Shackled To Debt

Britain (like every other significant national economy) is shackled to debt.

The UK public sector net debt has risen to £1.022 Trillion, that is the equivalent to 66% of GDP and the highest since records began.

Some are questioning how this can happen, given that the politicians have launched an austerity programme designed to cut back on on debt.

The answer is simple.

The "planned" cuts and austerity drive will never cut the actual level of debt, at best the cuts will reduce the rate of increase of debt.

We are destined to be shackled to debt for the rest of our lives!

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Greece's Deathmarch Continues

The Foundation for Economic and Industrial Research (IOBE) reports that the Greek economy will continue to shrink (5%) this year, and that unemployment is at 20%.

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1955: GDP Overview

This post is part of the Bonddad Economic History Project.  The purpose of this is to go back through the US' economic history and see what happened in each year starting in 1950.  I have links on the side of the blog to previous years writings..

Overall, 1955 as a very good year.  Growth started out strong, coming in at a 12% pave in 1Q, and then slowing at year end, but still coming in at a 2.2% pace.  Throughout the year, PCEs were a primary, driving force of the economy, usually accounting for at least 50% of total growth.  Also note the strong contribution from domestic investment in the first two quarters.  Government spending -- which contributed a large amount to the early decade growth actually subtracted from growth for three of the four quarters.  Finally, exports are also starting to subtract from overall growth during this time.

Let's turn to some of the charts from the Economic Report to the President:

The top chart shows that non-federal outlays were the primary source of growth in 1955, while the bottom chart shows that non-durable goods and service expenditures drove growth, along with business investment.

This shows shows a few important points.  First, in 1953, the Korean War ended, dropping federal spending.  As such, that part of GDP growth slowed.  In its place, we see PCEs and business investment rising, essentially taking the place of weaker federal government spending.

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1954: An Overview Of GDP and Its Subparts

The above chart shows the percentage change in GDP and the contributions made by its various sub-parts.   The data is very revealing, while the expansion of the early 1950s was caused by a combination of government spending (from the Korean War) and pent-up consumer demand, this expansion is starting off with a big increase from PCEs and investment. We see PCEs increase strongly starting in the 2Q and continuing through the end of the year.  Investment contributions slightly to the 2Q, but really kicks into gear in the third and fourth quarters.  Net exports are an after-thought.  And government spending is actually subtracting from overall growth.

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1953: GDP and Contributions to Growth

According to the NBER, the early 1950s expansion lasted from October 1949 to July 1953.  We can clearly see the contraction in the last two quarters in this chart:

We see the economy growing strongly in the first quarter, hitting a 7.7% growth rate.  Consumers are adding a fair amount to the overall growth, but the real contributor is government spending, which accounts for 43% of overall growth.  We see the same type of scenario play out in the second quarter, but government spending now accounts for 70% of all economic growth.  The third fourth quarter have contractions, where the big contributor to the contraction is the drop in investment, with consumer spending and government spending also contributing to the slowdown.

Also note the severity of the contraction, especially in the fourth quarter, where we see the economy contract by 6.2%.  That's a very large drop, and one we're not use to seeing.

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1952: A Look At GDP and Its Subparts

This post is part of the Bonddad Economic History Project. 

Above is a graph of the percentage change in GDP and the contributions of various subparts.   The data tells us the following:

1.) There were two quarters of very good growth -- the first and fourth quarter.  The second quarter the economy was very close to 0% while the second quarter's growth was fair.

2.) PCEs provided a lot of firepower in the second and fourth quarter, while they added some in the third.

3.) Gross private investment was very strong in the third and fourth quarter.  It was a primary reason for the drag on growth in the second quarter.

4.) Net exports subtracted from growth in each quarter of the year.

5.) Government spending (from the Korean War) was the primary driver of growth in the first and second quarter.  It contributed in the third and added remarkably little in the fourth.

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1951: GDP

Moving forward from 1950 and into 1951, we'll see the government spending -- in the form of war spending for the Korean War -- can indeed create economic growth.  In fact, it can be the primary driver for overall economic growth.

The above chart is of total GDP growth, along with the contributions of each sector of the economy to growth.  Notice that for each quarter of 1951, government spending  (the blue line) is very high.  In fact, the only other column as high are PCEs in the first quarter.  This chart shows that government spending can indeed drive economic growth.

1951 saw three quarters of very strong growth, with a very large slowdown in the fourth quarter.  Consumer spending was strong in the first quarter, contracted in the second and then returned to more normal rates of growth in the third and fourth quarter.  Investment was a remarkably huge drag for all but the second quarter.  Exports contributed some to growth, but the real story is the huge input of government spending, which basically drove growth for the entire year.

We'll start to look in detail at the various sub-components of growth over the coming week or so.

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1950: GDP and Contributions to Growth

1950 was a year of incredibly strong growth.  We see percent changes from the preceding quarter of 17.2%, 12.7%, 16.6% and 7.2%.  For the entire year, we see investment and PCEs alternating as the primary driver of growth.  The incredibly strong increase in PCE's in the third quarter was caused by mass buying in anticipation of shortages because of the Korean War.

Delving deeper into the gross private domestic investment numbers, we see that inventory stockpiling was one of the primary drivers.  Interestingly, this reminds of this latest expansion when inventory rebuilds were part of the growth story, which was vehemently denied as being real economic growth by many commentators.  Also note there was a pick-up in fixed investment in the second and third quarter.

PCes were growing strongly in the first two quarters, but really accelerated in the third quarter, as consumers stocked up on durable goods -- again, in anticipation of coming shortages.  PCEs contracted strongly in the fourth quarter.  It makes sense to look at the strong third quarter numbers as pulling fourth quarter numbers forward.

Helping spur the PCE binge was an increase in consumer credit, which had been increasing for the preceding two years.  From the 1951 Economic Report to the President:

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1950s GDP

The above chart is total GDP adjusted for 2005 dollars.  One of the problems with using chained numbers far away from the data (such as using 2005 dollars for 1950s figures) is you can get somewhat distorted data.  But it would be too severe -- plus, it's all we've got to work with.

First, note there were two recessions -- one from mid-1953- mid 1954 and a second from mid-1957- mid-1958.  Two, evenly spaced recessions over a decade is certainly different from our current experience.

Eyeballing the chart, total, inflation adjusted GDP increased from a little over $1.9 trillion to a little under $2.8 trillion -- or an increase of about 47%.  That is very impressive.   But, remember, the US was a smaller economy back then.  There was a tremendous amount of  pent-up demand and we were the only game in town -- Japan and Europe were still recovering from WWII, so we produced most of what we consumed by default and provided most of the goods to the rest of the world.

The above chart is the compounded annual rate of change of GDP.  Notice the very strong rates of growth in the early parts of the decade.  Remember the Korean War lasted from 25 June 1950 – 27 July 1953, so the 1951 figures include the country getting its war facilities up and running.  This explains the very strong growth rates in the early part of the decade.  However, there were two other periods -- the first clustered around 1955 and the second around 1959 - when the compounded annual rate of change was over 5%.

Looking at the first half of the decade, we see very strong growth rates 5%+ fort eh first 7 quarters. followed by four quarters of slower growth from 4Q51-3Q52.  There is another burst of three quarters of strong growth and then a recession from July 1953-May 1954.  However, the economy bounced from that lull in late 1954.

The economy grow strongly in the mid-50s, but slowed down in 1956-1957.  Notice there were three quarters of shallow contraction in 1956 and 1957.  In August 1957, the second recession of the 1950s started which lasted until April 1958.  This was followed by four quarters of incredibly strong growth.

What stands out here is that the economy vacillated from strong growth to recession fairly quickly.  Also note there were two quarters of extreme contraction -- the first quarter of 1953 and the first quarter of 1958.

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The Boil Must Be Lanced

Unsurprisingly, it has been confirmed that Greece will not meet it budget targets. The 2012 draft budget approved by the Greek cabinet on Sunday predicts a deficit of 8.5% of gross domestic product (GDP) for 2011, this is well short of its 7.6% target.

Markets around the world are falling, apparently they have been "surprised" by this news.

Why?

It has been obvious for months that Greece will not meet its targets and will default.

As neatly summed up in the Telegraph

"Until Greece defaults it's hard to see any resolution."

The boil must be lanced, and quickly.

Meanwhile, the Belgium bank Dexia (which ran out of cash this summer) is about to collapse/be nationalised.

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The Oil choke collar in one easy graph

- by New Deal democrat



Oil analyst Steven Kopits, along with Prof. James Hamilton, are the two leading experts on how Oil shocks result in recessions. I have been referring to Mr. Kopits' metric every week in my "Weekly Indicators" summations. Kopits says that every time Oil prices rise to a level of 4% or more of GDP, a recession has followed.



Occasionally even the most popular economic bloggers, including top flight professors, express mystification at why the economy doesn't seem to be able to generate a self-sustaining liftoff. In response thereto, I give you the following graph, in which Oil prices as a percent of GDP are shown in blue (inverted, left scale), and quarterly GDP changes in red (right scale):







A little explanation is in order. The left scale is set to show the divergence in price from Kopits' inflection point of 4% of GDP. Thus the left scale result, n, equals 4 minus Oil price/GDP. If Oil price =5% of GDP, then N = 4-5= -1. Contrarily, if Oil price = 3% of GDP, then N = 4-3 = +1. Also note that since the graph had to be done quarterly, it does not reflect the decline in Oil prices since June 30.



As you can see, since the price of Oil approached the inflection point in 2005, it has predicted GDP changes very well. And it does not bode well for revisions to Q2 2011 GDP or the third quarter either.



Just to put this in longer perspective for you, here is the a bonus graph - the same relationship expanded to the last 50 years.







The only good thing here is that the public can become habituated to a certain high level of energy prices, and adjust their spending accordingly (this is an insight from Prof. Hamilton). Since we just had $4 gas two years ago, the expected impact on consumer spending isn't as great as if we had never seen this spring's $3.90 gas before.



Overnight Oil went as low as $75.71, which is its lowest price since September 2009, nearly 2 years ago. Proving once again that the remedy for high prices is, high prices (but it's painful).

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China To Overtake US

The IMF has issued a prediction that the Chinese economy will overtake the US economy by 2016.

The forecast, based on "purchasing power parities", shows that China's gross domestic product (GDP) will rise from $11.2 trillion in 2011 to $19 trillion in 2016, while US GDP will rise from $15.2 trillion to $18.8 trillion.

China's share of the global economy will rise from 14% to 18%, whilst the US share will fall to 17.7% over this period.

To add to America's economic woes, Standard & Poor's have downgraded US sovereign debt.

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Economy Shrinks 0.5%

The Office for National Statistics (ONS) has released figures for Q4 2010 that show that the UK economy contracted by 0.5% in this period. "Experts" had been predicting a rise of 0.5%.

Needless to say, the weather is being blamed for some of this fall.

However, cold snap or not (even allowing for the fact that the ONS invariably has to revise its figures), it is clear that any rush to raise rates (as being mooted by some "experts") would be folly indeed when the economy is so very clearly "fragile".

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The "Luck" of The Irish

Commiserations to the people and government of Irleand who, having come to the rescue of their beleaguered banks during the global credit crisis, now have to do it again.

The Irish government will now take control of Allied Irish Banks Plc, and inject extra cash into the previously nationalised Anglo Irish Bank Corp. The cost of the rescue is estimated to be around Euro50BN.

The Irish budget deficit will be approximately 32% of GDP. In order to try to avoid following Greece, and having to ask for an EU/IMF bailout, the government will be making further cuts in its budget.

As to whether this is politically acceptable remains to be seen.

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Growth

As ever, figures provided by the ONS have had to be revised.

This time the figures for growth in Q2 2010 have been revised upwards, from 1.1% to 1.2%. This is the fastest quarterly growth in the UK since 1999. However, the economy had contracted by more than 6% before this.

A large part of this growth is made up of inventory building by companies, therefore it is presumed not necessarily to be sustainable.

Ed Balls, a Labour leadership candidate, used the revised figures to warn of an economic hurricane hitting the UK if the government cuts public expenditure.

The government, on the other hand, notes that the improved growth figures give them a sound base from which to cut excess public expenditure.

Doubtless both are right, but both will also be proven wrong.

Such is the nature of economics and politics!

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Oil Prices and the Recovery 2

- by New Deal democrat

Last week I said that I was re-evaluating my overall view of where the economy was heading for the first time in over a year. Having put some further thoughts into the matter, and having exchanged several fruitful emails with Professor James Hamilton of Econbrowser and Bill McBride a/k/a Calculated Risk, I do feel that I have a better grasp of the situation.

I do believe the economy is at something of a crossroads. In terms of reading the tea leaves, we may well have the crucial information that will determine its direction within the next several weeks.

In general, the economy is being buffetted by at least 5 more or less coincidental events: the crisis in the Euro, the ending of the home buying credit, the Oil cataclysm unfolding in the Gulf of Mexico, the withdrawal of stimulus from the states and from the long term unemployed, and the aftereffects of the run-up in the price of Oil in the last 18 months from $37 to $88 a barrel.

I've addressed the issue of the crisis in the Euro already, and my thoughts there haven't changed. Today I want to take a further look at the effects of the price of Oil on the recovery.

It has been noted by Oil analyst Steve Kopits, as shown in the graph below, that when the price of Oil causes consumption expenditures to exceed 4% of GDP, a recession has always followed:



That didn't happen now, but we came within a whisker for a few weeks in April. So I wondered if a similar situation -- of Oil approaching but not crossing 4% of GDP -- had occurred in the past. The answer is staring us in the face in the above graph: it did, and it wasn't long ago, either -- a very similar thing happened in 2006.

First off, here is a long term graph of GDP (red) and the inflation-adjusted price of Oil (blue), normalized so that the two lines cross at the 4% mark (which happened exactly at the height of the oil shock in 1990 when Saddam Hussein invaded Kuwait (essentially this shows the same information as the graph above, but in slightly different form, and updated through April 2010):



You can see the two Oil price shocks in the 1970s, and the similar shock in 2007-08. Here is a close-up of the same graph, for the last 5 years:



You can see that the price of Oil came quite close to 4% of GDP in mid-2006 before suddenly declining through November -- a very similar value, and a very similar move to what is happening now (note that since we don't yet have the CPI for May, the Oil price graph does not reflect the nearly $20 decline in the price of Oil last month.

In addition to the price of Oil, growth in "real" M1 and M2 were similar to what they are now:

The difference being that in 2006, real M1 was negative and real M2 was barely positive. This year real M2 is negative, and real M1 is positive but decliningly so since February.

Professor Hamilton has generally indicated that the effects of changes in the price of Oil show up first, after just a few (3 or 4) months, in auto purchases, and PCE's in about 6 months. These in turn have the maximum effect on GDP about 6 months later, or 12 months after the change takes place.

In that regard, here is a graph of the price of Oil (blue) and absolute real GDP (red) for the last 5 years. Note that in 2006 as the price of Oil approached the 4% of GDP mark, real GDP stalled for one quarter, literally growing at almost an exact 0% pace, before accelerating again as Oil prices fell going towards the end of the year:

Although I haven't reproduced the graph here, employment growth also nearly stalled, with several months of about 50,000 in gains just as the price of Oil hit its peak.

In other words, all else being equal, we should expect GDP to nearly stall either this quarter or next quarter in response to Oil prices being in the $80-$90 range in March and April. Should the decline in prices last for at least several more months, all else being equal we should see increase auto sales and a re-acceleration of GDP.

Of course, not everything else is equal, for the reasons stated at the outset of this post. In a day or two, I'll explain what data will be most important to me in the next couple of weeks that may tell us in which direction the economy will likely proceed.

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EU Puts The Boot In

The EU, keen to show that it will not be pushed around by failing states such Greece, has issued a strong rebuke to the UK over its debt levels.

A leaked draft from the Commission warned that Britain's budget plans failed to guarantee it would meet an EU deadline (2014-15) to cut its debt to below European stability rules which caps debt at 3% of GDP.

The government, not surprisingly, have rejected this rebuke and note that the cuts required by the EU (£20BN) would be half of the education budget.

"Ironically", the leaking of the EU rebuke has taken some attention off the EU's failure to address the Greek issue.

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Upward Revision

Last week saw the Office on National Statistics (ONS) issue revised growth figures for the last quarter of 2009.

The initial figures for growth of GDP) were revised upwards from 0.1% to 0.3%.

However, before champagne corks are popped, the ONS also revised downwards the overall contraction in GDP during the recession; from a 6% contraction to a 6.25% contraction.

Hardly time for celebrations just yet!

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Economists Get It Wrong

The dismal "science" of economics has managed to get something wrong again.

This time it has massively underestimated exactly how much in debt the UK economy really is. Economists had expected a January (traditionally a good month for tax receipts) government surplus of about £2.8BN. The reality was in fact a deficit of £4.3BN, the first time since records began in 1993 that the UK was in debt in January.

The Treasury claim that the Government forecasts remain as stated by Darling, namely government borrowing will be £178BN (12.6% of GDP). However, City experts now predict that the debt will overtake the 12.7% recorded by Greece.

Economists are now calling for a more credible plan by the government, to show how it will address this issue.

They should not hold their breath!

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Dodgy Stats

The European Commission (EC), despite supporting Greece's plan to reduce its budget deficit, is none too happy with Greece's less than "reliable" statistics.

In fact, it is starting legal proceedings against Greece for allegedly reporting faulty statistics. This move is based largely on Greece's drastic revision of its figures last October.

The Greek Government has until May 15 to adopt legislation that forces it to produce monthly updated public budget reports. If it does not, the EC may take the government to court.

The EC also told Greece to set aside a 10% (of current expenditure) contingency fund to cover future budgetary pressures.

Greece's 2009 deficit was 12.7% of GDP, three times initial estimates and more than four times the 3% limit set by the EU.

Greece is attempting to resist pressure from the EU to reorganise its finances. This resistance may be understandable from a domestic point of view. However, given that they knew what they were signing up to when they joined the EU, what did they expect?

Greece is learning the hard lesson, that the EU's "one size fits all" approach to monetary and fiscal policy simply does not work at a local level.

In the event Greece collapses financially; Portugal, Spain and Ireland will be next.

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