significant for the current decade's prospects considering that the average annual GDP growth in the 2000s, minus MEWs, would have been considerably less than one percent. And what would happen to that revised growth rate if we were to factor in a mere fraction of the irrationally exuberant construction and everything that came along with it?  One could make the argument that last decade's growth, had the housing bubble not occurred, could easily have been less than zero
         And yet the historic housing bubble hasn't been the only thing beguiling the US economy in recent years, has it? Have we already forgotten about the largest stock market bubble in US history that super-sized the 1990s? The US economy has been feasting on debt for more than a generation and the symptoms of this dependence have materialized in not one but two of the largest financial bubbles in US history in the span of a single decade. How much of the "growth" of the 1990s was simply a farce subsidized by the ever spiraling insanity of an overblown equities market? Should the trillions that vanished when that bubble burst be somehow factored into our official figures of economic growth? What would the growth rate in the 1990s have been without the largest stock market bubble in US history? Half of 3.2 percent? Or is that still too generous? Envision, if you will, what a revised chart of US GDP growth might look like if we sought to neutralize the ephemeral effects of these recent financial perversions:
         Whether or not the reader appreciates this revisionary experiment is really not the issue. For it is virtually undeniable that the data is misleading - only not in the way, perhaps, that our economic experts might suspect. The official figures of US GDP growth over the last two decades have been consistently exaggerated by the incendiary combination of skyrocketing debt, which any sane individual agrees cannot last indefinitely, and wildly speculative bubbles, which history proves are ultimately ruinous. The recent cycles of boom and bust are simply not comparable, qualitatively or ultimately quantitatively, to the sustained economic growth of the post-war era, which makes predictions of 3 to 4 percent growth even more ludicrous than they were when they were simply "based" upon official figures. In lieu of something genuinely miraculous occurring – benevolent aliens offering us exclusive rights to their superior technology, perhaps – it is difficult to imagine the US suddenly generating robust economic growth over a sustained period any time soon. If the lessons of history are of any value whatsoever the chances of this seem astonishingly remote.
          The US economy is venturing into choppy seas. Consumers, whose spending generates some 70 percent of it, are deleveraging at what can only be described as a frantic pace; in addition to MEWs, revolving credit has plunged by nearly 20 percent since late 2008. The good ole days when low-paid employees at Walmart could use plastic to purchase an endless stream of goods manufactured in China and conveniently mechandised by their employer are officially behind us. State and local budget crises have already begun to ripple throughout the economy and even the lofty federal government, which recently announced a record-setting $1.5 trillion deficit, will eventually be forced, no doubt kicking and screaming, to join this deleveraging stampede. Long before our national debt reaches $20 trillion, which will occur in 2016 according to the Congressional Budget Office, the bond market is sure to impose its own brand of discipline upon our hapless politicians. Hanging a banner across the deck declaring that the crisis has passed does not necessarily make it so.

    Smart money, stupid times

         The smart money,
    of course, understands all this. It realizes that that which is inevitable cannot be postponed indefinitely - that Quantitative Easing is really just a fancy way of saying you're kicking the can down the road. While the smart money will undoubtedly reap its share of short-term profits from a rising stock market, it will also keep an eye on the price of gold which will likely fall further as equities advance. And as the present sigh of relief from the so-called recovery gradually escalates into euphoria - if indeed it gets that far, this time - the smart money will quietly increase its position in gold to ensure that when this bubble invariably bursts it will have something tangible to grasp. Once equities have been thoroughly subdued, moroever, when the mainstream media is finally proclaiming that the end is nigh, the smart money will happily accommodate by scooping up value. Solid companies that form the bedrock of the economy will, as always in such circumstances, be available at discount prices. The smart money, well acquainted with history, has seen this all before. 
        When the panic eventually spreads to the bond market - whether this follows or precipitates equities is more or less beside the point - the smart money will be prepared for this as well. Well aware of the effect that soaring interest rates will have upon housing values, for example, the smart money will not leave itself vulnerable to such an overwhelming probability. As interest rates rise (and especially as they overshoot their historical norms) the smart money will also begin to invest in long-term US government debt, because it realizes that as bad as the crisis becomes it will eventually subside. Austerity measures will be taken if for no other reason than they must be taken, and when the carnage passes interest rates, impelled by the obligatory economic inertia that results from such events, will fall. Before that occurs, however, the smart money will seek to lock in a high rate of return for years to come which, if nothing else, will provide an excellent hedge against inflation.
          The moral of the story, from an investment perspective, is simple: It never hurts to see it coming. The worst investment strategy in such precarious times as our own is to embrace the conventional wisdom and to trust the powers-that-be; for both seek nothing more than a return to the relatively recent past. Their obsession with that objective, moreover, both distorts their perception of the past and undermines their ability to envision (let alone prepare for) the future. Thus, the smart money accepts the fact that, for better or worse, it is generally on its own. And considering the enthusiasm with which the lemmings seem to be racing towards the next cliff on the horizon, this independence may not necessarily be such a bad thing. 


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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