A Tale Of Two Streets: Main Street Lagging, Wall Street Booming

Submitted by David Stockman via Contra Corner blog,

The most important number in yesterday’s GDP revisions for Q4 was $16.20 trillion. That’s the annualized constant dollar (2009 $) value of final sales during the quarter and, naturally, it was not mentioned in any of the media reports. But its important because the final sales figures strains out the noise of quarterly inventory fluctuations, and thereby provides a reasonable benchmark for where the overall economy currently stands.

In that context, the second most important number was $14.97 trillion—the real final sales number recorded for Q4 2007 on the eve of the Great Recession. As a matter of calculation, the rate of change between those two points over the last seven years is 1.1% per annum, and it embodies the tale of how main street is lagging while Wall Street is booming.

The starting point for appreciating that proposition, therefore, is to recognize that there is no point whatsoever in comparing the Q4 figure with the prior quarter—–or even with the cumulative gain since the bottom of the recession back in June 2009.  Those kinds of comparisons are the gist of the Keynesian narrative that both Wall Street and Washington assiduously peddle—-but they are designed to rationalize the status quo, not to elucidate the real condition of our national economy.

As to the standard quarter/quarter comparisons, they are just plain irrelevant and more often than not misleading. The quarterly GDP data is seasonal maladjusted, full of short-term quirks and subject to so-called benchmark revisions in the future that can wash out today’s apparent Q/Q incremental changes entirely.

For instance, the national defense spending component of GDP dropped at a 12.8% annual rate in Q4, but not because Washington has gotten around to reining in the military-industrial complex. Actually, it reflected more nearly the opposite impulse—–a timing correction for an equal and opposite surge in Q3. During that period, national defense spending was up at a 15% annual rate, reflecting the fiscal year end scramble in the last days of September to spend the Pentagon’s available dollars.

In fact, on an apple-to-apples basis defense spending went nowhere over the course of the full year. At an annual rate of $699 billion in Q4, defense spending compared to $701 billion in Q4 2013, thereby neither adding to or subtracting from GDP over the past year. The quarterly numbers were just noise.

Nor is this example an outlier. On a year over year basis, the massive $1.87 trillion health care component of GDP grew at a 3.7% annual rate—undoubtedly reflecting the fact that Obamacare is adding smartly to reported GDP, even if its not adding to the efficiency and productivity of the nation’s already bloated medical care system. Yet within the course of 2014, the health care component dropped at a 1% rate in Q1 and then surged at a 7.6% annual rate in Q4.

Those extreme quarterly fluctuations obviously represent dislocations and measurement problems owing to the sweeping changes in the health care sector legislated by Washington, not real change in the size of the US economy. And they had absolutely nothing to do with improvements in the nation’s wealth or welfare.

Sometimes these short-term fluctuations in the GDP accounts get downright comical. For instance, beginning around Christmas eve of 2000, the Greenspan Fed went on a 30 month stimulus rampage during which it slashed the federal funds rate from 6.25% to 1% to ward off what were alleged to be severe recessionary pressures.  And in due course the official economic watchdogs at the NBER declared a recession for March to November 2001 based on negative real GDP and related factors recorded for that period.

Ooops.  During subsequent benchmark revisions, the 2001 recession disappeared entirely!  As shown below, real GDP during the final quarter of the recession is now actually posted at a higher level than during the quarter before this phantom “downturn” incepted.

Here’s the thing. There is absolutely no reason to focus on short-term changes in the published GDP numbers – given the endless quirks, revisions and timing anomalies of the type illustrated above. In fact, their only use is to provide talking points to politicians bragging about the benefits of their policies or criticizing the failures of their opponents, as the case may be.

Likewise, the quarterly GDP numbers keep Wall Street economists and strategists busy digging out clues as to why it is a good time to buy stocks; and most especially they provide an all-seasons basis for the monetary politburo to justify its chronic efforts at short-term micro-management of the US economy.

But that gets to the related reason why comparisons with the recession bottom are an even worse idea than the quarterly chatter that animates the financial media. As I have previously argued, we are now in the era of the Great Immoderation, not the self-congratulatory Great Moderation that Bernanke proclaimed back in February 2004.

That means that rather than flattening or even smoothing-out the business cycle, modern monetary policy has actually exacerbated the natural fluctuations of our capitalist economy. By systematically fueling financial bubbles that ultimately burst, they periodically send the main street economy into a nose-dive during which excess inventory and labor artificially built up during the central bank fueled boom are abruptly liquidated.

But capitalism is not a doomsday machine that inexorably veers toward collapse absent the ministrations of the state and its central banking branch. In fact, when excess payrolls, plant capacity, inventories and other operational inefficiencies are cured, the downward dynamic stops on its own, enabling business to regenerate and idle labor and capital to be redeployed.

In the context of a macro-economy that is already at peak debt—-and the US economy with $58 trillion of public and private debt outstanding surely is—–there is no reason for monetary “easing” whatsoever in response to a business liquidation; and most certainly there is no case for zero nominal interest rates, negative real rates and the accompanying torrential money printing spree that we have had during the last several decades.

The truth of the matter is that the FOMC amounts to a monetary chorus of lip-syncers. The 2% GDP growth they claim credit for has nothing to do with their monthly jawing sessions, the word clouds they emit after the meeting or the instructions they give to the open market desk to buy government bonds hand-over-fist.  All of that artificial liquidity and fiat credit never leaves the canyons of Wall Street.

By contrast, the main street economy is more than capable of producing 2% growth without any help from the Fed, and has actually done so almost uniformly year after year since the Great Recession ended – and regardless of which phase the Fed’s money printing campaign was under at the moment.

At the end of the day, therefore, our modern Keynesian central bank amounts to little more than a serial bubble machine. Its cheap money and severe financial repression campaigns inexorably fuel leveraged speculation in the financial markets which eventually cause asset prices and valuations to become unhinged from the real main street economy. Then the bubble bursts, as it has already twice this century – even as the Fed drives the financial markets to a third and even more spectacular meltdown in the not too distant future.

So the valid way to look at the GDP numbers is on a bubble-peak- to-bubble-peak basis. That is, to assess the rate of output expansion between the successive financial breakdowns which are embedded in the heart of current monetary policy.

And that’s where the 1.1% CAGR for real final sales during the last seven years since the last bubble peak comes in. Its actually the worst trend rate ever recorded in the post-1950 period—-and by a long shot.

Even the Greenspan-Bernanke housing/subprime bubble period did better, sporting an annual growth rate of 2.5% during the 7-years after the 2000 bubble peak.

Needless to say, earlier cyclical “recoveries” all generated real final sales growth rates that were 2X to 4X greater than the meager 1.1% trend rate which occurred after the housing bubble crash was supposedly “cured” by an even more stupendous spasm of money printing. During the 7-years after the 1981 inflation peak, for example, real final sales grew at an annual rate of 3.6%.

Even during the stagflationary 1970s, the record was far better. The 7-year growth rate after the 1973 peak averaged nearly 3X the annual rate recorded since 2007.

The bottom line is this. Since the credit channel of monetary transmission is broken and done due to the arrival of peak debt, the only thing that the Fed’s massive money printing campaigns actually reflate is the financial markets. Since the last peak the S&P is up by 31% as shown below.

By contrast, the main street economy is plodding along, making modest headway on its own two feet—notwithstanding the headwinds of financialization and the channeling of income and wealth to the top of the economic ladder in the Wall Street casino. Not surprisingly, therefore, the gains have been disproportionately among the top households which own more than 80% of financial assets.

At the end of the day there is a considerable irony. The Fed has now become the tool of liberal Keynesian do-gooders – exemplified by the school marm who heads it. But its policies are exclusively benefiting Wall Street and the top 1%. They are redistributing income and wealth to the top, not the bottom of society as liberals have always claimed.

Needless to say, main street does not need that kind of “help”. And it would do far better on its own hind legs if the monetary politburo joined its Soviet colleagues in the afterlife of mistaken ideologies.