Economic Whitewashing

If You Can't Fix It, Make It Look Better

Written by Adam English
Posted August 6, 2013

The Fed and Commerce Department are starting to remind me of my deadbeat landlord...

A couple months ago, I noticed that the paint in my living room was starting to separate from the wall. I took a picture and sent it over. I got no response.

A couple weeks later, the paint was peeling off... and something terrible revealed itself just below the surface...

Thanks to problems with the roof and a downspout, I now have a patchwork of black mold as a roommate.

After increasingly dire and desperate voicemail warnings about the health risks, destruction of the wall, and a reminder of legal obligations, I finally got some results. However, it was woefully insufficient...

A repairman stopped by, spent a couple of hours scraping off the old paint and wood, and repainted the wall. Nothing was done about the downspout, the water running down and eating out the wall from the other side, or the actual mold.

All my landlord paid to have done was to put a fresh coat of paint over the rotting mess — one that will continue to fester and worsen until it becomes a full-blown crisis and it costs far more to fix.

And then it struck me that this is precisely what the Fed and Commerce Department have been up to...

The Fed is throwing money at the markets, and the Commerce Dept. is slathering on a fresh coat of paint. Both are obscuring the real problems we face.

Constantly Paying to Treat Symptoms

For what seems like an eternity now, the Fed has been dumping money into the economy through its two-pronged quantitative easing program.

On one front, it is buying up $85 billion per month of the mortgage-backed securities from large banks, the very securities that became virtually worthless as investors realized they had been bilked into buying products designed to fail, as featured in the glowing press releases from the SEC following the recent guilty verdict handed to a former Goldman Sachs trader. (Apparently, we're supposed to believe the SEC has some teeth and will use them, assuming their target is small enough...)

On the other front, the Fed is keeping interest rates as close to zero as possible. The rate banks pay on overnight loans, or the federal funds rate, was at 4.5% in late 2007. As the recession bit into the economy, it was slashed to virtually nothing.

Long-term rates quickly followed suit and fell from over 5% in 2007 to record lows near 1.4% in mid-2012. It wasn't until May of this year that they crept over 2% again...

As a result, interest paid by U.S. businesses peaked in 2007 at $2.83 trillion, and then they fell sharply to $1.34 trillion in 2011, the last year data is available from the St. Louis Fed.

At the end of the recession in 2009, quarterly earnings per share (EPS) for the S&P 500 were less than $20, and companies in the index paid roughly $4 a share in interest. Now those figures are up to nearly $27 a share in quarterly EPS, but the companies are paying just $1.50 a share in interest on average.

Earnings have tripled since 2000, back when the economy was in far better shape (at least, for the little guys like you and me).

The Fed has created a massive boom for corporate America through historically cheap debt — all at the cost of anyone looking to limit their risk and protect their retirement funds.

Robbert van Batenburg, director of market strategy at brokerage Newedge USA LLC, used data from the Fed and other government sources to estimate that corporate savings on interest expense after rates fell to historic lows has accounted for about 47% of S&P 500 earnings growth since 2009.

The dramatically lowered interest rates account for almost 40% of total profit growth, according to van Batenburg. And he didn't even include savings from lower leasing, or rental costs that indirectly resulted from the low rates.

Since the end of the recession in 2009, the S&P 500 has gone up roughly 86%. Without the Fed padding the numbers, it would be reduced to roughly 45.6%. In turn, that would drive annualized gains from 16% down to 9.4% to date.

Throwing money at the problem didn't do anything for the massive increase in unemployed or underemployed Americans, who obviously had no income to invest in the market recovery.

GDP growth has averaged less than 2% per year since the recession. We're not seeing results that match the out-sized efforts.

The Fed has nothing left to offer for boost growth outside of QE infinite. It has removed all of its safety measures and is running at full steam. Even hinting at an end to QE resulted in a 4.3% drop in the market.

Without meaningful economic reform, QE has become a perpetual maintenance fee we're paying to stay out of touch with reality.

A Fresh Coat Coverup

We just saw an overhaul of the official GDP numbers released by the Commerce Department.

The plan is to give a greater economic weight to many types of intellectual property. Numbers will be revised to add in everything from pop culture to biotech drugs. As a result, our nation just gained about $560 billion overnight. That means we're all about $1,800 richer per capita!

Of course, that's only on paper...

It will also mask the downturn in real products that create lasting and meaningful growth.

Sure, summer blockbusters make hundreds of millions of dollars at the box office, but this is a one-time phenomena. Unless that money circulates into tangible goods and long-term growth, it is functionally meaningless to economic growth. 

And this is the crux of the problem: The revisions are only giving a boost to GDP on paper.

No method of measuring GDP is perfect, but the old version did a decent job of reflecting the spending and capital investments in machinery, equipment, and construction, which create long-term jobs and economic health for you and me.

Research & Development and Arts & Entertainment had very little impact on GDP up until 1983. A decade later, it had grown from 1% to 2% according to the new GDP data. Another decade later, and it has now grown to 3.5% of the real U.S. economy.

The change will tweak the numbers to make the recession seem slightly smaller and the recovery slightly better.

Over time, this gap will continue to increase and effectively make our economic recovery look better and faster on paper — while our dismal reality stays the same...

GDP Revision Effect Chart

Considering government officials and the press are breaking out the confetti and party hats when quarterly GDP figures hint at 1.7% annualized growth, I guess every little bit counts these days, regardless of how long it will take to claw back to economic stability.

Hiding the Real Problem

Even with the Fed's efforts and the mirage of accelerated economic growth, there is no denying that economic growth during our recovery from the recession was the worst after a recession in post-World War II America.

If you ignore the doctored unemployment figures and look at the big picture — as Shadow Stats does — it is the worst recovery for workers in our nation's history (although it does get kind of fuzzy going way back into antiquity).

Check out the following chart.

SGS alternative employment includes discouraged workers who were removed from official statistics in 1994.

SGS Alt Unemployment Aug 2013

The Fed and Commerce Department can pad the numbers and put a fresh paint of coat on the issue — just like my landlord did — but it won't stop the underlying problem from spreading and creating lasting structural damage...

Consumer spending still makes up roughly two-thirds of our economy, but is falling because an increasing number of people do not have a job or are underemployed; and real wages have been stagnant for decades — and show no sign of improving for decades to come.

If only making the market and official statistics look better on paper actually made our economy better...

Instead, this encourages politicians to leave everyday Americans wallowing in the cesspool of bad policies and inaction that has become our status quo.

If only we could put our taxpayer dollars in escrow, like I'm considering with my rent payments...

Maybe then they'd get the message. Maybe then they'd stop covering up the real issues we face and realize that it will only get worse — and more costly — over the long run.

Take care,

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Adam English

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Adam's editorial talents and analysis drew the attention of senior editors at Outsider Club, which he joined in mid-2012. While he has acquired years of hands-on experience in the editorial room by working side by side with ex-brokers, options floor traders, and financial advisors, he is acutely aware of the challenges faced by retail investors after starting at the ground floor in the financial publishing field. For more on Adam, check out his editor's page

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