Friday, October 30, 2009

US Economic Growth Deconstructed

I had planned a review of the UK economy and stock market, but I was overtaken by the news that US economy ‘grew’ by 0.9 percent in the third quarter. A fairly typical explanation for the growth can be found in a Telegraph article as follows:
The primary reason US economic output has rebounded so strongly is the slug of growth contributed by state programmes, including "cash-for-clunkers" and similar stimulus schemes.
As such, I thought it might be worthwhile to return to the well worn subject of GDP growth. What we are seeing is the mirage and magic of statistics. I will explain this as clearly and simply as I am able through an analogy, and show why this is all 'magic' growth.

Imagine that I am a farmer, and that my output of food is not quite enough to feed my family. As a result, I have frequently turned to my neighbour, who has each year lent me enough food to make up for the shortfall. As each year goes by, I am borrowing more and more from my neighbour, and I am starting to owe him a great amount of food overall. Finally, one year, a river floods and damages many of my crops and drowns some of my animals. My output is reduced to an even lower level, and I am going to struggle to meet my family’s needs.

Once again, I turn to my neighbour, and ask to borrow even more food to take my family through the next year. He agrees and loans even more food than on previous occasions, and I add the borrowed food to the store of my own farm’s output in the barn. At the same time, I also do something to address the problem of the shortage. I decide to change the systems of measuring the output of my farm. For example, instead of counting my units of corn in whole kilograms, I change the units so that one unit becomes three quarters of a kilogram. With my new system, I now measure my output from the current year as all of the food in the barn, and find that I have increased my output of units of food overall for the year.

I look at the large pile of food in the barn, and behold that, despite the problems of my lack of output of food; I have actually achieved an increase in output. There are more units of food in the barn than in comparison with the previous year.

As my generous neighbour is lending me so much food, he comes around to visit my barn, and see how I am running things. As reassurance, I count out my units of output, and show him how much my output has increased. I am very pleased with myself, and I smile with pleasure as I count the units. Then I note that my neighbour is frowning and I am puzzled to find that my neighbour does not share my pleasure.

He asks whether I am going to repay him in the old units of kilograms or the new units of three quarter kilograms. Now I start to frown, and suggest that he does not understand the situation. For every unit he has lent me I will, of course, return one unit as a repayment. I am a little grumpy. Can he not see that my output has grown? Can he not see that, if I can keep up this rate of growth, I will achieve a level of output that will allow me to easily pay him his food back? I wonder at his lack of confidence in me when I have demonstrably improved my output.

I am left wondering that my neighbour simply does not understand output. My neighbour is left wondering how much longer he will continue to lend me food.


I finally got around to reading this week's copy of the Economist magazine. On reading the magazine, I was struck how many of my views which were previously considered radical (if not barking mad), are now mainstream. There was even one section where they contrasted financial wealth with 'real' wealth, which is almost a perfect mirror of my first article, 'A Funny View of Wealth' (which predicted the economic crisis in the UK). The Economist also addressed the relationship between the US and China, and much of their analysis mirrors the analysis I offered a long time ago (though with different outcomes), and the same applies to the prospects for the $US (again with different outcomes).

I should also mention that I predicted a $US collapse for April of this year and got it wrong. However, the possibility of a $US collapse is now being discussed in the mainstream. What I am really saying is that, in about 6 months time (a wild guess), expect to be reading that the growth in the US economy was not genuine growth at all.


  1. On the farm analogy - ok so far as it goes but aren't you leaving out some details about your neighbours farming policies ?
    Let me try to extend the analogy - at least until it obviously breaks :

    Your neighbour , unlike you, pays his workers one turnip each per day. You pay 10 turnips per day and throw in access to the farm medical kit, and some free old age turnips for the elderly.

    Why don't his workers just come & work for you ?
    Well, one, because his actual labourers [ as opposed to a few of his accountants & clerks ] aren't allowed off his farm. It's surrounded by a big barbed wire fence.

    So all the farming business in the local county is slowly draining off to him. And he has pegged his turnip wages so that if you decrease yours, he decreases his too, so that , whatever you do, the wage( turnip) differential remains.

    The fly in the ointment in this is that your neighbour ( let's call him Mr Yuan) needs customers for all that produce he makes, and the customers are your workers ( and those on the other farms in the area) . And they are getting poorer because you pay less & less, and many of them are unemployed.

    If this carries on, Mr Yuan will eventually own the only farm in the world, but he will have no customers for all his produce, because they will all have died of abject poverty.

    Obviously this won't happen. Some thing will have to give. And what will give is the ability of the other neighbourhood farm workers to buy any more of Mr Yuan's turnips ( and potatoes etc etc). At that point, Mr Yuan will have to come up with a new business model. But... his workers are breeding like rabbits ( sry for unintentional racial slur if one is percieved) and he NEEDS to sell about say 9% more produce per year just to keep them all fed. If he can't do this, they will get restive & probably break into his farmhouse at midnight & chop him up with sharp farm tools.

    So - hypothetically, what should one do if one is Mr Yuan ?

    Now, the answer that occurs to me is for Mr Yuan to actually GIVE AWAY all his surplus produce to his workers, thus making them richer & less rebellious.

    And at some point, what with his workers getting richer & our farmer's getting poorer, we reach a point where it will actually be better economics for you to employ workers & for your farm to even export a bit to Mr Yuan !

    But the problem is, until that happy day, your workers are going to have to be satisfied with MUCH LESS THAN THEIR ACCUSTOMED AMOUNT OF TURNIPS for the foreseeable future.

    And you have not yet found a way of telling them that this is going to have to happen. Because you run a democratic farmyard, and, hell THEY VOTED YOU GENERAL MANAGER & you LIKE the job. If you told them that, you would be right out on your ear and someone who was prepared to lie to them would get voted in.

    So what's going to happen is... without warning... slowly ... your workers are going to find themselves poorer & poorer, and NOBODY is going to explain this to them, except maybe some silly blogger on some obscure website that no-body reads... And who the hell would believe THAT, f'chris' sake ?? :-)

  2. Chain gang Charlie: Thanks for the comment. Your analysis is quite reasonable, and you will find similar points throughout the blog. I wanted to keep the analogy as simple as possible to highlight the point about 'growth'.

    Of particular note is that we are indeed getting poorer in the West, and that very few people are explaining why. On several occasions I have written on the theme that 'we are poorer than we think' and that we are witnessing the shift to our real level of wealth.

    With regards to the 'silly blogger' (I am guessing that you are characterising me this way as from the perspective of others?) that nobody reads, I am happy to say that I have quite a large readership, though very small in comparison with the mainstream media. I also write for a trade magazine and am syndicated on Seeking Alpha.

    As such, whilst I am unsure of my total 'reach', it may be larger than you imagine. However, never as large as I would like. In particular, governments seem to be fixed on pretending that nothing has really changed, and the longer they delay adjustment, the worse the price to be paid. I think people need to understand this.

  3. Cynicus - No slur intended with the 'blog nobody reads'. I suppose I meant , nobody I know except me reads economics blogs. ( Any of them, not just not yours ) We all watch a bit of the news & go away & get on with our lives.

    Anyway, while you are here, perhaps you can help me with something that has long bothered me.

    The point will be expressed as briefly as I can manage, & I will probably use a few verbal shortcuts .

    If we imagine China as a 'black box' .. and we look at things from inside this black box, what goes on ?

    As I see it, they manufacture stuff, and we can imagine them putting these manufactured things in the mail & magically recieving green bits of paper called 'dollars' back in the mail some time later.

    They then take these 'dollars' along to the local bank & get them exchanged for local currency. ( yuan).

    This, from inside the Chinese Black Box, is the sum total of the process. It's all our factory owner needs to know.

    Now, it seems to me that, if we imagine the USA just happened to VANISH in a puff of smoke one night, ( bear with me, this is a thought experiment) , what the Chinese leadership could do - to prevent economic collapse - would be as follows:

    They simply DO NOT TELL the population of manufacturers that the USA has vanished.
    They allow the manufacturers to keep stuffing products in envelopes and snding them off... but they intercept the parcels, stick them on container ships, sail em out to the middle of the China Sea, and DUMP THEM OVERBOARD.

    They then print up a pile of damn good 'dollar ' forgeries and hand them over to our factory owner(s).

    Factory Owner then takes them to Bank which exchanges them for yuan as per usual.

    Now, so far as I can see, Internally, no-one is even going to notice anything has changed.

    Which suggests that ( amazingly) the USA can - at least so far as Chinese internal affairs are concerned - effectively be replaced by a little bit of slight of hand.

    The only economic differences I can see are
    1) the 'dollars' jimmied up by the PRC are fake. So they can't spend them externally. But then, they can't really spend the vast bulk of the 'real' dollars they collect anyway. So, a marginal effect there but not a whole lot.

    2)They can't ( see above) buy US treasuries etc etc with their fake dollars ( because the USA doesn't exist, you recall :_( ) so they forego maybe 1.23% interest. (Wow big deal ? ).

    So, ok there will be some marginal differences with what the state can do with faked up $ as opposed to 'real' $, but in the large, no big deal.

    Okay, now I have to say that this scheme appears to be insane. ( Dumping all those I-Phones in the Ocean ?!! ). So there is very probably something I am missing.

    My question is ( and it's a serious question ) WHAT AM I MISSING ?

    And if the answer is 'nothing', haven't we just solved the China development problem ?

  4. The annoying thing about 'stimuli' is that to the everyday person they appear to be working. It is very hard for the layman to see the financial trickery that is going on.

    "The U.S.A. is out of recession" people say. "We'll be next. Looks like the government did the right thing after all."

    Then later, when life seems to be getting harder and harder, taxes are rising, inflation is an issue and meeting the bills is tougher and tougher there's no obvious place to lay the blame.

  5. footnote :

    I should say that my 'dumping I-phones' scenario was developed more as a method of getting to the nub of what I don't understand about Chinese / US trade relations than as a realistic suggestion :-)

  6. @Cynicuseconomicus + @changangcharlie - the reach vs readership debate aside, I enjoyed the analogy constructed by the both of u :-) Made a simpleton like me understand the whole situation better. Thanks. Mr Yuan better be sleeping with a handgun next to him tonight (lest he gets chopped up sooner than expected).

  7. Steve: Nice to see you commenting again. I will be discussing the trickery in the next post (already written but will publish in the next few days).

    Clasydale: Thanks for the comment, as I can only guess on the effectiveness of these kinds of analogies.

    ChainGangCharlie: Thanks for the further comment. In some sense, you are right, but not quite. The $US bills do still buy real things, such as oil. The secret is that the $US is used so much as the currency of trade. However, that is diminishing, with for example Turkey and Iran deciding to trade in their own currencies in the last few days. There will be many more such deals, and I have written about many other deals in other posts.

    The problem for the Chinese is that, with each month that goes by, their prospects for getting the full value of their products back from the US is diminishing. It is the kilo versus three quarter kilo point. In some ways it is akin to Chinese manufacturers dumping their product into the ocean, but not as bad as that. In other words, if they sell an iPod to a consumer in the US, they will eventually have returned to them half an iPod or three quarters of an iPod (ignoring that these would be useless).

    In selling the iPods at such a discount, they make themselves very competitive. The downside is for Chinese business who do not (and will not) get the full value of their labour. This competitiveness meanwhile will see business in other countries forced out of business, leaving China as a dominant position in certain industries. In effect, they are investing some of the value of Chinese labour to put business overseas out of competition.

    It is simply a form of predatory pricing, and is a mercantilist strategy.

  8. Am I right in thinking that where these common sense analogies deviate from reality - in terms of government policy and what we hear 'Nobel Prize' winning economists saying - is that they all start from the assumption that economics is a zero sum game?

    But governments seem to believe that if we can just stimulate ourselves enough with borrowed and printed 'turnips' then we get self-sustaining growth, presumably based on innovation, better efficiency, technology etc. Could anyone suggest a 'common sense' analogy for this, which works?

  9. Cynicus :
    Thx for reply. ( Incidentally - can't seem to cut & paste into this window which is a pain when wanting to quote your points .. anyway ..)

    I'm not the greatest with trade /current account definitons, but I do know the Chinese have built up $ currency reserves of the $trillion order of magnitude. Also that they have real trouble buying anything with this huge amount of $ except US treasuries - the numbers being just so damn big.

    But in reality, all those dollars are just IOUs, an accounting mechanism that shows just how far US- China trade is out of balance. Now people say 'o the poor Chinese they will never get their money[value] back' but.. isn't it true that *they created the pegged yuan policy and thus deliberately created the whole imbalance * ? The currency peg is really trade
    protectionism under another name / mask. I have seen Martin Wolf arguing that , yes they will take huge losses on those $ eventually but the upside is that by that time they will have pretty well cornered world manufacturing . And this was my point about I-Phone Dumping, I suppose. It may appear lunatic, but it does/would boost their industrial sector no end.

    It might be interesting to look at trade between the 2 countries in terms of goods, regardless of the paper dollar surplus. This would represent the real world situation, ie what is being traded for what in real 9goods) terms. And obviously , on that basis, Chinese industrial produce would appear even more grossly under priced than it does already.

    Example =>
    USA exports say 20Bn goods to China.
    China exports say 200Bn goods to USA.

    The difference is made up with 180Bn bits of paper called 'dollars', which the Chinese stick under the bed.

    But isn't the reality that 20Bn US goods ( plus some bits of paper) is being exchanged for 200Bn Chinese goods and thus that Chinese goods would thus be in real trade balance terms cheaper by another factor of TEN ? ( 200Bn= 10X 20Bn) .

    You can see that for a poor nation, trying to avoid 'hot money' flows etc etc, this policy was once a pretty good idea. But now, are things not becoming, in a word, pretty ridiculous , with this vast overhang of US IOUs looming over the global trading picture like a guillotine ?

    I see the Chinese are now hinting that the US could settle some of those IOUs by selling *military* hi tech. That would be one way out I suppose.. but it does smell like an Armaggedon option for the US.

    Rock, meet Hard Place. :-)

  10. In answer to Lemming's question regading stimulus:

    The farmer comes up with a way of encouraging his workforce to work harder. The farmer thinks that if he gets everyone to buy a new tractor, they will break down less often, and so produce more turnips. He gives farm workers 100 extra turnips every time someone trades in their old tractor for a new one.

    Unfortunately there is only a certain amount of land to grow turnips on, so the tractors spend more time sitting in the barn. The turnip production does not increase. The workforce are poorer still, because they have to pay more of their turnip wages to the foreign tractor manufacturer, for the new tractors.

    The farmer has even less turnips than before, because he has the same income in turnips, but has to keep giving away 100 every time someone buys a new tractor.

  11. Ok I am going to carry on thinking aloud here - seems to be a good way of organising my confusion.

    A big question would be , what is the end game as far as the Chinese are concerned? ( Note that 'the Chinese' is a vast oversimplification. I don't suppose there's a a common 'Chinese' point of view any more than there is a common 'US' or 'UK' point of view. But there is, I imagine, a 'party line' or 'dominant train of thought' in the Chinese Communist Party . )

    So - is all this a nefarious scheme for world domination dreamed up in the shadowy halls of CPC headquarters ?

    What did 'they' imagine would be the end game ? An eternity of selling cheap 'stuff' to the 'developed world' until no manufacturing was left there at all ? Nope. Too dumb. Even I can see that with no more western jobs - outside the much vaunted & overblown 'service sector' - they would eventually run out of customers.

    So, were they as surprised as we generally were when everything blew up ? Or was that part of the game plan ?

    On China, Michael Pettis seems about the most reasonable informant & he is not optimistic about the road ahead for the Chinese & their uber-stimulus. Maybe they are just 'muddling through' as we seem to be, lurching from crisis to crisis, just trying to keep things going for another 6 months , putting off the pain , kicking the can down the road...

    Cynicus ? How about your thoughts on where this will all end ?

    I can't help but compare Hugh Hendry's video of the empty tower block condos in Shanghai (?) ( on youtube somewhere ) with Reggie Middleton's of ditto in the Bronx. (On his website)

    Perhaps the simplest way to look at it is that we in the West now have a vast army of industrial competitors in the Far East with workers there willing to slave for a fraction of 'what we are willing to slave for' & thus we are in for a long drawn out levelling of the international industry game, with lowering of wages here & raising wages 'there', all the while Peak Oil slowly drip feeding higher & higher energy prices to us, as populations inexorably rise ... meantime the US military rampages around the globe enforcing a New World Order ( read : 'we want your oil' ) on all & sundry.

    Tin hats all round ?

    How do I explain this to my children ?

    Or is it all a bad dream & will I wake up in the halcyon days when we in the West did all the manufacturing & we could look forward to a life of ever increasing leisure and an endless diet of tasteless air brushed advertising & prosperity ?

  12. Cynicus - I just found your article "Five minutes to midnight".

    Reading it, I found your answers to most of my questions.

    Unfortunately, it only reinforces my view ( 'less turnips' for the UK .. )

    I think I need a beer :-)

  13. Whilst we're on the subject of analogies, what about the concept of saving? The 'common sense' turnip analogy would be that you are storing produce to use for your old age. But turnips rot, so instead you have the concept of 'investing' your turnips in some way so that they can be redeemed at a later date, using paper certificates. Clearly, however, an entire community cannot literally 'live off its savings': individuals can redeem their savings certificates against a healthy harvest, but if the weather's been bad or the crop is blighted, the certificates are worthless.

  14. The notion of growth is core to economics, and is essential if 'saving' and 'investment' are to work. But can we be certain that it has ever actually occurred in the way we would like to think it has? Do we know that the effects of increasing efficiency, technology and so on are not just marginal these days, and that most growth is down to a 'Ponzi' effect of exploiting an ever-increasing number of people at the bottom of an economic pyramid? If we regard the globe as a closed community, we seem to have had growth in, say, 2005, but even then, the world was exploiting a rising tide of cheap labour coming in from the fields in China.

    And in the West we think we have seen growth, but we have moved from a single average income being adequate to support a family, to a situation where both parents must work (with unquantifiable effects on future society). The ageing population is supported by large numbers of young people who have 'signed up' for buying a house on the understanding that it will increase in value and that they, too, will be supported by the people below them on the housing ladder, but are there enough of them? We cynically exploit a tide of cheap labour imported from overseas, but the boost can only be temporary. Is 'growth' just an illusion?

  15. To answer the question what is the Chinese point of view, or more accurately what do they get out of it (The master plan). The Chinese will acquire all the west's technology and manufacturing know how. Eventually thier own middle class and as a result will no longer need the west's turnips. That's the 180 Bn value to the Chinese. The factories, technicians, skilled labour and a fast track to the developed world.


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