Every now and then the general media asks if the United States is heading towards a recession. Usually the discussion concludes by stating that the US economy is growing steadily and we have nothing to worry about. On July 28th, for example, the Wall Street Journal suggested that the US economy is likely to show an annual growth rate of more than 2% during the second quarter and indeed, when the Bureau of Economic Analysis released the second quarter data it showed the US economy had expanded by a seasonally adjusted annualized rate of 1.9%.

Yet we cannot rely on the Bureau of Economic Analysis (BEA) to give us an accurate assessment of US economic growth any more than we can rely on the Bureau of Labor Statistics (BLS) for an accurate Consumer Price Index. The BLS makes hedonic and geometric adjustments to the Consumer Price Index that result in an understatement of the actual increase in the cost of living. I am sure by now you are familiar with these adjustments, but you may not have realized that the BEA plays similar games with the country’s GDP.

Economic activity is usually measured and reported as Gross Domestic Product (GDP), which is the value of all goods and service produced in a country. The key here is that economic activity, or GDP, stems from “production”. Yet the BEA was not content to just measure the production of goods and services and decided to augment the data by imputing some very questionable “production”.

The largest imputation added to the US GDP adjusts the GDP for the value of owner-occupied homes. The theory goes that if you own a house you are getting an economic value since you don’t have to rent one. Therefore, if you own a house the country’s GDP is understated because you’re not paying rent, and the BEA corrects for this by adding an amount to the GDP equivalent to what they think a homeowner should be paying in rent. The purchase of a house is already counted in the GDP as part of Residential Fixed Investment, but that isn’t enough for the BEA.

Economic activity, by its very nature, has to stem from the activity of someone. An asset cannot generate economic activity unless some person causes it to do so. If I buy a house and let it stand idle it’s not producing any economic activity. If I decide to rent the house out, then I am producing economic activity by utilizing an asset, my house. However, I cannot see how I’m producing any economic activity if I merely live in my own house, and given the fact that the purchase of the house was already accounted for in the GDP this looks a lot like double counting to me.

Another very questionable practice is the imputed interest charge to checking accounts. Banks currently pay no, or very little, interest on checking accounts so the BEA adds an amount equal to the difference between what the banks pay and the yield on short-term government securities. They apparently reckon the banks should be paying interest on checking accounts and because they are not paying interest the country’s GDP is understated. The reality is that the banks are not paying the interest and therefore one cannot summarily add it to the GDP – it’s not real!

There are other imputations, but I think you get the idea – the BEA is increasing the GDP by adding fictitious amounts to the data. According to their website, the share of all imputations grew from 13.8% of GDP in 1996 to 14.8% in 2006. That means that roughly 15% of the United States’ GDP was created on a spreadsheet.

The BLS creates jobs on a spreadsheet in what is called the Net Birth/Death Model, the BEA imputes economic activity into the GDP figures, and the BLS adjusts the CPI to understate the rise in the cost of living. While the US government has to be commended for making as much data publicly available as it does, it should also be chastised for manipulating the data into almost useless garbage.

So now let’s get back to the question of whether the US could enter a recession. A recession is two consecutive quarters of negative economic growth, which is usually measured as two consecutive quarters declining GDP. But the BEA didn’t like that much, so they assigned the job of deciding when, or if, the US economy “officially” experiences a recession to a special committee of experts at the National Bureau of Economic Research (NBER). This committee of specialists analyzes many economic variables to decide whether the US is officially in a recession, or not, and they caution that their findings may, or may not, coincide with two consecutive quarters of negative GDP growth. Well, I guess they can do whatever they like; the reality won’t change one bit. If the US economy grows, the country’s prosperity grows and if the economy contracts prosperity will be reduced. Poverty is the opposite of prosperity, so a decrease in prosperity is also an increase in poverty – a stark reality worth bearing in mind.

Let’s forget about recessions and depressions, and just look at US economic growth to see if prosperity is increasing or if poverty is increasing. Unfortunately we’re going to have to work with the BEA’s GDP data, but we will do our own adjusting of the nominal data to real, inflation-adjusted data.

As you can imagine, the nominal value of goods and services keeps increasing over time due to inflation, which is not an increase in prices, but an increase in the supply of money that in turn causes an increase in prices. Therefore it becomes critical to adjust GDP data for inflation before we can ascertain if there has been any real increase in economic activity. The BEA does report real, inflation adjusted, GDP data; however, if the economists at the Federal Reserve Bank cannot define or measure the money supply I don’t see how the BEA can accurately correct nominal GDP data for inflation.

It is a very simple matter to adjust nominal GDP data to real GDP data -- just account for the increase in the money supply. Since we have an accurate model for calculating the money supply (AMS) this is not a problem for us; however, it would be impossible for anyone who did not know how to define money or calculate its supply, which is why it is so obfuscated.

The chart below shows the annual change in real GDP calculated using AMS, and the real GDP as calculated by the BEA. Economic expansion occurs when GDP growth is positive and contractions occur when GDP growth is negative. Negative GDP growth leads to poverty while positive GDP growth leads to prosperity.

There is reasonable agreement between the real GDP growth calculated by the BEA and that calculated using AMS during the 1930s and 40s; however, beginning in the 1950s the BEA consistently overstates GDP growth. This is solely due to the BEA not adequately adjusting nominal GDP for inflation. The average annual increase in real GDP from 1950 to 2007 was 3.45% according to the BEA but only 0.52% when using AMS to adjust for inflation. Believing that an economy can grow for extended periods of time at the kind of rates the BEA suggests is foolish. At a compound growth rate of 3.45% an economy would double in size every 21 years! Remember, we’re talking in real, inflation adjusted terms here, not just nominal growth. Such a high growth rate is just not sustainable.

From the chart we can also, quite clearly, see that the US economy has been contracting every year since 2000. The BEA may not want to call this a recession yet -- and what they want to call it is quite irrelevant -- the fact remains that the US economy is contracting and eroding American prosperity. You would also have recognized by now that the apparent prosperity in the US, as measured by consumption, has been entirely debt financed, which is why the US is in such a mess today. The collision between make-believe and reality has only just begun for US consumers and it is bound to be an unpleasant experience.

While some economist may argue whether or not the US is in recession, heading towards recession, or growing rapidly enough to make all current woes disappear, the reality is that the economy contracted 2.92% in 2007 and 4.16% in the second quarter of 2008 versus the second quarter of 2007. Just to be clear, that is a GDP growth of -4.16%.

Inflation Watch
Current Inflation Rates:
US 8.12% as of July 23, 2008
Canada 13.10% as of June 2008

The current inflation rate for the US is calculated as the percentage change in the Actual Money Supply on a rolling four-week basis for the most recently published weekly data compared to the same four weeks a year ago. The current inflation rate for Canada is calculated as the percentage change in the Actual Money Supply of the most recent published monthly data compared to the same month a year ago. All current rates are subject to change as the data sets are published and revised by the respective central banks.