Yesterday, it was announced that the Bureau of Economic Analysis would once again change the methods by which the economic growth of the country (GDP) would be measured. To wit:
"Nicole Mayerhauser, chief of BEA's national income and wealth division, which oversees the GDP report, said in the statement that the agency has identified several sources of trouble in the data, including federal defense service spending. Mayerhauser said initial research has shown this category of spending to be generally lower in the first and the fourth quarters. The BEA will also be adjusting "certain inventory investment series" that have not previously been seasonally adjusted. In addition, the agency will provide more intensive seasonal adjustment quarterly service spending data."
Now, for all of you playing the home version of "Nail That GDP Number," it was just a couple of years ago that the BEA decided that the economy was not growing fast enough and "tweaked" the GDP calculation and added in "intellectual property." Those adjustments boosted GDP by some $500 billion.
The problem with adding "intellectual property" is that the cost of a new cancer drug treatment, a Hollywood movie or a new hit song is already included in the value of product brought to market. In other words, since production is what drives economic growth, that value is captured in the quarterly analysis of business investment, spending, etc. Furthermore, how does the BEA value "intellectual property" accurately and fairly across all industries and products? Some products like a cancer treatment have a much different "value" than a song.
However, since those tweaks did not boost the economic growth rate as much as was hoped, the BEA has now wondered if maybe their statistical modeling is wrong and will be making adjustments once again to boost economic output in the U.S.
I am not a conspiracy theorist by any stretch. However, something strikes me as very odd about the timing of this announcement.
The Federal Reserve understands, at more than six (6) years in the current economic expansion; we are likely closer to the next recession than not. The problem is that the Fed Funds rate is still stuck at the zero bound.
Since QE programs have not been effective at creating organic economic growth, the only effective monetary policy tool of the Fed to stave off the effects of a recessionary drag, lowering interest rates, is not available. This is why, despite weak economic growth, little inflation and a large amount of labor slack in the economy, the Fed has consistently hinted that they will likely raise the overnight lending rates in June. Therefore, since the Fed is "data dependent," a boost to GDP, via the recalculation of the numbers, would be vastly supportive in justifying that increase.
However, is economic growth really stronger than currently reported? We can look at some alternative measures of the economy to answer that question.
Alternative Measures Of Economic Growth
While the BEA is suggesting that it is simply "residual adjustments" lingering in the inventory and production related data, that does not really explain the economic weakness in other areas of the economy.
The chart collection below is from a variety of reports that I have produced in the past. However, most importantly, the bottom chart is the best overall indicator of economic activity in the domestic economy. The Economic Output Composite Index (EOCI) at the bottom is a compilation of broad economic inputs from manufacturing to small business to leading economic indicators. (read more on construction here)
Importantly, all of these indicators confirm that economic weakness is pervasive across a broad swath of the economy, and weakness in GDP growth in Q1 was likely more than just a "weather related or statistical anomaly."
But it is here, as suggested above, that the Federal Reserve finds itself trapped. The Federal Reserve needs stronger economic growth to justify raising interest rates. After all, the reason the Fed tightens monetary policy to is SLOW economic growth to mitigate the potential of surging inflationary pressures. The problem currently, is that the Fed is discussing raising interest rates into an environment of low growth and inflation.
So, what has happened historically when the Fed has raised interest rates in such an environment?
Interest Rates Versus Economic Growth
Currently, employment and wage growth is extremely weak, 1-in-4 Americans are on Government subsidies, and the majority of American's are living paycheck-to-paycheck. This is why Central Banks, globally, are aggressively monetizing debt to keep growth from stalling out. If the Fed starts hiking rates in June or September, and the next recession doesn't occur for another three years as the majority of economists suggest, this would be the single longest economic expansion in history based on the weakest economic fundamentals.
Furthermore, 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 slow economic growth and ease inflationary pressures by tightening monetary supply. For the last six years, the Federal Reserve has flooded the financial system to boost asset prices in hopes of spurring economic growth and inflation.
Outside of inflated asset prices there is little evidence of real economic growth as witnessed by an average annual GDP growth rate of just 1.2% since 2008, which by the way is the lowest in history....ever. The chart and table below compares real, inflation-adjusted, GDP to Federal Reserve interest rate levels. The red vertical bars denote the quarter of the first rate hike to beginning of the next rate decrease or onset of a recession.
If I look at the underlying data, which dates back to 1943, and calculate both the average and median for the entire span, I find:
- The average number of quarters from the first rate hike to the next recession is 11, or 33 months.
- The average 5-year real economic growth rate was 3.08%
- The median number of quarters from the first rate hike to the next recession is 10, or 30 months.
- The median 5-year real economic growth rate was 3.10%
However, note the BLUE arrows. There have only been TWO previous points in history where real economic growth was below 2% at the time of the first quarterly rate hike - 1948 and 1980. In 1948, the recession occurred ONE-quarter later and THREE-quarters following the first hike in 1980.The importance of this reflects the point made previously, the Federal Reserve lifts interest rates to slow economic growth and quell inflationary pressures. There is currently little evidence of inflationary pressures outside of financial asset prices, and economic growth is weak to say the least. Therefore, rather than lifting rates when average real economic growth was at 3%, the Fed will not start this process at less that half that rate.
Think about it this way. If it has historically taken 11 quarters to fall from an economic growth rate of 3% into recession, then it will take just 1/3rd of that time at a rate of 1%, or 3-4 quarters. This is historically consistent with previous economic cycles, as shown in the table to the left. This suggests there is much less wiggle room between the first rate hike, and the next recession, than currently believed.
But then again, if you can just keep changing the data calculation to goal seek a better economic picture, then surely that is enough. Right? Might want to ask those 100 million on government welfare what they think.