The Daily Reckoning PRESENTS: Four strong reasons why the
recovery is bogus and cannot last.
THE EMPEROR HAS NO CLOTHES
by Kurt Richebächer
"The deficit country is absorbing more, taking consumption
and investment together, than its own production; in this
sense, it is drawing upon savings made abroad. Whether this
is a good bargain or not depends upon the nature of the use
to which the funds are put. If they merely permit an excess
of consumption over production, the economy is on the road
to ruin. If they permit an excess of investment over home
savings, the result depends on the nature of the
investment."
- Joan Robinson, "Reconsideration of the Theory of Free
Trade," Collected Economic Papers, Volume IV, 1973
America's economic recovery and its likely strength have
been and remain the central preoccupation in economics
around the world.
In the consensus view, the U.S. economy will record in this
year's second half its strongest pace of growth since the
late 1990s. According to a monthly survey of 53 economic
forecasters conducted by the Wall Street Journal Online,
its seasonally adjusted annual growth rate during the
current quarter will be 4.7% and 4% in the fourth quarter.
While a few economists have been warning that this
recovery's actual pace may disappoint, our own view is that
the U.S. economy's higher growth rate in the second quarter
was totally deceptive. Focusing strictly on the hard
economic data, like employment, personal income,
production, business fixed investment and profits, we
completely fail to see any recovery at all in the United
States.
Ever since 2001, the United States has been running
monetary and fiscal stimulus of unprecedented largess. In
July, the government's tax cut and rebate checks turned an
income gain of $19 billion into a $120 billion gain in
disposable income.
In the bullish consensus view, the medicine is finally
working. Above all the upward revision of the second-
quarter real GDP growth rate from 2.4% to 3.1%, following
1.4% each in the two prior quarters, has caused virtual
euphoria.
Knowing these are annualized growth rates is the first
reason why we are still unable to see a sustained, let
alone a self-sustaining, economic recovery in the United
States. When American economists speak of 4% growth in the
coming quarters, they really mean 1%, and that is a far cry
from what used to rank as a cyclical recovery. Growth rates
of postwar recoveries in the United States averaged 5.4%
over the first two years after recession - and that needed
very little monetary and fiscal stimulus, as against less
than 3% growth currently.
The second reason for our disbelief is that U.S. GDP has
been heavily bolstered by government spending. In the
fourth quarter of 2002, it accounted for 24.5% of nominal
GDP growth, in the first quarter of 2003 for 40.7% and in
the second quarter for 38.2%.
A third reason is that the recovery completely fails to
show in the current-dollar data. In these dollars in which
all economic activity takes place, GDP grew 0.99%, after
0.94% in the first quarter, an acceleration hardly worth
mentioning. But measured in chained dollars, it more than
doubled from 0.35% to 0.775%. Taking the big boost from
government spending into account, it was more slowdown than
acceleration.
The fourth and most important negative point is that the
trumpeted recovery in business fixed investment, in
particular in high tech, is just another statistical
mirage. In the second quarter of 2003, overall business
fixed investment in structures, equipment and software,
measured in current dollars, amounted to $1,119.9 billion,
slightly down in comparison with $1,126.8 billion in the
first quarter of 2002.
Measured in real terms, chained dollars, it was up $64
billion, or 0.5%.
I hardly need remind you that a true economic recovery
essentially must come from a balanced rise in consumer
spending and business investment spending. But what really
happened to the two during the first half of 2003, being
generally hailed as the start of the U.S. economy's final
recovery?
Let us look at the changes in aggregate GDP. Measured in
current dollars, it grew by $99.6 billion in the first
quarter and by $105.5 billion in the second quarter, hardly
an acceleration.
Looking at the demand components, growth of consumer
spending, its biggest component, slowed between the two
quarters from $87.1 billion to $83.1 billion.
Nonresidential fixed investment dipped in the first
quarter, but recovered in the second quarter to its earlier
level. From first to second quarter, the growth of
government spending slowed from $40.7 billion to $33.6
billion, and that of residential investment from $21
billion to $6 billion. Not one single GDP component rose.
The sharply rising trade deficit subtracted $11.1 billion
from GDP growth in the first quarter and $23.8 billion in
the second.
But this dismal picture, measured in current dollars,
radically changed for the better after the statisticians
had treated the numbers with their price indexes. GDP
growth, measured in chained dollars, surged from $33.8
billion to $73.5 billion. Growth in consumer spending, down
in current dollars, went steeply up from $33 billion to
$62.4 billion, and growth in government spending even shot
up from $1.7 billion to $31.7 billion.
Yet by far the single biggest contributor to this sudden
surge in real GDP growth from the first to second quarter
came from the calculation of the price deflator for
computers. Measured in current dollars, this investment
inched up by $0.8 billion in the first quarter and by $6.3
billion in the second quarter, but the hedonic deflator
boosted the two numbers in real terms to $15.3 billion and
$38.4 billion. Hedonic pricing of computers in the first
quarter accounted for 43% of real GDP growth and for 44% in
the second.
The bullish consensus, flatly disregarding the overwhelming
hedonic component, immediately hailed the sharp rise in
computer investment as the rapid comeback of high-tech
investment. Wall Street celebrated with the NASDAQ up 56%
since March.
In its absence, nonresidential investment remained dead in
the water across the board.
Warm regards,
Kurt Richebächer,
for The Daily Reckoning
Editor's note: Dr. Kurt Richebächer's articles appear
regularly in The Wall Street Journal, Barron's, the U.S.
edition of The Fleet Street Letter and other respected
financial publications.