GDP Number Not an All Clear for Recovery


The big story in markets today is going to be the US GDP number. It was up 3.5% in the third quarter, according to the U.S. Ministry of Commerce. We predict that everyone is going to use it to claim that the recovery is upon us and that stock markets did not get too far ahead of themselves after all. That’s just what happened overnight in the States. And stocks rallied smartly.

Don’t believe the hype, though. The big problems in the economy—too much debt, too much leverage, too much government—are still there. They didn’t go anywhere overnight. We’d suggest that getting sucked back into stocks now because of the US GDP figure is a very bad idea.

Of course we could be wrong. Maybe stocks will go up another 20% from here. Or 30%. Or 50%. But it’s not likely. It’s more likely that the recession is over, but that the Depression has just begun.

It’s begun because what the US GDP numbers actually show is a private sector in full retreat as its income shrinks, its assets fall in value, and the cost of servicing debt rises. Into that terrible breach the public sector has stepped, armed with an arsenal of inefficient and stupid programs that give the illusion of economic activity but actually prevent the economy from liquidating excess capacity and bad debt (the two conditions required for a real recovery).

So we’re sorry to have to ruin your Friday making this point. But there are actually a couple of points we have to make with regard to US GDP to show that its effects on the Aussie market are not as benign as you might think. Just the opposite really.

The GDP figures presage a massive increase in government spending in America and elsewhere. This debt binge is driving the public sector ever closer to its own reckoning with Ponzi Finance—where new debt barely covers the cost of interest and principal payments on old debt.

But again, why so serious? Shouldn’t we celebrate? U.S. GDP has contracted each of the last four quarters. We are not going to rain on the parade by trying to prove that it didn’t grow. But the real question is whether the GDP figures show that the economy is recovering, or whether a quarter or two of government intervention can give the economy a healthy looking flush, while concealing the disease that is eating away at its insides.

It all depends on what kind of recession we had. In a garden variety recession, businesses build up too much capacity in anticipation of consumer demand that never materialises or suddenly vanishes. Think of the U.S. housing boom. Its seeds were sown when homebuilders built way too many units in places like Nevada, California, and Florida.

They failed to realise that soaring demand for these units was driven by the supply of cheap credit. When the credit dried up, so did the demand. And the homebuilders were left a massive over-supply of housing. The ones that survived had to liquidate inventory (land as well) at bargain prices.

Excess productive capacity is exactly what gets liquidated in a normal recession. Inefficient producers of goods and services get booted from the marketplace. Inventories are worked down until they are in line with a lower level of demand. And then, maybe, the economy starts a new cycle.

But what we have here, dear reader, is not a garden variety recession. While it’s true that there is a huge amount of excess capacity in the world economy (hence wage deflation in the West), there is also another, more serious problem: too much private and household debt. That is what makes this, as others have written before, a balance sheet recession.

You get a balance sheet recession when households and businesses must reduce the amount of debt they have. They “must” do this because cash flows aren’t robust enough to service accumulated debt AND send little Timmy to private school (in the case of households). People have to cut back until expenses are less than income.

Or (in the case of a business), they must cut back because the cash flow isn’t robust enough to cover the interest and principal payments on existing debt AND finance the operating expenses of the business. Businesses have to shift back to investing in capital goods and new growth, rather than speculating in financial assets and paper wealth.

There is no escaping a generation of accumulated debt. When the cost of debt begins to consume most of your free cash flow, well, sooner or later you have no free cash flow. There’s nothing left. You’re spending every last dollar maintaining your household, paying your mortgage, and putting gas in the car. This doesn’t leave room for much else—unless someone gives you money to spend (aha!).

For the last four quarters, American households have been reducing debt in order to get their financial house back in order. They are no longer borrowing against the equity in their house (because that equity is vanishing or has vanished) or spending their capital gains in stocks on a new TV (because those capital gains are smaller too). Instead, they have been de-leveraging.

Did all that really change in just one short quarter? No. What happened in the last quarter is that the U.S. government gave people money, albeit indirectly. The Commerce Department reported that real personal consumption expenditures increased 3.4% in the quarter. They had declined by nearly one percent in the second quarter. So people spent money.

But whose money, and on what?

According to the Commerce Department, “Durable goods increased 22.3%, in contrast to a decrease of 5.6% in the second quarter. The third-quarter increase largely reflected motor vehicle purchases under the Consumer Assistance to Recycle and Save Act of 2009 (popularly called, ‘Cash for Clunkers’ Program).”

All up, the Feds tells us that (see page seven) the “Cash for Clunkers” program added about 1.66% to third quarter GDP. Keep in mind that in September, car sales fell 40% from August levels. Either the program will have to be extended, or it’s shot its one-time stimulus bolt. But what a bolt it was!

Unless we’re mistaken, however, about half the GDP growth came from one government program that’s expiring and stopped working in September. Chuck in another half a percentage point due to the tax credit for new house buyers (sound familiar?), and another half point from the 7.9% increase in government spending—and you get your 3.5% GDP growth.

That’s it, then? The government pours billions of dollars into the real economy and trillions into the financial sector to support bankers, and all we get is more cars and more houses bought by people with credit provided by a government that doesn’t have any? That’s a recovery? That’s the tipping point?

Excuse our scepticism. It’s not like household balance sheets improved that much in the last three months. In the very same glowing press release that announced the 3.5% growth, we learn that people had less disposable income in September, despite the rosy growth number.
“Disposable personal income decreased $20.4 billion (0.7 percent) in the third quarter, in contrast to an increase of $138.2 billion (5.2 percent) in the second. Real disposable personal income decreased 3.4 percent, in contrast to an increase of 3.8 percent.”
That sounds like households—when they are not spending government money on houses and cars—are still cutting back. They’re cutting back because there’s no wage growth in the economy and no job growth. But there is still a lot of debt!
“What destroys individuals, ruins families, and fells nations is debt—or rather the inability to service debt, and the cultural ramifications that follow,” writes Victor Davis Hanson. Attitudes to debt are both private and collective. And they tell you something about the people you are, or are becoming.

Take classical Greece. Hanson writes that, “The difference between the 5th century BC and late 4th century BC Athens is debt-and not caused just by military expenditures or war; the claims on Athenian entitlements grew by the 350s, even as forced liturgies on the productive classes increased, even as the treasury emptied.

“At Rome by the mid-3rd century AD the state was essentially bribing its own citizens to behave by expanding the bread and circuses dole, while tax avoidance became an art form, while the Roman state tried everything from price controls to inflating the coinage to meet services and pay public debts.”

Speaking of Rome, Barack Obama’s pick to run America’s National Endowent for the arts has recently said that, “Barack Obama is the most powerful writer since Julius Caesar.” If that’s the case, we suggest a new slogan to replace “Hope and Change” for the President: We came, we saw, we spent!

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. I have to agree. Eventually all the government spending/discounting within the market must have at some point expanded GDP and technically ended the recession.
    If as you state this 3.5% quarterly increase is fuelled not by productive effort but by recycling government future receipts, then this is expanding the money supply and is inflationary.
    The question then is at what level is this an inflationary influence.
    I would suspect its influence was greater than 3.5% in the quarter making it a virtual recovery not a real recovery.
    The proof will be in future periods. I doubt that growth can continue.

  2. “We came, we saw, we spent!”

    reminding me of the old joke at the Italian or Greek immigrant builder’s expense
    “I came, I saw, I concreted”

    which I Obamify to

    “I came, I saw, I counterfeited”

  3. G’day Lachie – Have you bought a house yet mate? They are really, really, really, really, really, really, really overpriced – But Uncle Kev an his mates reckon it would be a bit crook if they should go down – By more than 20% leastways. “Ozzie Gold” – That’s what I reckon houses here are – Cheers eh? Ned.
    PS: scrounged about $20 worth of weed out of me local creek without trying hard (OR DROWNING.) Looking at same I just might have $50 worth of other weed I can swap down the local pet shop for some fish – LIFE’S GREAT MATE!

  4. Sorry, no house Ned. I want a farm for Christmas actually to go with the house part. The idea is to work up through work trading and saving so I can be a poor farmer :) Just wanna feed the world for some reason.
    My problem is that good ag land is possibly going to increase in value. I dont have good prospects looking at the current price of land but I dont give up easy on anything. Meantime I caretake on a farm anyhow. Unfortuneately not allowed to plough it up.
    Glad to hear about your water weed success. Your on a nature high now Ned. Good stuff. I collected some water weed too for my ex wifes fish tanks. Took the kids of course. To my suprise we found 5 seperate species in a small area of our local dam. All very different characteristics.
    Nice to know your local creek isn’t a concrete lined drain too like what I see in many suburban areas.
    I agree with your point on home ownership (unencumbered at this point) as per a personal priority and also acknowledge those who rent for financial reasons a valid point too. Some people are homebody’s, while some attribute less value to it. I feel very displaced since forced selling out and dont expect that to change until I own once more. Enjoy your home Ned, thats what money is for eh, to buy what we really desire.

    Oh also Ned… “$50 worth of other weed I can swap at the local pet shop” . Hmmm further examples of intoxicant, fiat substitutes to expand on last weeks discussion. Hear the ROI’s are high in this regard too. Yes its getting late.
    Night Ned.

    Lachlan Scanlan
    October 30, 2009
  5. G’day Lachlan – I figured that was your plan. Work, trading and saving surely must have a lot to be said for them in that regard I reckon. (You had a nice little uptick in AUD gold prices last night too – Good to see!) Plus you have a roof over your head as part of the current deal anyway. It must be nice to know what your goal is as well – Many don’t I suspect – But those who do can say Yep, that’s it and grab the opportunity with both hands when it does come their way.
    Home ownership – Just depends on one’s priorities as you say. With homebodies (which I am) maybe having a stronger bias towards it than others – Leastways once they see a place that suits them really well. Most of my “fun” centres around the home – A bit of room to grow some plants, a decent sized shed to store junk in and do a bit of handyman type stuff. I’m even looking forward to putting my own pond in the front yard one day. Plus renovating the joint and doing some mods and extensions. But each to their own in such regards of course. And Yes, with debt being something to be pretty careful of.
    Five species – You did well – I got three that I reckon will grow. It’s an acceptable enough little creek for suburbia – No concrete! The sacrificial fish has survived his introduction to the tank – So back to the pet store to get him a lady friend today. Plus some food :) (That’ll be finely crushed dog biscuits as it’s way cheaper than pet store bought fish food!) Cheers mate.

  6. A very closely reasoned essay which is, above all, very common sensible.

    I wish thousands of copies could be sent to Washington until every politician, staffer and lobbyist is inundated with them – and can’t help but read what you have written.

    This article transcends ideology; whether one is conservative or progressive the political buyouts and pandering must come to an end if we are to have any hope for sustained self-generating prosperity in the future.

    I am forwarding your article to all my contacts.


    vinton e. heuck
    October 31, 2009
  7. Agreed, vinton. Actually you didn’t ruin my Friday Mr. Denning – we’re ready for the next great depression. And if it doesn’t eventuate, we’ll gladly eat our pride but at least we won’t be needing to eat our shoes for a feed (Hard Times, Charlie Chaplin).

    Never too late to start for anyone else of course.

  8. Interestingly, Julius Caesar was the one who changed Rome from a Republic to a Dictatorship. This is what Brutus stabbed him for. If Obama is the most powerful writer since Caesar…

    I’m hoping that thought I had doesn’t happen.

  9. A depression…mmm..really? Just in the U.S. or? Can someone in the doom and gloom crowd please outline in a little more detail how we will all end up in an Idaho bunker complex?

    Greg Atkinson
    October 31, 2009
  10. It might be the sort of depression Japan has been in for last few decades Greg? Yunno – A bit of deflation, a bit of inflation … Do a BB maybe? Own a few properties in different places you like spending time. Have a bit of bullion in case that goes up. And a few stocks in case they go up. And a job just in case everything goes down.

    Wonder what BB’s cash position is? Or does he agree with Buffet that cash isn’t a good thing to be in long term?

    Or is he thinking more in terms of a 1930’s deflationary crash? Or more like a USSR (or even Zimbabwean!) inflationary depression. (Assuming there isn’t actually growth???) So many questions. So few answers. :)

    But given the way central bankers can twiddle things, Japanese style sounds like a probable worst case scenario for mine? Which doesn’t sound that bad???

  11. I know doom and gloom is boring and sounds crazy but it has its role for planning purposes – not for moping around the house making everybody else’s life miserable. Life goes on and if you can profit from a rally, go for it. What has changed in my outlook is a move away from looking just at cash flow, but gearing towards cash-flow independent living. It’s a good idea to me regardless of ups or downs.

    Separate virtual economies from real ones and the range of scenarios becomes clearer (and less extreme). For Australia, there’s a reliance on imported oil, but not a total one. Plus, food production is still good. So apart from losing money on stocks or having some kind of dumb-ass regime put in place, and barring some kind of fatal disease, we should be _materially_ okay even if Lord Voldemort takes over Hogwarts.

    Thing is, the US’s return to its feet so soon is… unconvincing. I don’t under-estimate the size of its economy or its global power, but the idea of a real recovery in US this soon raises at least one eyebrow. Amazing what a band-aid and a bottle of rum can do, eh?

    If the US wants to drag herself out of this one and enjoy another half century of blissful, effortless prosperity, then international markets have to be refashioned. China has to become weaker, for example, and the US’s other potential rivals need to be put back in any box they might hope to jump out of. Other real economies are looking like outshining the US’s real economy soon (with all its other knock-on effects including military development). The only way to stop that trend is to do real things to those rivals – not just talk or fiddle numbers on electronic fiat money. Consider the effects of blocked sea trade routes, flash invasions of small countries by large countries (aside from US) and quite quickly we could be cut off from our favourite trading partners. Then we could expect a bit of real hardship plus some artificially imposed hardship on top, considering how much governments love to benefit from people’s bad luck.

    There isn’t a precedent for the current situation, but it doesn’t mean it’s unpredictable, but mustn’t think we can predict the swing of an elephant’s tail just by the movement of flies around its backside.

  12. Ned I think we all focus on GDP too much. I would like to see more focus on GNP and other measures of the economy. A GDP figure can look good even if a nation is effectively wasting resources and heading backwards.

    Depression in Japan? Not that I have seen. In fact it has been hard to see too much impact even from the latest GFC. When demand crashes they switch off robots, shut down shifts etc… it is amazing actually how well many Japanese companies manage slow downs. (they learned a lot from the post bubble days)

    Greg Atkinson
    November 2, 2009
  13. There is definitely a lot to be learnt from Japan’s experience (although they did shrink by 12.7% over a 12 month period .. ouch! .. manufacturers closed hundreds of factories and laid off hundreds of thousands of workers). At least the numbers suggesting a down-turn exist … might they be a bit dodgy?

    I don’t live there of course, but from my reading (including your musings, Greg :) ) and talking to recent Japanese migrants, there is a frugality and with it a tremendous work ethic. The frugality thing is often criticized, but I think they will have the last laugh – it’s only logical.

    The economic equivalent of measuring economies can be likened to taking a ruler to the toilets for a measure-up – what it indicates is debatable, and how many will walk out of the loo and give an honest answer? It would be interesting to hear about what Japan did with the workers that were laid off … were they paid, fed and put to work nonetheless?

  14. I’ve personally started to think growth is over rated anyway – Oz has had 16 years of it or somesuch and I can only say that I found it harder to get ahead in a recession free environment than in an one that had it’s ups and downs. Never ending growth might be just fine for governments that keep feeding off the ever increasing tax revenue; Or for people who are very comfortable with debt; Or for businesses. But I’ve got a funny feeling that a lot of more average types just could be getting stiffed in the process? And yes, I do accept that the business people who go broke in recessions and the staff they lay off would see it very differently. But I’m just saying is all …

    Sure Greg – ‘the sort of “depression” Japan has been in for last few decades’ – Might have read better. As a comparative sort of thing that doesn’t sound all that bad maybe? (Not compared to a real whatever type of “__flationary” depression.)

  15. Japan is hard to read because the Japanese generally are not big on boasting. So even when times are good people tend to take a cautious view so I often have trouble working out if I should be upbeat or not :) What is often missed when looking at Japan is that so much of it’s industry is overseas. If we could get some figures on Japanese GNP then I think they would be very interesting. (I will see if I can dig some up) In any case, the balance of trade statistics over the last 10 years look better to me than Australia’s.

    The unemployed were encouraged to undergo training or take up positions in rural areas where there are often labour shortages. A lot of farmland lies idle in Japan simply because there is nobody willing (or able) to farm it..strange but true. My understanding is unemployment benefits here are not as generous as Australia and hence people tend to be pretty motivated towards finding a job. Having said that, I have no doubt the government here has used all the usual tricks to massage the unemployment rate down.

    As for the work ethic, yes the Japanese are hard workers but so are the South Koreans and the Chinese. It is a competitive part of the world up here! Keeps everyone on their toes.

    Greg Atkinson
    November 2, 2009
  16. Ron Paul had this to say (among other things) in Forbes magazine recently regarding the recent positive figures for the US economy:

    “Even with the massive interventions, unemployment is near 10% and likely to increase, foreigners are cutting back on purchases of Treasury debt and the Federal Reserve’s balance sheet remains bloated at an unprecedented $2 trillion. Can anyone realistically argue that a few small upticks in a handful of economic indicators are a sign that the recession is over?”

    And he’s toning it down. Real unemployment is likely to be 50% greater, if not worse. He believes we’re about a year away from an historically unprecedented worldwide economic crash.


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