Memo To Yellen: What 'Escape Velocity'----The Q4 GDP Report Was Not "Solid"

Janet Yellen and her band of money printers think they are driving the GDP forward toward the nirvana of full employment and the achievement of every last dime of "potential GDP". What they are actually doing, instead, is inflating the Wall Street bubble to ever more dangerous heights because their monetary injections never make it to the real main street economy; they just whirl around in the canyons of Wall Street where they enable speculators to wildly inflate the price of risk assets.

Now comes another GDP report card, this one "disappointing". Not only does it refute the claim of the Wall Street Keynesian chorus that the U.S. economy hit "escape velocity" last spring and summer, but it is also chock-a-block full of evidence that the Fed's machinations have nothing to do with the performance of the real economy.

As usual, the seasonally adjusted numbers on a annualized basis are full of noise----the most significant being inventory fluctuations. The latter flattered the 5% number that so excited the headline writers last quarter, but had the opposite impact this time. The actually gain in real financial sales, therefore, was only 1.8%----even more tepid than the headline.

But the annualized quarterly figures just don't cut it, in any event. National defense spending in Q4 declined at a whopping 13.2% annualized rate, but unfortunately, it did not reflect the actual hard-chop to the Pentagon's budget that is long over-due. It was just the payback for the anomalous annualized growth of 15% in Q3. The latter period tracks the fiscal year-end in September, and therefore the big figure which ballooned Q3 GDP did not reflect economic growth at all-----just the usual scramble of bureaucrats to waste money at year end before appropriations lapse.

In fact, real defense spending in Q4 2014 was identical to the figure recorded for Q4 2013. This unfortunately means that the nation continues to waste vast resources on defense at a constant level, but that has nothing to do with the trend rate of economic growth.

So the point is to get out of the GDP reporting weeds. That requires eliminating the volatile element of inventory fluctuations, and looking at the rate of change on a year or over year basis in order to screen out temporary anomalies and dispense with the faulty seasonal adjustments entirely.

Here's what we get. During the year ended in Q4 2014 (LTM), real final sales grew at a 2.2% annual rate. That's right. When you eliminate the noise from an allegedly bad winter quarter (Q1) and the annualized distortions in the Q3 headline owing to defense, the Obamacare catch-up and several others, you get an economic expansion rate that was humdrum, not evidence of escape velocity; and worse still, it actually represented a deceleration from the 2.6% rate of real final sales gain for the LTM ending Q4 2013.

Indeed, scrolling back several more years the pattern is remarkably consistent. Real final sales for the LTM period ending in Q4 2012 grew by 2.1%, and by 1.5% and 2.0% for the LTM ending in Q4 of 2011 and 2010, respectively.  In short, during the last  60 months the US economy as measured by real final sale has grown at a middling rate that has centered tightly around 2.0% per annum. Despite all the massive money printing by the Fed and the earlier Obama fiscal stimulus, the real economy has not accelerated and has not exceeded an expansion rate which American capitalism is more than capable of accomplishing without any help from Washington at all.

Actually, the true state of affairs in much worse. After all, we did have a thundering recession before the US economy hobbled back onto its 2% growth track. Therefore it is necessary to go back the pre-crisis peak in Q4 2007 and calculate the 7-year trend since then----that is, the average of 18 months of recession and the 60 months of recovery documented above; and to view all of this free of the inventory swings that make recession appears deeper and recoveries more robust in the headline GDP number.

The peak-to-present trend is flat-out punk in absolute terms and relative to recent history. Real final sales have grown at only a 1.1% annual rate during the past seven years. And that compares to a 2.5% annual rate during the 7 years after the dotcom bust in 2000-2001, and a 3.1% annual gain during the seven years after the 1990-1991 recession.

In short, the current trend rate of real expansion in the US economy is barely one-third that of the early 1990s. Indeed, during the past 25 years of Keynesian doctoring, the American has been drastically winding down, not escaping off into full employment nirvana.

And here's the thing. All three of the recessions embodied in the seven-year cycles reported above were caused by the Fed. In the late 1980s, Greenspan panicked after the Black Monday crash of October 1987 and fueled a storm of consumer and commodity inflation that had to be curtailed after the first Gulf War oil price surge. Likewise, the stock market crashes of 2000-2001 and 2007-2008 were the handiwork of the Fed stimulus and wealth effects policies which preceded them.

So the truth of the matter is that in the intervals between the Fed's cycles of boom and bust, the trend rate of real economic growth has been steadily slowing. That outcome, of course, is the very opposite of what the Keynesian money printers claim-----yet it should not be surprising.

The Fed's money printing and Wall Street coddling policies have caused a destructive financialization of the US economy. By transforming the money and capital markets into gambling casinos, capital and human resources have been channeled away from productive investment and into speculative activities which drastically inflate the value of existing financial assets, and provide windfall riches to a small slice of the population.

Yet owing to its obstinate belief that it is actually stimulating the main street economy, the Fed's ZIRP and wealth effects policies only inflate the Wall Street bubbles to even more dangerous extremes; and thereby pave the way for the next financial meltdown and the attendant relapse of the main street economy into another even more difficult grind of recession and halting recovery.

And for what? As we have previously demonstrated, the Fed's traditional credit channel of monetary transmission is broken and done owing to the fact of "peak debt". Financial repression and cheap interest rates, therefore, have not enabled the household sector to augment consumption spending derived from current income with incremental borrowings. The only real exception is auto credit which has soared by more than 40% from the recession bottom and is now at an all-time high nearing the $1 trillion mark.

But the boom in sub-prime auto lending based on drastically underpriced junk debt is not sustainable, and will soon result in a breakdown of the auto finance food chain. That is, soaring defaults will cause the repo man to dump a rising level of vehicles on the used car market, and thereby trigger a downward spiral of vehicle prices. In turn, a breakdown of vehicle prices will expose the whole chain of auto finance to shrinkage owing to the fact that loans and leases today are being financed at upwards of 120 percent LTV ratios.

But that's not all. During the last 12 months, nearly 85% of the $355 billion increase in real final sales, representing a meager 2.2% gain over the prior year, was accounted for by personal consumption expenditures (PCE). Yet the only real impact on PCE from Fed policy was the junk-debt fueled boom in auto finance. And the latter resulted in just a $40 billion gain in motor vehicles sales. In short, barely 11% of last year's gain in real final sales can be attributed to the "credit channel" of monetary transmission.

By contrast, the overwhelming share of the PCE gain game from the top 20% of households which have benefited from soaring asset prices and the boom in the finance related industries, including the vast venture capital/IPO bubble in silicon valley. But those gains are not sustainable------and represent the feedback loop from the Fed's massive inflation of financial assets. As has already been demonstrated twice since the mid-1990s-----when the financial meltdown inevitably arrives, boom time spending at the top of the income ladder dries up rapidly.

So the Fed is not merely pushing on a string. It is recklessly inflating the biggest and most dangerous financial bubble yet owing to its obstinate adherence to ZIRP 80 months after the last Wall Street meltdown, and to its delusional belief that the main street economy would tumble into a smoking heap of recession absent its ministrations.

Stated differently, today's GDP report makes it plainly evident that there is no escape velocity, and that the Fed's cheap money has hardly moved the needle at all on the main street economy. The only thing "solid" about the prospects for the American economy, therefore, is the certainty that the Fed is driving it headlong into another debilitating cycle of boom and bust.

David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

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