A gross domestic situation

Larry Kudlow
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Posted: Aug 03, 2001 12:00 AM
NEW YORK -- It's a recession. The headlines don't tell the story, but it's the real story. Stock-market investors have known it for over a year. People in business know it, as inventories and jobs have been slashed. The latest government report on the nation's gross domestic product for the April-June quarter revealed that the heart of the U.S. economy has indeed slipped into recession. It's the second consecutive quarterly decline for the private sector economy. Although the official figures cited a tiny 0.7 percent annual rise in overall real GDP, this barely positive total was made possible only by a $22 billion rise, calculated as a 5.5 percent yearly rate of increase, in federal, state and local spending. A new category called adjusted real gross domestic purchases, a measure of private-sector consumption and investment, actually declined at a 0.1 percent annual rate. During the prior January-March quarter, the story was similar. Overall, GDP adjusted for inflation increased at a slow 1.3 percent annual rate, but even this near-recession number was artificially boosted by a $21 billion government-spending boost. Without it, adjusted real gross domestic purchases actually declined by 0.2 percent annually. In other words, the productive sector of the U.S. economy has been sinking for six months, actually falling $6 billion from $8.112 trillion in last year's fourth quarter to $8.106 trillion in this year's second quarter. These totals exclude government spending, and also remove the so-called net export sector (exports minus imports), whose inaccurate accounting practices frequently mask real economic trends. The focus here is on the domestic private sector, the heart of the economic story. Private-sector real GDP (adjusted for inflation, excluding government pump-priming) accounts for 83 percent of total economic output. All of the nation's industrial production and business investment comes from the private sector. And 85 percent of the country's 132 million jobs are created privately. An incredibly harsh Federal Reserve policy that deflated the basic money supply, the stock market, commodities and everything else in its path, as well as a series of OPEC-induced energy price shocks, have put the squeeze on the private sector. And the carnage continues to mount. In just 18 months, the growth rate of inflation-adjusted private domestic purchases has swung from plus 8 percent to minus 0.2 percent. Nothing like this has occurred since the early 1980s. In the business sector, the rate of change of investment in equipment and software has plunged to a negative 14.5 percent from a positive 18 percent. Over the past three quarters cumulatively, the level of business investment has dropped 5 percent, while industrial production has fallen 4.5 percent. Over the past year, corporate profits have declined 21 percent. Even consumer spending has eased to 2 percent from 6 percent. Adding to the economic malaise, the Fed has forced more than half of U.S. banks to tighten their business-loan standards. Meanwhile, the venture capital flow -- the real-money supply for the wired economy -- has dropped over 60 percent during the past year. Without a sufficient supply of risk capital and bank credit, entrepreneurship and innovation are left dead in the water. Technology breakthroughs go unfunded. You might say, "It's the business sector, stupid," as businesses (not government) create jobs, and capital (not government) creates businesses. But the latest GDP figures tell us that it's government spending, stupid. While the private sector is sinking, government is soaring. Big public-sector spending is keeping GDP in positive territory, misleading some into thinking that the economy is really OK. Surprisingly, state and local government spending -- growing at a 7 percent rate this year -- is providing the artificial stimulus to GDP. And just as surely as day follows night, rising government spending at any level will lead to higher tax burdens -- a negative omen for the future economy, as taxes are inversely related to economic growth. The new GDP figures tell us that we have a private economy recession and a government economy prosperity. In order to achieve long-run economic growth, however, what we really need is a government recession and a private prosperity. President Bush has already reduced personal tax-rates, and hopefully he will move to lower investment and business taxes, as well. The Fed should heed the message of deflating commodity markets and inject substantially more liquidity into the economy. Then it will be up to the nation's governors and mayors to follow Bush's lead. So far they haven't, and that's one reason why private GDP is in recession.