The Bureau of Economic Analysis
elevated its estimate of third quarter GDP from 2.9% to 3.2% last week. They
intend the decimal points to give an illusion of accuracy when they know there
is a lot of slack in the numbers. Corporate profits rose in the third quarter
on a year-over-year basis 2.8%, the first rise in profits in five quarters.
Tossed with expectations about
Trump’s spending and tax cuts we should have a salad that promises improving
health for the economy. It should end business cycles and bear markets, except
for the fact that we have seen similar scenarios before. Mainstream economists
gathered around the casket of the business cycle in the late 1990s, just before
the recession of 2001. Bear markets are wedded to recessions for the most part,
so the death of business cycles would mean the death of bears, too.
If that sounds too good to be true,
then join me in looking into the numbers a little more closely. The Bureau of
Economic Analysis (BEA) explains the jump in GDP this way:
The increase in real GDP in the
third quarter primarily reflected positive contributions from personal
consumption expenditures (PCE), exports, private inventory investment, and
federal government spending,that were partly offset by negative contributions
from residential fixed investment and state and local government spending.
Imports, which are a subtraction in the calculation of GDP, increased…Considering job gains, wage increases and low debt levels, Bloomberg quoted
Russell Price, senior economist at Ameriprise Financial Inc. in Detroit on the
topic:
Growth is going to remain heavily
reliant on the consumer, but consumers are in very good position to lead that
charge…Overall, it’s an encouraging sign for the path ahead. So basically, the GDP jumped because of greater consumer and government
spending, some building of inventories before the Christmas season and an
increase in exports. Those of us with ears finely tuned to the beautiful music
of economics from Vienna, the noise of greater consumption strikes a dissonant
chord.
We know that investment, not
consumption, spurs a growing economy. Businessmen in the medieval period
thought that spending by the nobility caused growth. It was the original
“trickle-down” economics theory. Pieter De la Court destroyed that nonsense in
1662 in his book The True Interest and Political Maxims, of the Republic of
Holland.
Adam Smith added to de la Court’s
wisdom and the subject was dead among real economists until Keynes used his
electric personality to shock the monster back to life.
An increase in consumer spending
triggers the Ricardo Effect. Profits rise in the consumer goods sector, as we
saw last quarter, and pull investment from capital goods to consumer goods. At
the same time, the prices of inputs, such as labor and materials, rise and thus
squeeze the profits of capital goods producers. And as the Bloomberg article
reported:
Corporate spending on equipment
decreased at a 4.8 percent annualized pace in the third quarter, more than the
initially estimated 2.7 percent and subtracting 0.28 percentage point from
growth, the report showed. Those outlays had declined 2.9 percent in the prior
three months.
As the Ricardo Effect predicts,
greater consumption reduces spending on equipment that boosts productivity. So
while costs are rising for those equipment makers, sales are falling because
consumer goods makers are hiring more people instead of buying equipment to
boost productivity. Many businesses continue to buy back their own shares
instead of investing in new equipment because they don’t see as rosy a future
as most investors see. Buying back shares is a form of increasing dividend
payments without the share owners having to pay taxes unless they sell.
The lack of investment has kept this
recovery from tanking sooner. Past expansions have been shorter because
businesses rushed to invest and caused the longed for spike in GDP right after
a recession. But that increased investment causes more workers to chase a
limited amount of consumer goods and thereby boost prices and profits in the
consumer goods sector. By withholding investment in the recent expansion,
businesses unwittingly extended the expansion even if the rate of increase has
been disappointing.
Keep in mind the BEA’s definition of
GDP: Gross domestic product (GDP) is the value of the goods and services produced by
the nation’s economy less the value of the goods and services used up in
production. GDP is net spending, not gross. Seventy percent is consumer spending and 25% is
federal government spending. That leaves 5% for investment and production. So
by definition a GDP jump tells us that consumers and governments are consuming
more while investment has fallen.
With all of that in mind, I still
expect a recession next year and a bear market with it. In the short run I have
some money in natural gas because production has fallen so much and winter is
coming. Meanwhile, I’m hanging on to gold and silver. If you happen to still be
in equities, you might want to consider some downside protection through
options.
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