This article originally
appeared on PaulCraigRoberts.org.
The third and final estimate
(until the annual gross domestic product revisions) of first quarter 2014 real
GDP growth released June 25 by the U.S. Bureau of Economic Analysis was a 2.9
percent contraction in GDP growth, a 5.5 percentage point difference from the
January forecast of 2.6 percent growth. Apparently, the first quarter
contraction was dismissed by those speculating in equities as weather related,
as stock averages rose with the bad news.
Stock market participants
might be in for a second quarter surprise. The result of many years of changes
made to the official inflation measures is a substantially understated
inflation rate. John Williams (www.shadowstats.com) provides inflation estimates based
on previous official methodology, when the Consumer Price Index still
represented the cost of a constant standard of living. The 1.26 percent
inflation measure used to deflate first quarter nominal GDP is unrealistic, as
Americans who make purchases are aware.
A reasonable correction to
the understated deflator gives a much higher first quarter contraction. The two
main causes of inflation’s understatement are the substitution principle
introduced during the Bill Clinton regime and the hedonic adjustments ongoing
since the 1980s that redefine price rises as quality improvements. Correcting
for excessive hedonic adjustments gives a first quarter real GDP contraction of
5 percent. Correcting for hedonic and substitution adjustments gives a first
quarter real GDP contraction of 8.5 percent.
Realistic economic analysis
is a rarity. The financial press echoes Wall Street, and Wall Street economists
are paid to help sell financial instruments. Gloomy analysis is frowned upon.
Even negative quarters are given a positive spin.
Years of understatement of
inflation has resulted in years of overstatement of GDP growth. Thinking about
the many years of misstatement, we realized that the typical computation in
nominal terms of the ratio of debt to GDP is seriously misleading.
Consider that debt is issued
in nominal terms and repaid in nominal terms (except for a few Treasury bonds
with inflation adjustments). However, nominal wealth or nominal GDP overstates
real economic strength. The debt is growing, but both the nominal and real
values of the output of goods and services are not keeping up with the rise in
debt.
To understand how risky the
rise of debt is, nominal debt must be compared to real GDP. Spinmasters might
dismiss this computation as comparing apples to oranges, but such a charge
constitutes denial that the ratio of nominal debt to nominal GDP understates
the wealth dilution caused by the government’s ability to issue and repay debt
in nominal dollars. We know that inflation favors debtors, because debts can be
repaid in inflated dollars.
The graph below shows three
different debt-to-GDP ratios. The bottom line is nominal debt to nominal GDP,
the financial press ratio. The middle line is the ratio of nominal debt to the
official measure of real GDP. The top line is the ratio of nominal GDP to
Shadowstats’ corrected measure of real GDP that puts back in some of the
inflation that is no longer included in official measures. The basis for this
corrected measure is also 2000, but as the GDP number for 2000 is lower due to
correction, this graph begins with the ratio at a slightly higher point.
The nominal debt-to-GDP ratio
shows that as of the end of the first quarter of 2014, the total outstanding
U.S. Treasury debt is 103 percent of U.S. GDP.
The ratio of Treasury debt to
official real GDP shows debt at 136 percent of GDP.
The ratio of debt to real GDP
deflated with a more realistic measure of inflation — one more in keeping with
the experience of consumers — puts U.S. public debt at 185 percent of GDP. In
other words, the burden of U.S. debt on the real economy is almost twice the
burden that is normally perceived.
The Shadowstats adjustment we
made to real GDP does not fully correct for what we believe has been a growing
understatement of inflation since the 1980s. The adjustment we made corrects
the implicit price deflator for a two-percentage-point understatement of annual
inflation due to hedonic distortion. Real GDP with this correction since 2000
looks like this:
We have calculated the ratios
of U.S. public debt to nominal GDP and to two measures of real GDP. The ratios
of debt to GDP would be much higher if we used total credit outstanding — or
total public and private debt — and if we used the government’s unfunded
liabilities. The fact seems clear that debt is a major and unappreciated issue
for the U.S. economy. The enormous debt, especially with the middle-class
economy largely offshored, implies substantially lower living standards for the
99 percent.
The first quarter
contraction, especially our corrected number, implies a second quarter negative
real GDP. In other words, the years of quantitative easing (money printing) by
the Federal Reserve has not resulted in economic recovery from the 2008
downturn and has not prevented further contraction.
Massive money creation and
huge fiscal deficits have protected the balance sheets of “banks too big to
fail” but have harmed the American people. Retirees and pension funds have been
deprived for years of interest income as the Federal Reserve engineered zero or
negative interest rates for the sake of a handful of oversized banks.
The extraordinary creation of
new dollars diluted the dollars held by peoples, companies, institutions and
central banks throughout the world, raising fears that the dollar would lose
exchange value and its role as world reserve currency.
Washington’s use of financial
sanctions to force other countries to bend to Washington’s will is causing
countries to leave the dollar payments system. Russian President Vladimir
Putin’s adviser has said that the dollar must be crashed as the only way to prevent
U.S. aggression. The Chinese have called for “de-americanizing the world.”
The imperialistic Foreign
Account Tax Compliance Act (FATCA), which comes into full force July 1, 2015,
imposes such heavy reporting costs on foreign financial institutions that these
institutions might opt out of dollar transactions. Altogether, the result could
be a serious tumble in the value of the U.S. dollar, more wealth contraction,
higher inflation via import prices and less U.S. wealth available to support
U.S. debt.
In view of this reality, why
is Washington pushing its puppet in Kiev toward war with Russia? Why is
Washington pushing NATO to spend more money and build more bases on which to
deploy more troops in the Baltics and Eastern Europe, especially when Washington’s
contribution will be the largest part of the cost? Why is Washington
re-entering the Mideast conflict that Washington began by inciting Sunni and
Shia against one another? Why is Washington constructing new naval and air
bases from the Philippines to Vietnam in order to encircle China?
If Washington is this unaware
of its budget constraints and its financial predicament, it cannot be long
before Americans experience economic catastrophe.
–Paul Craig Roberts, Dave
Kranzler and John Williams
John Williams, an expert
on government economic statistics, has been a private consulting economist for
more than 30 years (www.shadowstats.com). Dave Kranzler (www.investmentresearchdynamics.com) has years of experience in financial
markets. Paul Craig Roberts is an economist and former Assistant Secretary of
the U.S. Treasury for Economic Policy.
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