Saturday, October 27, 2012

U.S. Economy Grows at 2%?

That is what the GDP statistic published by the US Bureau of Economic Analysis (BEA) says. However to better understand how the economy changed during the past quarter, as is always the case, we must drill deeper into the numbers. It turns out that the deeper we go, the less rosy things appear. This quarterly release in particular demonstrates the danger of looking to aggregate macroeconomic statistics as a guide for how an economy performs.

 It turns out that the main reason GDP increased at a rate larger than forecast was a significant increase in government spending. Real federal government expenditure increased 9.6%. National defense spending itself increased 13% over the third quarter. These increases at the national level contributed to an overall increase in all government spending (federal, state, and local) of 3.7%. Government spending is what drove this increase.

Unfortunately, we cannot rely on government spending to result in sustainable economic expansion. The economy is not a machine that is ailing from a dead battery. Alas, modern macroeconomists and policy makers often talk and act like it is. They speak of "jump-starting" with a little government spending or monetary inflation or both. Such actions, however, do not generate wealth. They surely cause a redistribution of wealth, benefiting some while harming others, but they do not provide any general social benefit. Neither government spending nor monetary inflation results in more production of more goods that are able to satisfy the subjective ends of people in our social economy.

Economic expansion and development is the happy consequence of people participating in an extensive market division labor made possible by the accumulation of capital that is wisely invested and directed by entrepreneurs. It is voluntary savings and investment--not government consumption--that generates economic expansion in an economy free enough to utilize it.
A look at third quarter investment numbers are nothing to feel excited about. Gross private domestic investment increased an anemic 0.5%. Net Private Domestic Business Investment, while positive, declined for the second quarter in a row.

Economic expansion that does not result from increased saving and investment is more apparent than real and cannot be sustained. The minute the government slows the rate of government spending or the Fed slows the rate of growth in the money supply, the economic lie is exposed and economic law once again asserts its authority.

Another thing we should keep in mind is, as the BEA press release reminds us, "the third-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency." Last quarter's data were revised downward--twice. This resulted in one commentator quipping that they hoped there were no more revisions because pretty soon GDP growth for the 2nd quarter would turn negative.

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