GDP reports indicate recession over - but look at the measurement

By DAVID MOON, Moon Capital Management, LLC
November 8, 2009


You may have missed it, but the recession ended five weeks ago. Don’t feel embarrassed if, like me, you need convincing.

The traditional definition of a recession is two consecutive quarters of decline in the Gross Domestic Product (GDP.) It’s an objective, mathematical measure that reduces the risk of someone managing or manipulating the declaration of the economic cycle for political purposes. The measurement is precise.

And at times, it is precisely wrong.

Based on third-quarter GDP estimates, the U.S. economy grew at an annualized rate of 3.5 percent in the past three months. The average annual growth in GDP in the 1990s was 3.4 percent. In the 1980s it was 3.3 percent. Did the late summer feel like either of those decades to you?

The primary driver of the 3.5 percent growth rate was an increase in consumer spending. So far, so good. But the two components most responsible for this increase were durable goods (up 22.3 percent) and residential real estate fixed investment (up 23.4 percent.) Direct federal government spending also increased 7.9 percent, adding to the overall growth figure.

The increased durable good expenditures were primarily autos, buoyed by the Cash for Clunkers program. The residential real estate component was likewise inflated by rebates and mortgage rates that have been pushed lower by government purchases in the mortgage market.

These forces aren’t sustainable. In fact, consumer spending actually declined in September, following the end of the Clunkers program.

Personal income declined over the quarter, yet personal consumption expenditures rose 3.4 percent. How do we spend more money than we earn? By borrowing.

Excess debt is the root of our current economic problem. Consumer spending may be the traditional way we grow ourselves out of recessions, but if we do it on the back of increased debt, the recovery won’t be lasting.

Government subsidies of home and auto purchases create the illusion that debt isn’t increasing since the feds are merely printing money to fund these programs. Consumers and taxpayers aren’t borrowing more money; it is being done on our behalf. In the past year, the total debt of the federal government grew 12.5 percent, or $1.3 trillion.

Government debt isn’t some nebulous accounting trick that allows individuals to avoid repayment. It will be repaid, either with additional taxes, reduced services or higher future inflation.

Devaluing the dollar and the resulting inflation is the easiest tax to impose. Ironically, it is also the most regressive, since higher prices affect everyone based on their spending levels, not their income levels.

If an individual buys a new TV by adding $1,000 to his credit card balance, all he has done is create two offsetting entries on his personal balance sheet. The new asset is “TV.” The new corresponding liability is an increase in his VISA balance. No wealth is created.

The only way he can increase his net worth is by making more money, not spending more money. It’s true at the individual level. It’s also true in aggregate.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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