Gross Domestic Product (Expenditure Method)

Over the last week I’ve shown a series of charts depicting

Personal consumption
Business investment
Government spending
Exports
Imports

Using what’s referred to as the “expenditure method”, gross domestic product, a measure of economic activity, is calculated

GDP = C + I + G + X – M

where

C is personal consumption
I is business investment
G is government spending
X is exports
M is imports

Policy for many years but particularly over the last dozen years has been intended to increase personal consumption. Given that the U. S. economy already depends more highly on personal consumption expenditures than any other developed economy, I doubt that personal consumption can be goosed much more than it already has been.

Government spending is already at historic levels as a proportion of GDP. All non-federal government spending is derived from one of two sources: taxes or borrowing. State and local governments are already strapped; they have taxed as much as has been politically possible and their increased borrowing has resulted in loss of credit rating, i.e. borrowing is become increasingly expensive for them.

The federal government has another arrow in its quiver not available to state and local governments. In addition to taxing or borrowing the federal government can simply print money or, if you would prefer, extend credit. Doing so will ultimately produce inflation or, possibly, hyperinflation. The absence of high inflation at the level of the ordinary consumer suggests that there’s still some headroom for this. My own suspicion is that asset inflation and, due to the perverse nature of our system, commodity inflation in the things that rich people buy are already upon us. I consider the print money/extend credit strategy pretty risky and, indeed, uncontrollable. You won’t know that you’ve created a problem until it’s too late to do anything about it.

I’ve already expressed my opinion of exports as a major source of economic growth for the U. S. I think we’re too big and too rich to have an export-driven economy.

Our imports, which by definition reduce economic activity, come in two flavors: oil and other. We are already reducing our imports of oil and I expect that trend to continue, at least for the near future. That will help a bit. I think we need to reduce our “other” imports. Having worked for a foreign company, I think that our imports are drastically underestimated. For example, intra-company transfers are not considered to be imports.

Domestic business investment has received far too little attention over the last half dozen years. Business investment in real estate, where much has been focused, doesn’t do much to produce the products, services, and industries of tomorrow. I’ve frequently heard it said that “we just aren’t as rich as we thought we were” and that’s probably true. What’s also true but has largely gone unrecognized is that the return on investment wasn’t as high as we thought it was. Or, said another way, the world is a riskier place than we thought it was. Businesses became accustomed to unrealistically high and improbably safe rates of return. Now they’re gun-shy.

I think the emphasis of policy needs to turn to increasing domestic business investment in something other than real estate and reducing imports. Or, alternatively, we can just shamble along at our below 2% GDP growth and let the unemployed stay that way.

29 comments… add one
  • Icepick Link

    Or, alternatively, we can just shamble along at our below 2% GDP growth and let the unemployed stay that way.

    This is the preferred approach of the President.

  • Red Barchetta Link

    Many of the themes and observations in the blogpost are those that I have made many times, often being chided. I would make a couple observations.

    “The absence of high inflation at the level of the ordinary consumer suggests that there’s still some headroom for this. My own suspicion is that asset inflation and, due to the perverse nature of our system, commodity inflation in the things that rich people buy are already upon us.”

    I know that Dave and some others believe this, and perhaps even have data they could cite. I’ve been aroung too long to believe all the published data. (Just look at AGW) I buy regular stuff as much as anyone. Commonly purchased goods and services are escalating at high rates. Store and eatery food, utilities, car fuels, health care and other staple items aren’t escalating at 1-2%. Its more. Clothing seems to have largely escaped because its largely made elsewhere. Consumer electronics and gadgets probably because of technology. We own a food related company and just put through an 11%, commodity driven, price increase that was accepted and the industry followed. All of the food related industry rags report similar things. Now, what IS happening is that apparent prices may not be increasing, as food retailers are downsizing portion sizes. The quality of purchased clothing seem to be declining as a response to holding price as well. One could argue that fuel price increases (sans natgas) are being driven by taxes, not “true” inflation, but as Jack Nicholson’s character in The Departed noted – “you can be cops or criminals, but when you are looking down the end of a loaded gun, whats the difference?” That is, its all purchasing power. And there is more than just price……quality, reliability, features, service…….

    As for luxury goods. High end cars aren’t escalating that much. I just bought one. Don’t know about boats, but my partner does and he’s not impressed. High end real estate and associated furniture seeem to be moving fast, if only in certain locations. I don’t do jewelry.

    “What’s also true but has largely gone unrecognized is that the return on investment wasn’t as high as we thought it was. Or, said another way, the world is a riskier place than we thought it was. Businesses became accustomed to unrealistically high and improbably safe rates of return. Now they’re gun-shy.”

    That’s a tough one, and I think it might be overstated. Let’s bifurcate it into two pieces: investment in companies vs investment in plant and equipment for companies. Returns are down in the former simply because of capital availability, although that is rapidly changing. As for the latter, all of our portfolio companies invest, and continue to invest heavily for growth and efficiency. Not gunshy. I don’t see a return problem. But I would have to caveat these points with the observation that we are involved in one of the riskiest segments of investing (PE) and are risk takers by nature; and invest in plant and equipment for companies historically underinvested, for risk tolerance reasons.

    Lastly, to riff off of ice, (and given what I hope people understand is THE central theme of all that I comment on here) given the blogpost observations can someone tell me how you could support more govt/more taxes/more regulation/leftist priorities like AGW or solar companies/the current president’s view/ etc given that we will just lumber along at modest growth rates; and if we do that we fail to deal with the reality of high unemployment and with a huge debt to finance?? Its bizarre on its face. Aren’t debt service and unemployment the highest priorities?

  • steve Link

    1) I dont believe the inflation alarmists. They suffer from observational bias. The CPI is strongly supported by the billion price project. Several economists have printed the entire list of items that are used to determine the CPI. A lot of things are up, but a lot are down. Or, you can just look at the bond markets.

    2) The return on investment was as high as we thought, at least partially, because they were leveraged returns. That doesn’t work if you cant run up the debt anymore. Also, I would agree that what we invest in matters a lot. It cant be innovative financial products or commercial real estate. I do think there is room for growth in the home industry.

    3) If investment is the key, how much? If you aim to make up the difference in lost output arent you talking about record levels of investment? Invest in what?

    Steve

  • jan Link

    Now, what IS happening is that apparent prices may not be increasing, as food retailers are downsizing portion sizes.

    Good point about sizing reductions, as one can readily see it in many common items such as TP, paper towels, coffee being packaged at 12 ounces rather than the customary pound, etc.

    I don’t believe the inflation alarmists. They suffer from observational bias.

    Observational bias versus statistical bias. I think I would put more validity into the observational crew — Main Street instead of DC — in drawing conclusions about where the economy is drifting or stagnating. Even my very liberal friends (and Obama supporters) say that inflation on food and basics seem much higher than what is being stated by the government — one woman speculating something like “20%.”

    Another cost observation is one associated with medical care. The new projections for the ACA have now more than doubled. But, the blame continues to be deferred elsewhere — like HHS Secretary Sebelius casting blame on the republicans and sequestration. In the meantime my own ‘observational bias’ reports that my HC premiums have gone up, and a recent eye exam (which I pay privately b/c of not having a vision rider on my policy) more than doubled.

  • jan Link

    Lately I’ve been hearing more people say, “We are poised for a surge in growth. When questioned further, though, being poised simply means there are liquid assets readily available to be invested, but people remain hesitant to make the move. The reasons cited for their resistance or leeriness is distrust and even fear of government policies and tidal waves of regulations.

    Of course the looming costs of Obamacare are usually included in the litany of reasons why investment continues to lag. However, the undercurrent of uneasiness, presiding beneath most business considerations, seems to tether people to their money, rather than give incentives or assurances for them to risk it on extracurricular entrepreneurial ventures.

    IMO, the current government is perceived by many in the business community to be adversarial in it’s dealings with them. Although, government entities do throw out occasional nibbles to business, in efforts to re-engage their interest, it is mainly seen as disingenuous foreplay by most. So, instead, investors tend to sink some money into tangible real estate or financial pastries like the stock market, giving them a temporary sugar high as the DOW mystically rises to new heights. But, overall, the foundation of this economy remains shaky, secured by few (if any) long term policies that makes any real fiscal sense.

    BTW, my RE broker husband commented this morning that the lending ads are starting to hawk no-down, low-down borrowing home financing gimmicks, similar to the sub prime era which brought the runaway buying fervor to a halt, leading to the ’08 market crash. Bubbles are funny cycles, as while they are blowing up there are so many people denying any impending problems, until they burst — sort similar to the insidiousness of an often fatal aneurysm.

  • Icepick Link

    Let’s see, gas prices are up big. Food prices are up a good amount (frequently hidden by changes in packaging). Healthcare prices continue to surge. (We’re going to have to downsize our coverage this year – downsize what we get, we’ll be paying the same amount.)

    I don’t care if car prices are steady, as I’m not buying a car. I don’t care if housing prices are down, as I’m not buying a house. I really don’t care about bonds either, as I’m not buying treasuries. (Who is, besides the Fed?)

    All I know is my wife got a small raise, and our expenses are up much more than her raise. And we’re not buying anything we didn’t buy last year.

  • I’m not finding fault. I’m probing for where the most likely sources of increased growth in the near to medium term might be with an eye to what sort of policies would help that along. I don’t think that personal consumption, government spending, or exports are particularly good prospects.

    That leaves business investment and imports. As I’ve shown in the posts below, imports are at historic highs and business investment, unlike personal consumption, exports, or government spending, remains below the previous peaks.

  • My point on inflation is this. As steve points out, above, the BPP is tracking pretty closely with the official rate of inflation so we really don’t see much inflation there in consumer commodities, generally.

    I’ve given my hypothesis: that inflation is concentrated in assets and a few consumer product classes.

    The Fed’s balance sheet is expanding at a ferocious rate, nearly $100 billion a month, which you would think would be enough to produce more than 3% inflation per annum. If you don’t agree with my explanations, offer your own.

  • steve Link

    ” I really don’t care about bonds either, as I’m not buying treasuries. (Who is, besides the Fed?)”

    85% are not being bought by the Fed.

    Steve

  • At this point about 50% are.

  • Icepick Link

    Last I heard the Fed is hoovering up about $85 billion a month. That’s about a trillion dollars a year, which is the size of deficits that Democrats don’t care about. If they’re not buying the actual bonds being put out there, they’re buying up enough of the old ones that it’s a wash.

  • steve Link
  • steve Link
  • jan Link

    I noticed today that gold prices dropped like a rock. In the aftermarket they are below $1500. Then I saw this story on Zerohedge: 11 economic crashes are happening right now.

  • You might want to take a look at the date on that piece from Kevin Drum, steve. It’s six months old. Right now the Fed is buying $40 billion in Treasuries a month. That’s roughly half of what the Fed is selling a month.

    Also, one thing I’ve noticed about Kevin Drum, at least lately, is that he can be lazy. For example, in a recent post about CalPERS he appealed to authority, in this case Dean Baker, who had also not done any homework. The specific issue was how the CalPERS portfolio was allocated. That’s not something you can deduce from first principles or need to. You just go to the CalPERS investment report, handily online, which shows the total percent of the portfolio that are in equities and the percentage return, by investment. The actual facts support the claim he was challenging, that CalPERS isn’t realizing what it needs to on its investments.

    Illinois is even worse BTW. Last year the Illinois TRS earned about 1% when the planned earnings are an absurdly high 8%.

  • Icepick Link

    It’s a little hard for me to focus (the sun comes up too damned early), but it looks like the Fed has purchased about $17.8 billion dollars of treasuries so far in April.

    Stories from last December state that the Fed was going to increase Treasury purchases to about $40 – $45 billion per month, as well as starting rollover purchases on expiring Treasuries, which indicates more than that might be spent.

    See here for the latter.

    If you want the Fed stuff, do your own search on their website.

  • In addition to purchasing Treasuries the Fed is also purchasing mortgage-backed securities to the tune of about $40 billion a month. Between the two that means it’s pumping about $1 trillion a year into the economy. Either that’s not leaching over into the real economy or you’ve got to come up with some other explanation for why inflation is as low as it is.

    I think the empirical data strongly supports the low inflation hypothesis. See, for example, the Billion Price Project. Its index is tracking the CPI pretty closely—around 2%.

  • Icepick Link

    The FOMC site isn’t the most user friendly I’ve seen, but it will do for the moment.

    Assuming I haven’t messed anything up (which is doubtful – who put that sun there, and what the Hell were they thinking?), here’s what I got from the FOMC website, after downloading data to Excel and doing some editing.

    Purchases of US Treasuries by the FOMC by month for CY 2013 ($ in billions):
    Jan: 44.197
    Feb: 44.693
    Mar: 41.055
    Apr (first two weeks): 22.572

    That projects to about $539 billion for the year.

    Note the discrepancy with the earlier total for April. I did the earlier total on operation dates, but the totals above are based on settlement dates. This pushed an extra purchase into April. If you want operation date totals, they are as follows.

    Purchases of US Treasuries by the FOMC by month for CY 2013 ($ in billions):
    Jan: 45.762
    Feb: 44.573
    Mar: 44.372
    Apr (first two weeks): 17.810

    Those are strictly purchases. I did not look to see if the FOMC unloaded any Treasuries, as they said back in December that weren’t going to do that. I’m not going to bother looking up sales by the Treasury Department, either. The amounts being purchased come to about half of the projected annual deficit, so that’s close enough for now. It’s sure as Hell more than 15%.

    The Fed is as good as their word (from December 2012) on purchasing about $45 billion in Treasuries on a monthly basis. Additionally, they stated at that time that they would continue to purchase about $40 billion a month in MBS. The net effect of this is approximately one trillion dollars of extra “liquidity” being pumped into the system annually just by these two measures.

    That’s a lot of cash for financiers, not so much for the rest of the country.

  • Icepick Link

    Crossed comments, but the same conclusion on how much money is being pumped.

  • Icepick Link

    First, I’m not buying that inflation isn’t higher than reported, at least for the stuff we buy regularly. Gas prices are up, food prices are up, healthcare insurance prices are up, and way more than some lousy two percent, or whatever the fuck they’re trying to tell us.

    Second, look at where the money is going: It’s primarily being sent to financiers (directly and indirectly) and the government. Where’s it being spent? The financiers are driving up prices in markets where they purchase: Forget the caviar, look at the stock markets, look at the commodity markets. Where’s government spending the money? Transfer payments, healthcare spending and more government. Transfer payments aren’t going to do a lot, but government spending seems to be hitting some markets, especially the property market around DC. And healthcare spending is doing worlds of good at inflating healthcare prices.

    The inflation is there, it’s just not spread evenly. And many of the inflated items are things the government wants inflated (fuel, stocks, the property values of their most important employees, healthcare expenses), so no one is going to complain. At least no one that matters.

  • Icepick Link

    A couple of other points.

    First, note that by purchasing treasuries the Fed is taking pressure OFF of primary dealers – it frees up money for them to do other things. In fact the primary dealers may well be making money on the transactions if the Fed is going through them instead of purchasing direct from the Treasury. (I have no idea how the FOMC is purchasing Treasuries, and don’t care to find out. I’ve wasted enough time this morning on this nonsense.)

    Second, it would be interesting to see from whom the Fed is purchasing MBS. If they’re purchasing from primary dealers, then they’re basically providing those dealers with the money necessary to purchase the rest of the federal government debt issues for a given month. (This idea is behind the thought that the Fed is basically financing 100% of the US Federal debt – half directly and half indirectly.) But there’s an upside to any dealers in that realm: They’re getting rid of risk with the MBS , possibly at a significant profit (anyone know off-hand whether the MBS are being purchased mark-to-market or at some notional face value?), while getting something that is (a) very secure and that (b) the Fed may well purchase in the future.

    All of this ignores other stuff going on with very low interest rates and God-and-the-corporate-lawyers-only-know-what-else that’s part of this transfer of wealth from the Treasury to the finance community rulers.

  • The inflation is there, it’s just not spread evenly.

    We’re saying the same thing, just in different ways.

    Second, it would be interesting to see from whom the Fed is purchasing MBS.

    One wonders whether Fannie Mae’s announcement of its largest-ever monthly profit is a coincidence.

  • Icepick Link

    I hadn’t heard that about Fannie Mae or I’d’ve been making the conspiracy call.

    And I think the inflation is hitting the “average” consumer more than you do.

  • jan Link

    Various news sources have been saying that the fed is pumping around $80 billion a month into the economy, but haven’t broken it down to specifics like Ice and Dave have. I continue in agreement with both Red and Ice about the inflationary impact on specific, basic items — the staples that people have a difficult time doing without.

    Also. when the sudden windfall for Fannie Mae was reported the other day it took me by surprise. It just gets too complicated for me to follow some of the fiscal complexities back to root reasons.

  • Ben Wolf Link

    “Between the two that means it’s pumping about $1 trillion a year into the economy. Either that’s not leaching over into the real economy or you’ve got to come up with some other explanation for why inflation is as low as it is.”

    Bank reserves cannot be inflationary.

  • Bank reserves cannot be inflationary.

    Absolutely true as long as the money is held as reserves. However, money is fungible.

  • Ben Wolf Link

    Reserves are always reserves. They never leave the banking system unless the Fed drains them by selling securities.

  • Ben Wolf Link

    Not that providing information ever makes a difference, but all reserves exist on hard drives at the Fed. They never leave, they aren’t used for speculation and they don’t become the dollars you buy dinner with at The Melting Pot. This is easily confirmed should one care to actually learn something.

  • Icepick Link

    That money the Fed is creating is ultimately being SPENT by the rest of the federal government, so it isn’t just sitting around in some sort of electro-static state waiting to be turned into something – it’s already being turned loose. It isn’t just a bunch of account juggling between big banks and the biggest bank – instead it’s a fancy way to print money.

    Further, those reserves count – they help the banks meet funding requirements, allowing them to at least appear solvent and thus keep operating their usual lines of business.

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