Alasdair Macleod – 1 June 2010
In the US, revised GDP figures for the first quarter were released last week, showing that the economy grew by 3%. These growth estimates are important because all economic policy is dependant on them: they determine the course of both fiscal and monetary policy. But no attempt is ever made to differentiate between the quantitative, or the bald numbers, from the qualitative, their true economic value. There is no debate about the relationship between the public and private sectors, and certainly no questioning as to whether or not all the newly printed dollars in the numbers should be counted as growth.
The public sector, which is the non-productive element of the economy, is basically a distortion of the picture. It is a burden on the private sector, and to the extent that it leeches financial and labour resources from the private sector, an increase in the public sector’s share of GDP is a negative factor, even though it is presented as a positive. Critics of Keynesian economics, who are unfortunately very few, understand this point. But in Keynesian economics, the function of the public sector is to manage the private sector, so even on this basis the health of the economy should be measured on the private sector alone. For decades governments have conjured up the illusion of growth by expanding the public sector. And no one considers the distortions of monetary inflation on GDP statistics; adjustments for inflation are only applied by means of a producer price deflator.
Monetary inflation is in the GDP numbers for a Keynesian purpose: according to Keynes, deficit spending by government is the way to soften recession and hasten recovery for the private sector. There is however a statistical effect, in that deficits financed through monetary inflation themselves are included in the GDP numbers, making them appear better than they would otherwise be. For example, if domestic production is unchanged and money in the domestic economy is inflated by 10%, reported GDP will be up 10% even though there is no extra production. The current situation illustrates how misleading this can be.
The sources of this inflationary finance include treasury securities bought by foreigners as well as by other government departments and agencies, together with the increase in the monetary base. There are two figures outside the Federal budget, the Troubled Asset Relief Programme, and military spending in Iraq and Afghanistan; the former should be allowed for, but the latter is outside the scope of GDP, being money spent abroad and so can be ignored. Using these adjustments, one can estimate the monetary impact of government finances on private sector GDP to get a truer picture of economic performance.
Over the calendar year to March 2010, foreign investors bought $620bn of US Treasuries, purchases of Treasuries by government departments amount to a further $190bn, and the Fed has increased the monetary base by $431bn. TARP funds of $181bn have been repaid. These flows represent the net total money issuance of $1.06 trillion as shown in the calculation below:
The GDP figure for the end of the quarter was $14.6 trillion. Of this, total Federal State and local government spending is approximately $3.5 trillion, leaving private sector GDP at $11.1 trillion. We can therefore see that the injection of inflationary money on private sector GDP works out at 9.5%, very different from the 1.1% deflator in the official announcement. Furthermore, it is apparent that because GDP is being overstated the economy is still in a severe recession.
Keynesians will be baffled by this discovery, preferring the comfort of a producer price deflator. It does however help explain why on the broader U6 measure unemployment is at 17%, yet GDP is the highest it has ever been. It also explains how easy it is for the government to ensure that GDP need never fall, so long as the printing press works and the public remain gullible.
And this is why the quality of economic growth is so much more important than the quantitative numbers. The headline statistics are not a true reflection of the economy, and should not be the driving fiscal and monetary policies.