GDP and the Mirage Economy

Economic analysts are a lot like meteorologists. They take available data, make assumptions, run models and make their best guess on what is about to happen. Unfortunately, they are just about as accurate. It’s always good to have an umbrella on hand, just in case.

Despite expectations of around 1.1 percent growth in GDP, this week’s numbers are showing a 0.1 percent drop in the fourth quarter. While the news has caused a lot of dramatic yelling and finger pointing, this is, in some ways, a sheep in wolf’s clothing. The short-term dip isn’t really something to fret about. However, it does point to an underlying problem with the government’s approach to “recovery.”

Two primary causes

One major reason for the loss was a substantial cut in federal defense spending. But, as government spending relies on borrowed funds and taxes—which means it comes out of the economy at some point—we aren’t talking about a true economic loss. Rather, this is a reduction in something that wasn’t real to begin with. A drop in GDP due to cuts in government spending is a drop only in nominal terms, not in the actual overall health of the economy. If anything, it signals a chance for the private sector to improve without the taxes, debt and crowding out that comes with government spending.

The second major cause of the decline is that companies recently began selling off overstocked inventories, leading to a slow down in the production of goods. This would be a concern if such an overstocking was due to a consistent drag in consumer spending, but that does not appear to be the case. This suggests that the problem is more a hiccup than a disease; it is part of the cyclical ebb and flow of a national economy.

In short, the news of a drop in GDP is good news—a result of natural fluctuations and a scaling down of government spending, which should enable stronger private sector growth.

Lest I paint too cheerful a picture…

The serious threat remaining here is that government spending continues to prop up a mirage economy. Our bloated government spends a little extra one month or cuts a little the next, obfuscating the GDP measures and leaving the public perplexed as to the real fundamentals.

The defense cutbacks themselves are misleading, as they follow a 13% gain in the previous quarter, which artificially boosted GDP performance. Expanding our horizon a few extra months shows little difference in the overall status of the American economy. So things are not much better, but they’re certainly not worse. However, we should be cautious of letting this sliver of good news distract us from the grim reality of our situation: If high levels of federal spending continue to dramatically distort economic measures, the market cannot correct itself and will eventually go bust.

When that happens, swarms will hit the airwaves to blame capitalism and propose “solutions” in the form of more regulations. If history is our guide, those solutions will be the seed for the next boom and bust.

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