The inflation of economic data.
"There are three kinds of lies: lies, damn lies, and statistics."
–Commonly attributed to Benjamin Disraeli
If we are to believe the government statistics, the GDP of the US grew by 0.6% in the first quarter of this year. And unemployment actually fell. And there were only 20,000 job losses. This week I'll do a quick review of why the statistics can be so misleading. I also look at why I was wrong about the housing number last week and highlight what could be a very serious Black Swan lurking in the agricultural bushes. It's hard to know where to begin, there are just so many tempting targets; so let's take the statistical aberrations in the order they came out this week.
Who's Inflating the Numbers?
In my January 2007 annual forecast, I said that we would see a recession or a serious slowdown by the end of 2007 and that it would be mild as these things go, triggered by a bursting of the housing bubble and a slowdown in consumer spending. During the summer and specifically in October I wrote that we were facing a Slow Motion Recession – that the recovery process would be lengthy and take several years before we got back to the 3% growth rate that is more typical of the US economy.
There were lots of people who made fun of my forecasts, and some were quite snide. I really let stuff like that roll off my back. But I have yet to see those writers admit they were wrong (as I will later on). And I doubt I will. I take little pleasure in being right on the recession call, as recessions are not fun for those in harm's way, but I call it as I see it. We'll just have to wait and see if some of my other forecasts come to pass. I am sure I will miss a few things. Part of the nature of the business.
Last week I suggested that this week's release of the GDP would be slightly positive, as the Bureau of Economic Analysis (BEA) of the Department of Commerce would have a much lower number for inflation than our common experience suggests to be the case in the real world. It turns out my cynicism was well justified.
The BEA publishes the GDP statistics. It tells us the US economy grew by 0.6% in each of the last two quarters. It comes by that number by taking the nominal or "current dollar" measure of the economy and subtracting its figure for inflation, which gives us "real GDP," or after-inflation GDP.
Nominal GDP in the fourth quarter grew by 3%. In the first quarter it was 3.2%. The BEA figures that inflation was 2.4% in the fourth quarter and 2.6% this quarter, giving us the slightly positive growth numbers.
There are several government agencies which track inflation. And in fairness, inflation in an economy as large as that of the US is a very tricky thing to measure. The Consumer Price Index (CPI) is done by another division of the Department of Commerce, the Bureau of Labor Statistics. Let's look at what it calculates inflation to be since last August, in the following table.
Consumer Price Index
Note the string of five consecutive months of 4%-plus inflation, and that the average for the 4th quarter was 4%, while for the first quarter of 2008 it was over 4.1%. Never mind whether that is the right number or whether there are problems with how it's calculated – that's a story for another letter. The key here is that if the BEA used the BLS number (remember, both groups are in the same Department of Commerce), it would show the economy shrinking by 1% in the 4th quarter and by almost 1% in the first quarter. That's not what the happy-talk analysts are saying.
But let's use the Fed's favorite measure of inflation, personal consumption expenditures, or PCE. The PCE has been about one-third less than the CPI since about 1992. The difference is in the way they are calculated. The CPI uses a weighted average of expenditures over several years. As I understand it, the PCE tracks changes in relative expenditures from one quarter to the next, assuming that consumers change their habits as prices rise and fall. In simplistic terms, if steak gets expensive, we substitute with hamburger or chicken. One index tracks those changes over years and the other (PCE) does it over quarters. Also, the PCE only tracks personal consumption and not imports or inventories.
If we use the PCE numbers (yet another measure using Commerce Department data), inflation was about 3.3% for both quarters, which would mean negative growth quarters by a few tenths of a percent. That would also mean two quarters of negative growth and a recession.
Further, GDP in the first quarter was helped by inventory build-up to the tune of 0.8%. In times of expansion it's good to see inventories grow, as that means companies are optimistic. But when the economy begins to slow, growing inventories mean that companies anticipated sales that did not materialize. That means that as inventories are allowed to fall in the second quarter, they will show up as a negative factor in second-quarter GDP.
But all these numbers will be changed in a few years, as looking back over several years is the only way we can get somewhat accurate numbers. My bet is that the numbers for GDP will be revised down when the economy is well on its way to recovery. It will show up on page 16 of The Wall Street Journal and no one will care. That is what happened when we found out a few years later that the last recession started in the third quarter of 2000. The initial numbers were positive.
The "official" arbiter of whether or not we are in a recession is the National Bureau of Economic Research. And it doesn't use the GDP numbers. If it did, then what would be the point of asking? We could just look at the government statistics. But we don't. Normally, we think of two consecutive quarters of negative GDP as a recession. But NBER has other ways to look at it.
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