Why An Unsatisfactory Recovery Keeps Getting Worse

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In November 2013, prosecutors in Nashville were apparently frustrated by a defense attorney's repeated reference to them as "the government." As USA Today points out (h/t National Review), it was an aggravated burglary case where the lawyer for the defense, the aptly named Drew Justice, was chastised to the judge by written motion to force Mr. Justice to stop using what the state called an intentionally derogatory slur, "meant to make the State's attorney seem oppressive and inflame the jury." Being a serious criminal case, bias is nothing to easily dismiss on either side, but the defense's motion in response was pure genius:

"If the court sided with Rettig, he demanded his client no longer be referred to as ‘the Defendant,' but instead be called ‘Mister, ‘the Citizen Accused' or ‘that innocent man' - since all defendants are presumed innocent until a judge or jury finds them guilty. As for himself, clearly ‘lawyer' or ‘defense attorney' wouldn't do him, well, justice.

"'Rather, counsel for the Citizen Accused should be referred to primarily as the 'Defender of the Innocent.' ... Alternatively, counsel would also accept the designation 'Guardian of the Realm,' Justice wrote."

His concluding demand did perfect righteousness to the matter, ""WHEREFORE, Captain Justice, Guardian of the Realm and Leader of the Resistance, primarily asks that the Court deny the State's motion, as lacking legal basis." He didn't win his motion, unfortunately, but neither did the state and was allowed to continue his semantic attack on those that would call his client the "defendant." Jury trials are, by nature, as much show as evidence, with how evidence is presented sometimes far more important than what is presented (OJ might agree).

This kind of deception is not limited to criminal justice, of course, as almost any major endeavor of importance will be marked by war of words, including and especially war itself. A great many human advances owe themselves to armed conflict, though we dearly wish sometimes it weren't that way; even to the point that economists more recently have been searching for our "missing" recovery and growth in the quite welcome dearth of conflagration.

Economics as a discipline, and even once an almost scientific effort, used to be inseparable from such politics - spoken without being self-conscious at one time as political economy. Even the basis for how we think about the economy in the mainstream owes itself to the great conflicts of the earlier 20th century. GDP as a statistic is rooted in World War II, created by Simon Kuznets in 1934 first as a response to the government's blinding ignorance about the economy in the worst parts of the Great Depression. In reviewing what the BEA called "one of the great inventions of the 20th century", Paul Samuelson and William Nordhaus mused about the grand gulf in what they called "knowledge":

"One reads with dismay of Presidents Hoover and then Roosevelt designing policies to combat the Great Depression of the 1930's on the basis of such sketchy data as stock price indices, freight car loadings, and incomplete indices of industrial production. The fact was that comprehensive measures of national income and output did not exist at the time. The Depression, and with it the growing role of government in the economy, emphasized the need for such measures and led to the development of a comprehensive set of national income accounts."

Implicit in that recounting is that government should have great knowledge with which to openly interfere into economic function. GDP was created for that circumstance, and used as much as it was adopted full-scale in World War II (though it would not fully supplant GNP until the 1980's). The origins of the concepts of national accounts far predated Kuznets, but, as always, attached eagerly to some war or another.

The first to suggest this kind of national accounting was an English scientist (in the full Enlightenment sense of the word) named William Petty. Nautical by way of his birthplace, Petty found himself injured by maritime activity, stranded in Normandy and, after some study by way of Jesuit college, thrust into fame by way of medically resuscitating a woman who had just been hanged (incompletely, apparently). His reputation landed him as a landowner in Ireland as physician general where upon he came into close contact with government and its second brand of arbitrary redistribution: taxation (the first and related being to just expropriate by force of arms).

The general need for taxation, which is to say the desire of the crown to increase it, was tied at that time to repeated war with the Dutch. As a scientist, Petty was as much self-interested but also bitten of apparently national interest, setting himself to the task of designing a more efficient tax scheme that would not overly burden one segment over another (that he found himself in the former is still no accident, but that the product of self-interest isn't always or even often disqualifying as it is so taken today).

Having been granted an estate, Petty was always at least somewhat thinking about its value if not for taxes alone. He reasoned that cattle grazing in one of his fields might put on extra weight for their natural process and thus the value of the land could be extracted mathematically by "value" of the potential meat all that would create. From that he deduced a finite limitation to that value (21 years, as it was enough time for crossing generations but not too much as to be meaningless) and hit upon one of the first references to present value.

But when thinking about taxation, value was entirely absent in favor of income and transactions purely. According to the Office of National Statistics in the UK, Petty figured, "the average personal income was £6 13s 4d per annum, meaning that national income would be £40m based on the then-population of six million." He even applied double-entry bookkeeping as a means to sort out his national accounts, which, indubitably, gives rise to the idea that someone's spending is someone's income. Working backward, he tallied the income from assets was £15m leaving £25m from wages - thus taxation should be shifted in that direction.

This manner of accounting for an entire economic system led to the now-familiar beliefs about it, including the role of money (specifically, as Newton even pondered, the "right" quantity). Long before John Maynard Keynes made widespread his "pyramids in the desert" Petty had surmised that even non-productive or meaningless work was better than nothing for sake of income even on borrowed money; that, in Petty's scheme, the unemployed might be paid to build a useless pyramid on Salisbury plains or even transport Stonehenge to London.

This reductive presentation of an economy survived even though reference to Petty nearly ceased. The idea of double counting is what generated the emphasis upon national accounts, as does the constant basis of spending as income; transactions above all without reference, curiously, to value. That is what GDP is in all its facets, a tally of transactions without guide as to value upon them, making all transactions simultaneously substitutes.

The fact of "why" people engage in transactions is left as at best a peripheral matter. There is just an assumption as a fact of life that trade will occur and will always occur given basis for mixing assets and effort. This notion has acquired some nuance over the decades, as economists (now almost all stranded Keynesians) do not presuppose transactions in all circumstances but only where the economy is not performing. Thus, it is better to do something inefficient and wasteful than to let assets be "idle", by way of assuming one could, from afar, judge what is and is not inoperative.

If building pyramids in the middle of nowhere were profitable, it would be done without forceful government redistribution (Las Vegas proving that point). In other words, if it was "worth" doing then someone would be doing it, and usually with great vigor. So what the "idle" resources is really about is not economy itself but inasmuch a way of convincing the rest that their current assessments of value are wrong; that there will be more spending as income and thus greater opportunity at least generally for all the inefficiency that will come with it.

That factor has both a fiscal and monetary reference, as money itself is never more than derivative of value. People don't engage in transactions to obtain money for the sake of money, but money as medium of exchange. The entire premise of monetarism is that a central bank can interfere in this by way of making money, or currency really, "less valuable" so as to induce spending and transactions regardless of what the economy thinks of it. And so what "stimulus" is is really not "of the economy" but almost a parallel economy meant to act as a detached agent of momentum. That would suggest that there is a great difference, owing to the state of value, between transactions taking place of redistribution and transactions that occur naturally or organically.

The imposition of value is not really thus an imposition, as it exists prior to the notion of transactions. Mr. Petty's cows were meat before they sold, and thus were grass and water (and human tending) before they were meat. The true value of the cows was not in the end product but in how and why they got there in the first place. It is thus curious that the process would be so left out, for centuries, in thinking about how to measure an economy.

That is why asset bubbles are so injurious in the long run. In the scheme of double counting GDP, activity generated by a bubble is taken as spending and income; inseparable from activity generated by profitable endeavor free of any redistribution (as much as that is possible). So any GDP that is derived from the bubbles is not "of the economy" but rather this parallel "economy" that will of its own inefficiency come to wind down to nothing at some point. Economists do agree on that, only that they disagree in what will come of it - as they believe the parallel, redistribution winds down the real economy will have been much better for it and so will make up easily any difference.

If that were ultimately the weight of math on the subject, it would be worthwhile. But here is the problem - how do you know when it is? Orthodox economics just assumes as much in all circumstances; again, the idle vs. nothing. The only way to judge is to insert value, a concept that led to the creation of balance sheet accounting not as an imposition but as a flawed manner in which to capture more broadly and comprehensively what economic agents do innately. All transactions carry personal value judgments that are inseparable from the transaction; yet economics on the macro level leaves no room for it.

The housing bubble itself provides useful illustration of these concepts in close experience. The Federal Reserve sought out financial imbalance as a means to enact any kind of transaction vs. idleness. The incremental expansion of GDP during that era "confirmed" that it was the correct means of redistribution. The panic in 2008, however, stands in stark rebuke, as what that signals is again now-severely wounded value. In terms of GDP, the parallel redistribution "account" of the housing mania was an addition to short-term "growth", really just transactions, but also a coinciding subtraction upon long-term growth. Using another form of double-counting, the housing bubble increased short-term measures while reducing their long-term relations. This makes intuitive as well as mathematical sense - to the point of being not insightful at all and rather obvious.

The net result, from that kind of framework that includes value, far more closely resembles what we actually see today. In other words, there has been no real recovery to this point because, in the end, redistribution did not overcome its primal burden. It did not make up for its removal, and in point of fact left the economy worse off for having so many resources un-"idled". GDP itself is wholly incomplete to that effect, as usual offering only a partial response to what is believed to be a wholesale ability to provide precision as if an economy were so mechanical.

Yesterday, the BEA offered its annual benchmark revisions to GDP, and aside from the uninteresting and pointless reduction of "residual seasonality" the revisit of economic growth in prior years was really quite astounding. Samuelson and Nordhaus only fifteen years ago groused about Depression-era statistics of "freight car loadings, and incomplete indices of industrial production" as if the matter of precision has been settled permanently. But GDP had already, as noted above, wandered heavily into uncharted areas. That deficiency is now on full display in this "recovery" as it has proven time and again unequal to defining the true economic condition.

It is by now well-known how the US economy, in particular, but by no means limited to our debasement, has a labor problem. Specifically, despite all the supposed gains in GDP after 2009, even admitted as weak, labor utilization languishes as if we had befallen some depression suited more for the 19th century than the 21st. In many respects, the asset inflation taken in under the serial asset bubble regime of the eurodollar standard has masked this grand decay, only becoming more visible after the Great Recession even though it began long before. That is the great drawback of omitting value from our accounting of the economy, as we see starkly now how that view alone provides no basis for what to expect. Had GDP been properly double counted with redistribution transactions sifted and separated, the danger would have been far more calculable ahead of time rather than the now-post hoc revisions telling us what we already know.

Whereas GDP had been more comforting in its first run of estimates, not just in the middle of the 2000's but even in the past few years, revisions particularly lately have brought it more in-line with the labor view of the economy rather than the purely assumed transactional view. The most significant aspect of the latest benchmark update was the incorporation of the 2012 Economic Census data, which "found" far more missing economy than even the deficient recovery widely acknowledged. As if the economy permanently shrunk, spending activity and transactions were hugely stunted beyond all previous expectations.

And so the downward revisions have been working their way through lower economic accounts first, to land upon GDP as an enormous thud. That reduction was directed especially to 2012 itself, as what GDP before described as a one-quarter "anomaly" (the economy seems particularly beset with these lately, which is suggestive of all this) has turned into a wide gulf of five quarters of near-recession; again, more like the labor view than the mainstream narrative. The effect of that reduction is not just lower growth rates for the "recovery" but really a painful deduction against opportunity cost of righteous compounding lost; the housing bubble's ongoing subtraction is indeed proving to be deep and wide.

What we see, then, of GDP is twofold. First, it is nowhere near as precise as it is presented which has had the effect of, again, the recurrence of "anomalies." First there was a negative reading in 2011, then near zero in 2012, the Polar Vortex of 2014 and now "residual seasonality." That is an awful lot of "anomalies" to the point of being typical. The net result is not just a recovery "stuck" at 2% GDP growth, but one that is really exhibited of instability. The latest quarter of GDP supposedly showed 2.3% growth, allowing economists to at least plausibly assert that the economy is, yet again, moving toward rebound; but they made the same proclamation of Q3 2012 which was first thought at 2% before being revised up to 3.1%, but is now a recessionary 0.5%. Because of the 2012 Census, the average GDP growth rate during those five quarters is just 1.09%, which is not appreciably different than the average 0.2% growth during 2001 and the whole of the dot-com recession.

The instability that GDP has attained is traced back to that missing value concept - reducing the long run "account" for favor of the short run. Despite this shortcoming and massive prior revisions, GDP remains as if it were the economy itself. That is the second part of this, namely that GDP is as the semantic haggling over "Captain Justice." GDP is, for all the math, statistics and reputation, semantics, a cloak of objective science that is really performance art particularly in its presentation. It is a highly flawed statistic that has not performed anywhere near the stability it needs to in order to engage the credibility it has attained, but that does not stop economic commentary and even monetary policy for taking it as unbiased "evidence" free of all theatrics. In that manner, it was the worst possible outcome, as monetary policy takes it as gospel and then sets about its continued depravity based on that almost alone - keep pounding away in search of the short-term account without any regard for the accumulating minuses in the long-term reciprocation.

Like inflation, their conceptions over the economy are intentionally narrow in order to allow the economy to be viewed as (or even become) mechanical. That is why the recovery that nobody is satisfied by keeps getting worse in retroactive measurement, as economics simply assumes circumstances, by way of all this imprecision, that were long ago subtracted as a violation upon true and useful value. The problem really isn't with GDP itself, which has some limited value. It is really how that view of the economy supplanted all other, more comprehensive if non-quantitative interpretations. GDP is a thumbnail, but taken as the entirety. If the thumbnail was so wrong about 2012, what might that say about the histrionics of 2015? Maybe three years from now GDP will tell economists what the "dollar", taking great account of value, had already alarmed a year ago. The recovery is not missing, as neither is the depression; they just haven't been properly accounted.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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