Wednesday, November 25, 2009

Another V-sign

As a supply-sider, consumer spending is not one of the things that I pay a lot of attention to. Spending is the by-product of production, so it's better to know whether jobs are increasing or likely to increase, and whether people are working harder and/or more productively, than it is to know how much people are spending. As the late Jude Wanniski used to say, as a nation we can't spend our way to prosperity. It's amazing to me, really, how much attention people and governments pay to spending, as if it were truly the key to prosperity. How can we grow the economy by spending more? Common sense tells you that the economy can only grow by producing more.

Here's an easy example: If I invented a machine which turned the labor of a $10/hour worker into enough food to feed 100 people per day, a lot of things would happen. To begin with, food would get a lot cheaper, and that would allow just about everyone in the world to spend more money on things other than food. A lot of the people employed in the food-production business could devote their energies to other pursuits instead. Some could build me an office. Others could make more food machines. Others could manage all the money I made, by investing it in new startups. And so on. They key to all these changes would be my invention, which allowed one worker to become hugely more productive.

When you consider the world as a closed economic system, it's a mathematical fact that total world spending can only be equal to total income—we can only spend to the degree that we earn, and we can only consume to the degree that we produce. On the margin, changes in spending are not what drive growth, it's changes in income, and income grows only if we produce more. In short: work—and the investment in new stuff which allows people to work more productively—comes first, then spending.

Back to the chart above. What it shows is that the downturn in spending has been much deeper (with the negative growth lasting longer) than in other recessions. But it also shows that the turnaround has been just about as sharp as in other recessions, hence my claim that this is a V-sign. The turnaround has nothing to do with cash-for-clunkers, since that washed out of the numbers by the end of October (i.e., some spending was accelerated, followed by some payback). On balance, real spending increased in 5 out of the six months ending October, and it rose at a 2.6% annualized rate in the four months following the likely end of the recession in June.

This recovery will likely be a little different from past recoveries, however, since the recession was precipitated by a major shock to confidence, and that in turn resulted in a sudden pullback in spending worldwide. So to the extent that confidence returns—and there are lots of signs that it is returning, if for no other reason than that the world didn't end as everyone feared it might—spending could be a leading indicator of improvement. Skeptics argue that fiscal stimulus is responsible for the improvement, but I've been highlighting evidence all year long that confidence was returning and that was a very strong argument for a recovery. We know that money velocity turned up in the third quarter, following steep declines in the prior four quarters; we also know that the demand for money has declined significantly, as reflected in a sharp slowdown in the growth of currency and M2, and in the value of the dollar.

Those are big macro variables that count for a lot more than the meager amount of stimulus that has come from Washington. After all, most of the stimulus is still unspent, and most of what has been spent was in the form of transfer payments that do nothing to stimulate investment or increase people's work effort, and thus do absolutely nothing to grow the size of the economy.

Looking ahead, I see the economy continuing to grow by 3-4% or so. That's not a very robust recovery given the depth of the recession, but it is a lot more than most people are forecasting. Growth is likely to be driven by increases in productivity, something that has been very evident in recent months, and by the natural growth in the number of people entering the workforce. Over long periods, productivity tends to average about 2% a year, while the labor force tends to grow about 1% a year, so add the two together and you get a 3% baseline for growth. But if that's all we get, then it means that the economy is going to have a lot of unused capacity and a lot of unemployment. In a typical recovery, productivity tends to be very strong coming out of the recession, due to strenuous efforts on the part of businesses to cut costs and wring more work out of a smaller workforce. The recovery then strengthens and extends as businesses invest in new plant and equipment and hire more workers.

What will keep growth from being robust during this recovery is weak investment. The Obama administration has shown itself to be very hostile to capital, and the prospect of trillion-dollar deficits for as far as the eye can see makes everyone fearful of higher tax rates on work, investment, dividends, and capital. As Art Laffer always says, if you tax something more, you are likely to get less of it. To make the fallacy of Keynesian pump-priming obvious, take the analogy to an extreme: you can't make an economy grow by borrowing money from those that are working and giving it to those who aren't working.

I'm very encouraged when I see that, after a big lurch to the left earlier this year, the political pendulum is now swinging back to the right. The polls have been saying this, and the elections in November confirmed it. There's a lot more work to be done, but my sense is that Congress is going to run out of energy as public support for a "tax and spend without end" agenda continues to wilt. Simply removing the threat of a further increase in spending and regulation could be enough to revive interest in new investments, and that could help the economy in coming years.

Things could be a lot better, to be sure, but there are things to be thankful for this Thanksgiving. One year ago we were standing on the edge of a fearsome abyss, while today we are arguing about how fast the economy is going to grow.

UPDATE: Mark Perry adds to this meme, noting that "Another V-sign of economic recovery is the turnaround in overtime hours for manufacturing workers. The 23.1% increase over the last seven months, from 2.6 hours in March to 3.2 hours in October, is the largest 7-month percentage increase in manufacturing overtime hours since 1983 following the 1982 recession."


alstry said...

Do you really think we should be so thankful when over 100% of the "growth" comes from our government's rapidly growing deficit and on track to expand as we send thousands of additional troops overseas?

The hole gets deeper and the deficits only get larger as we prepare to give thanks. On the bright side, if we weren't running such a massive defict...could you imagine how much WalMart's sales would contract if 40,000,000 Americans weren't getting deficit spending food stamps. Or 16,000,000 families weren't receiving deficit spending Unemployment checks. Or hundreds of billions of dollars was withheld on deficit spending medicaid/medicare?

Heck....spending on drugs would evaporate without the massive deficit spending.

No wonder Obama rating is below a coin toss....pretty soon there won't be many coins to toss.

Happy Thanksgiving for a great blog.

Игры рынка said...
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Игры рынка said...
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Игры рынка said...

(have some problems with comments)

when people do not pay they credit cards and mortgages surely they have more (all) money left for consumption

Scott Grannis said...

Игры рынка: That's true, but then the people who lent them the money have less cash flow. This is just another example of a transfer of money from one group (the lenders) to another group (the borrowers). This is not a big growth-creating activity. Also, it tends to discourage banks from lending.

Tom Burger said...


You say "This recovery will likely be a little different from past recoveries, however, since the recession was precipitated by a major shock to confidence, and that in turn resulted in a sudden pullback in spending worldwide."

I think this "recovery" is shaping up as fundamentally different from all post-war recoveries. The Contrary Investor commentary has, among other things, shown that all past recoveries have been accompanied by rapid credit expansions. Now, for the first time ever, we have a pronounced fall off in credit.

The truth is that all past recoveries have involved people spending more than they were earning, with debt accumulations slowing growing for decades. Now it looks like people are going to be paying back some of those debts, which necessarily means spending less than they earn.

This is one of the problems associated with using GDP as a measure of "the economy." It's a lousy measure of how well off we are -- and the numbers are severely distorted when the government is applying its usual collection of stupid monetary and fiscal "recovery" policies.

The "higher GDP" fetish is one of the things underlying the flawed notion that government spending produces "growth."

seekingtraceevidence said...

You make the comment that the economic system is closed, but then go on to discuss productivity increases. I suggest not using the term "closed system" at any time as it is confusing. The system is not closed but increasing real value via new inventions and greater productivity by some ~3% annually(Real GDP Growth. Ou problems derive from when we grow spending via debt at higher rates than Real GDP can support.

Public Library said...


You made a comment awhile back that the difference between 2.5% GDP and 3.5% is essentially meaningless to the economy.

Most "bearish" investors as you describe them see the economy growing around 2-3%. This is hardly different from your 3-4% forecasts.

mojakus said...

Scott - thanks for the post. Is your 3-4% forecast on nominal or real GDP?

Scott Grannis said...

Seeking: the system is closed, because as you say we can only consume what we produce, and the only way for the economy to grow is to produce more with a given amount of capital and labor.

Scott Grannis said...

mojakus: I'm referring to real growth of 3-4%

Scott Grannis said...

Public: perhaps I was referring to a quarterly annualized growth rate. On that basis, the difference between 2.5% and 3.5% is only 0.25% and thus not very important. On an annual basis that does become important as you note.

MadTax said...

Scott as you write' "...dollar weakness continues to predict equity strength. It may be... the dollar's weakness is a reflection of money velocity. ...fueling economic activity worldwide."

However, is possible equities are not reacting to the dollar but that equity prices and the low dollar are symptoms of the same cause, money velocity. In theory therefore a shock to the dollar on the upside may not destroy the stock market if the two are not connected. What do you think?

Scott Grannis said...

Daniel: I think you are correct. I believe I said something similar awhile ago on this subject. For now, the dollar is moving inversely with equities, and I think money velocity is the explanatory variable. But at some point the dollar/equity connection will probably break down--velocity is not going to be the story forever, after all. It is certainly possible for the dollar to strengthen and for equities to rise. I have also said that a Fed tightening would be good for the dollar and for equities, since it would greatly restore the world's confidence in the Fed and in the future of the U.S. economy.

ronrasch said...

Scott, the government redistribution is going to support public jobs that keep excessive state funding a unsustainable levels. What happens when stimulus money is not present to support these jobs? Thank you for your terrific blog and all good things to you and your family this holiday season.

Scott Grannis said...

ronrasch: I think that canceling all stimulus spending tomorrow would be greated by great cheers from the market. The prospect of such a wonderful thing does not worry me at all.