A few years ago, Paul Wallace wrote an article entitled: “GDP is a very flawed product.” The recent release of the Q2-2020 report reminded me when the media had a 7.6% impression.
“Despite its theoretical appeal, GDP is, in practice, a fallible measure. Each time it is becoming one that could be described as severely defective product.
While it looks seemingly strong, the recent report leaves a lot to be desired when looking below the surface.
Estimates lost by a mile
The 6.35% impression was one of the strongest rates of “Annualized” growth since the early 1980s. However, there are two ways to take this data. First, while the growth rate is impressive, government spending during the recession is $ 5 trillion that drove growth. (The following graph is current during Q2 and is estimated until Q4)
Second, the growth rate is substantially weaker than previous estimates of more than 13% and a full percentage point lower than the Atlanta Fed’s GDPNow forecast of 7.6%. It probably also represents the peak of economic recovery. (This is a topic we’ll cover more next week.)
Over the next two quarters, economic growth rates will continue to weaken. This is due to the massive amount of direct stimuli disappearing from the system.
By the end of 2022, the economic growth rate is likely to set a new growth trend of less than 2%. These will be weaker than the previous two growth trends “Real” economic recessions.
As always, economists and analysts are always overly optimistic in their valuations. But while being overly optimistic is certainly a media preference, it entails possible capital misallocations by investors.
The yields had it right after all
How discussed in April, when estimates were 13% of GDP growth, bond yields signaled a peak in economic growth. This is:
“As shown, the correlation between rates and the economy as a whole suggests that current expectations of economic expansion are overly optimistic. At current rates, economic growth is likely to return to less than 2% growth in 2022. “
Since then, yields have continued to fall, along with the flattening of the yield curve. Historically, yields are a strong predictor of economic growth and inflation. However, as stated above, disinflation is more likely to accelerate inflation.
“With the basic effects now exhausted, cyclical, structural and monetary considerations suggest that inflation will decline by the end of the year. Therefore, the “inflationary psychosis” affecting the bond market has already been reversed as slower economic growth takes place. “
Of course, this is problematic for the Federal Reserve. The current $ 120 billion a month program in monetary injections only sustains economic growth. But alas, these monetary interventions do not translate into “economic activity” either directly or indirectly.
“Whenever the Fed has participated in QE programs, banks “treasure” these reserves because the “risk / reward” of lending money to the economy is not justified. For example, in early 2020, as the economy “closed” due to the COVID pandemic, companies took advantage of their banks ’lines of credit to ensure sufficient capitalization. After this initial increase in lending activity, banks returned to a more “protective” mode.
QE programs have NOT been effective in creating organic economic growth. However, they were effective in raising asset prices and providing an exciting wealth effect.
The Fed faces a challenge in trying “conical ” asset purchases. Although there is more robust economic growth, a booming real estate market and falling unemployment, they can eliminate the economic “life support?” Some alternative measures suggest that this may not be the case.
Alternative measures of economic growth
While conventional economists suggest that the economy is booming based on more traditional economic data, other data suggest that this may not be the case.
It is important to note that American economic performance peaked in the late 1990s. Thus, the erosion in crucial economic indicators such as the rate of economic growth, productivity growth, employment growth and investment it began long before the Great Recession.
A look at the workforce participation, the proportion of Americans in the productive workforce reached its peak in 1997.
With fewer men and women of working age in the workforce, per capita income continues to decline. Not surprisingly, the real median income of households remains well below the real cost of living stagnant income in the lower 80% of employees.
In addition, stagnant incomes and limited job prospects have disproportionately affected low-income, low-skilled Americans, leading to household inequality.
Finally, the United States does not have an economic strategy, especially at the federal and government levels. The implicit strategy remains to rely on the Federal Reserve to solve our problems through monetary policy. However, rising wealth inequality has fueled demands to transform the U.S. into a “Socialist” economy.
Neither strategy has ever solved the problems of people with less promise.
As noted, the Federal Reserve is trapped. The Federal Reserve needs more substantial economic growth to justify rising interest rates. After all, the reason the Fed is tightening monetary policy is to ENCOURAGE economic growth to mitigate the potential for growing inflationary pressures. The problem currently is that the Fed is discussing rising interest rates in an environment of weakening economic growth and disinflationary headwinds.
Currently, employment and wage growth remain weak, 1 in 3 Americans has government subsidies, and most Americans live on payroll. That’s why central banks, globally, are aggressively monetizing debt to keep growth from stopping. However, many analysts and economists are currently raising the odds of Fed hiking rates next year. The belief is that economic growth may continue to accelerate despite tighter monetary policy.
Most of the analysis overlooks the level of economic growth at the beginning of interest rate hikes. The Federal Reserve uses monetary policy tools to curb economic growth and alleviate inflationary pressures by tightening the money supply. Over the past decade, the Federal Reserve has flooded the financial system to raise asset prices in hopes of spurring economic growth and inflation.
As stated, outside of inflated asset prices, there is little evidence of real economic growth, as evidenced by an average annual GDP growth rate of only 1.1%.
Although conventional media can promote the “The highest rate of economic growth in decades” the widespread weakness below the headlines will continue to erode the projections.
The problem for investors is asset price inflation far beyond what the real economy can generate in terms of future revenue growth and profits.
The re-alignment between overly bullish expectations and a “Very defective product ” it will probably be more painful than most expect.
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