Are GDP and Productivity Understated or Overstated? Why it Matters!

by the Curmudgeon with Victor Sperandeo


BEA Admits GDP Calculation is Inaccurate (the Curmudgeon):

The Bureau of Economic Analysis (BEA), the U.S. government agency responsible for calculating the nation's economic growth rate, this week acknowledged problems with its numbers and is pledging a series of fixes over the next several months.  In a statement to CNBC, BEA said it's "aware of issues" in its GDP data and "it's developing methods to address what it has found."

The BEA statement comes after CNBC, in a detailed report in April, showed that 1st quarter GDP data have been weaker than the other three quarters for the past 30 years and substantially weaker in the past five.

Several economists, including researchers at the San Francisco Federal Reserve Bank, think that 1st quarter GDP has been understated:  “the anomalous pattern of generally weak first-quarter growth suggests that the BEA’s estimate of GDP growth for the first three months of 2015 may understate the true strength of the economy.”   Others, like John Williams of ShadowStats (see quote below) believe it was overstated!

Many attribute the problem to what is known as "residual seasonality," which are seasonal patterns that remain in the data even though the information is already adjusted for seasonal variations.

Nicole Mayerhauser, chief of BEA's national income and wealth division, which oversees the GDP report, said in the statement that the agency has identified several sources of trouble in the data, including federal defense service spending. Mayerhauser said initial research has shown this category of spending to be generally lower in the first and the fourth quarters. The BEA will also be adjusting "certain inventory investment series" that have not previously been seasonally adjusted. In addition, the agency will provide more intensive seasonal adjustment quarterly service spending data.

Ms. Mayerhauser said that an initial round of revisions will be completed by July 30, in time to be incorporated into the annual benchmark revisions of GDP.  These revisions, however, will only go back three years, to the years beginning in 2012.

"Longer term – beyond July 30 – BEA will continue looking at components of GDP to determine if there are opportunities to improve seasonal adjustment methodologies," Mayerhauser wrote in a statement emailed to U.S. News.

"Should BEA identify other areas of potential residual seasonality, BEA will develop methods to address these findings."

Other Voices on GDP reporting (the Curmudgeon):

In a note to On the Money subscribers following the BEA admission of inaccurate GDP reporting, Dennis Slothower wrote: 

"We have seen from our government that when the GDP is slipping the easiest way to fix this is to simply adjust the way they calculates the GDP. We saw the Fed add in the Hollywood creative credits to add 3% to the GDP annually. We saw the Fed change the way it computes inflation data, to adjust it downward which improves the deflator data within the GDP to boost it."

"It is simply unbelievable the extent to which this government administration is willing to go to ensure a positive GDP number. They no longer hide what needs to be done to cover the real damage of their failed monetary policy. They see no problem at all with doubling seasonal adjustments (or maybe even triple them) – whatever is needed to get the desired GDP figure."


In commentary No. 721 to ShadowStats subscribers, John Williams asserts that pending GDP numbers will likely show a contraction.

"With a looming GDP contraction, apologists for the U.S. government and Fed policies, and those who need to report perpetually Happy News, are lambasting GDP reporting quality. The last week or so has seen a chorus of criticism arising in the popular financial media as to why the weakness in the GDP is not meaningful, along with suggestions as to how the GDP reporting should be corrected. There even were purported comments from the BEA that they were aware of the reporting issues and would address them. Those who are squawking now generally accepted the nonsensical annualized four-to-five percent quarterly real GDP growth rates in mid-2014 without a question."

"The first estimate of 1st quarter Gross Domestic Income (GDI) will be published along with the May 29th revision to the 1st quarter GDP estimate.  We shall see then what the first-quarter combination looks like."


Zero Hedge reports that "the BEA has finally thrown in the towel on weak seasonally-adjusted US GDP data, and as a result has decided to officially proceed with a second seasonal adjustment: one which will take all the bad data, and replaced it with nice and sparkly, if totally fake and goalseeked, GDP numbers."

The above blog post goes on to provide details on "how economics has just devolved into a complete farce on a scale that even the Chinese Department of Truth will find laughable."


Ultra perma-bull Gene Epstein wrote in his May 25th Barron’s column “Robust Economic Growth Is Off the Table in 2015:

“THE APRIL DATA GOT OFF TO A DISMAL START with the release on May 13th of the retail-sales figures. Circumstances seemed right for a bounce in retail spending, but consumers didn’t seem to agree. Retail sales were flat in April (=0% growth), compared with March’s total, signaling growth in real consumer spending in the second quarter at an annual rate of only 2%....Growth last year ran at just 2.4%, about average for this below-par expansion, and noticeably lower than in 2013, when it was 3.1%.”


Victor's Comments & Analysis:

The genesis of this GDP reporting inaccuracy discussion was stimulated by highly esteemed economist Martin Feldstein's May 19th WSJ editorial titled: "The U.S. Underestimates Growth1."  His major theme was that official government statistics are missing changes that are lifting American incomes. 

"Today’s pessimists about the economy’s rate of growth are wrong because the official statistics understate the growth of real GDP, of productivity, and of real household incomes. Understanding this problem should change the political debate about income growth and income inequality.........Americans are enjoying faster real income growth than the official statistics indicate," he wrote. 


Note 1:  The Curmudgeon felt that the Feldstein WSJ editorial lacked credibility and therefore didn't want Victor to write about it.  However, all the comments this week about flawed government reporting of GDP has reversed that decision and precipitated this blog post.


Generally, Mr. Feldstein is a logical thinker from the conservative wing of ideological beliefs.  He was Chairman of the Council of Economic Advisors under President Reagan, is a tenured professor at Harvard and a member of the WSJ Board of Contributors.  With that high powered background his opinion seems rather startling.   Let's compare Feldstein's opening statement (noted above) to a quote the brilliant writer Mark Twain:   

"Sometimes I wonder whether the world is being run by smart people who are putting us on, or by imbeciles who really mean it."

Is Mr. Feldstein losing it, or is he taking a politician's prerogative to lie without shame or guilt?  It seems similar to President Obama saying about ACA: "You can keep your doctor."                                                                                                                                                       

Feldstein writes that "Government statisticians are supposed to measure (or manipulate? VHS) price inflation and real growth...In short, there is no way to know how much of each measured price increase reflects quality improvements and how much is a pure price increase. Yet the answers that come out of this process are reflected in the consumer-price index and in the government’s measures of real growth."

That quote is truly astonishing as the BLS and BEA try to measure "quality improvements" via hedonic adjustments that are 100% subjective and 100% of the time used to lower the prices of what is being measured.   Of course, lower inflation raises the real GDP growth rate.  

For example, when you buy a car the price is not the price the BLS uses, because the seat belt and catalytic converter (both mandated car add-ons by the U.S. government) are higher priced, but "quality improvements."  Professor Craig S. Marxsen notes in an academic paper: 

"For its inability to objectively value environmental benefits, the BLS thus began using a "cost of production" procedure to value automobile pollution reductions as if they were "quality improvements" worth their full cost of production."

The net result is that the consumer price index doesn't count the increased price of government mandated auto add-ons as rising prices, but they actually DO count in the total price one pays to buy a car and/or finance it!  Yet that's not included in the official inflation numbers, which thereby artificially boosts reported GDP.

Let's look at the flip side.  Most would agree that health care "quality" has gone down in recent years, but the BLS doesn't move the price of health care up (via deteriorating quality).  Why don't they make such an adjustment in the other direction?  Answer: it would raise the inflation rate and thereby reduce real GDP growth.  In short, government corruption is fooling the people!

Mr. Feldstein neglects to mention "imputations" to GDP (discussed in many previous Curmudgeon posts) which are "make believe" increases in GDP estimated to add ~15% to official reported GDP.  Why? Because the government feels it should be added so GDP can appear to be higher than it really is.

Also, he does not mention that economic growth is not real in that 47 million people get food stamps (Supplemental Nutrition Assistance Program or SNAP) and many other subsidies, paid for by newly printed paper money or more government debt (due to budget deficits).  Hence, many things are purchased for free by food stamp recipients without anything being produced except paper credits to buy food and other items.  Yet the sales of such items count as revenues included in GDP!

On Feldstein's last point of income not really falling, please see the above Mark Twain quote again as it is not worth refuting. To make the case that inflation has not lowered real income is really laughable, in my humble opinion.

Feldstein's conclusion that GDP is actually higher and inflation lower than reported is not at all believable.  Saying they are "understated" is flim flam material.  Using any historical data stream, much less using common sense and empirical evidence to proves his assertion to be invalid.


Productivity Measurements Also Flawed:

As far as productivity being higher than stated, Feldstein remarks differ from those of Alan Blinder -- a Princeton Professor and former Fed Vice Chair.  In his November 24, 2014 WSJ editorial titled "The Unsettling Mystery of Productivity,” Blinder states:

"Since 2010 U.S. productivity has grown at a miserable rate.  And no one, not even the Fed, seems to understand why....over 143 years, the U.S. has averaged about 2.3% annual gains in productivity." That raised living standards more than 25-fold, according to Blinder's calculations!  Blinder also states that productivity has grown at (only) a 0.7% annual rate since 2000.                                                                                                      

"In sum, here’s what we know—and do not know—about productivity growth.  First, it’s been dismal for the past four years. Second, economists cannot predict swings in productivity growth. Each sharp swing shown in the chart took us by surprise. Third, while the Fed is now forecasting something near 2% productivity growth over the next several years, it really has little basis for choosing that number. That’s not a criticism; no one else has a better basis for a different number. We are all in the dark."  Why don't we hear this from our elected representatives?

In a more recent (May 14, 2015) WSJ editorial titled: "The Mystery of Declining Productivity Growth," Blinder states:

"Are you worrying about America’s recent dismal productivity performance? You should be. Productivity gains are the wellspring of higher living standards, and the well has been running pretty dry lately. How dry and how lately? I prefer to date the slowdown in productivity growth from the end of 2010, because productivity growth (in the nonfarm business sector) averaged a bountiful 2.6% per annum from mid-1995 through the end of 2010, but only--- a paltry 0.4% since. Other scholars prefer earlier break points. For example, productivity growth averaged 2.9% from mid-1995 through the end of 2005, but only 1.3% since.  Either way, the drop is large, and the scary thing is that we don’t understand why."

In exploring why Blinder says, he has three assumptions.  The most logical being..."A third hypothesis weak investment, is more promising. The basic idea is straightforward: If the capital stock grows more slowly, as it has in recent years, workers will have less new capital to work with, and their productivity will therefore improve more slowly."                 

This of course is the point and conclusion of low CAPEX spending, but huge stock buybacks, which I maintain are the consequences of CFO/CEO low confidence in real economic growth due to the anti-business agenda of our government.

Until the Keynesian Monetary/Marxist fiscal agenda changes, seeing real U.S. economic growth above 2.5 % (as in the "forecast that never comes true") is like looking for a dinosaur.  In my humble opinion, the current gang of Republicans are far worse than the Democrats, because they pretend to be something they are not - "constitutional freedom lovers."

To deny reality is to repeat it and to commit economic Hara Kari.  Or as the quote attributed to Vladimir Lenin: "The way to crush the bourgeoisie is to grind them down between the millstones of taxation and inflation."  Unfortunately, this is the reality of the U.S. Congress, the Fed and (nonexistent) fiscal policy.

Victor's Conclusions:

Prepare for an economic crash- no matter how GDP is calculated!  I sincerely believe that when the Fed finally starts raising short term interest rates, the second if not the first rate increase will cause the economy to "fall off a cliff."

Why? At zero interest rates for going on seven years (ultra cheap borrowing costs) and the U.S. dollar index up from the low 70's to 96 (which makes foreign goods much less expensive), consumer demand has been satiated. Everyone who wanted a new car has bought one.  Anyone who wanted a low mortgage house (or refinance their existing mortgage) got a deal not seen since the Pilgrims landed.  Therefore, if everyone already has their "high priced stuff" and low mortgage homes, when rates rise the economy will stop on a dime.  When this happens is unknown as there is no free market to make even a speculative guess on the timing of the coming economic crash.    

Good luck and till next time...


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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