The US Department of Commerce has released its latest stats, and they are not exactly impressive. Gross Domestic Product (GDP) growth comes in at a measly 1.5%, and with the US economy reaching the end of a growth cycle (we’re 7 years into a business cycle that averages 6 years), some say that the US economy is heading for a recession. I’d take this a bit farther and argue that we are already there; further, it’s possible we’ve actually been in recession for the entire “recovery”.
Let’s begin by analyzing the evolving method the State uses to calculate inflation, specifically the Consumer Price Index, which is considered the broadest measure of inflation. To understand how this could impact an expansion or a recession when measured by GDP, First, let me explain how the GDP number is calculated. It’s a pretty simple formula – GDP = C + I + G + (X – M). That translates in English to – GDP = private consumption + gross investment + government spending + (exports – imports). This formula calculates what is referred to as “nominal GDP”. In an effort to seem “scientific”, the State then coverts that number into “real GDP”. This is done by adjusting (i.e., deflating) the nominal GDP for the rate of inflation in an attempt to normalize the projection.
There’s the rub. Since the State deflates the Nominal GDP to normalize it, the rate of inflation is a key variable in the final GDP results that are reported. This rate is derived from the Consumer Price Index (CPI), which measures changes in the price level of a market basket of consumer goods and services purchased by households. It shouldn’t be surprising, but in case you are unaware, the State has changed the formula for calculating CPI/inflation over the years. There’s something I frequently say, but it always seems to apply to economic data the State produces – “If you don’t like the results, change the formula”. I’d like to walk you through an example that illustrates how a change in this formula could produce vastly different results than what is currently being reported, and ultimately show that the US may be in recession.
During the 1970s, the biggest ailment of the economy was high inflation. The US had inflation reaching nearly 13%, as measured by the State at that time. In the 1980s, the Bureau of Labor Statistics (BLS) changed the way it calculated the CPI by allowing for product substitution (e.g., buying pork instead of beef) and the quality of products (e.g., if a product increases in price but the BLS says the quality has gone up, then it’s not included in the calculation), along with other adjustments.
If inflation were measured using the methodology leveraged prior to the 1980s and compared it to the current methodology, we would see a stark contrast. Luckily for us, the folks at shadowstats.com have done so for us:
The spread between State reported inflation levels using the current/80s model and the levels calculated using the pre-80s approach ranges from ~2% to ~10%. When you’re talking about trillions of dollars flowing through the economy, that spread is pretty staggering, and represents two very different economic climates. If we were take a median of that range and assume, on average, that the current inflation calculations are understated by 6%, this indicates that the US economy has been under deflated by 6% each year. If that’s true, the economy has really been in recession for the entire “recovery” period, given that we haven’t seen a single year with growth greater than or even close to approaching 6%.
The official definition of a recession is two consecutive quarters of negative GDP. The last two quarters as reported by the US Department of Commerce, Bureau of Economic Analysis were Q3 – +1.5% and Q4 +3.9%. If we were to further deflate those numbers by 4%, which is in the bottom quartile of the range in the variances above, we would *officially* be in recession. I’m not unequivocally stating that we are or aren’t, but these example illustrates the point that a good statistician can get the data to confess to anything. When those statisticians work for the State, who have every incentive to show economic growth, it’s no surprise that when the results of the formula won’t fit their desires, they change the formula.