July 13, 2018
Two weeks from today we will get our first look at second quarter GDP growth. It appears to be somewhere around the 4.0% mark. We can see the headlines already. “Economy Gathers Momentum in the Second Quarter”, “Inflation Soon to Rise”, “Rapid Growth Accelerates Path Towards Higher Interest Rates”. While this is not exactly “fake news”, it is important to understand that there is no “truth” in economics. Every economic indicator we see is an estimate to some extent despite the best efforts of the number crunchers at the Commerce Department, the Census Bureau, and the Bureau of Labor Statistics. These dedicated people do an outstanding job of providing us with as accurate an estimate as they can. But in the end, much of what we see is estimated. Thus, it is imperative for us to view each economic indicator with a healthy degree of skepticism.
The press dutifully reports the published data and the big numbers – GDP, employment, retail sales, and the CPI get page one headlines. But their job is to get you to buy their paper or watch their television broadcast. They like to embellish the significance of the latest indicator. Frequently, the headline number is misleading. The caveats are buried on page 4. Then, the broadcast media will get the talking heads to provide “color”. They first one will support the strength (or weakness) of that number. The next one will have exactly the opposite view. All of that is by design and represents their attempt to be “unbiased”. How in the world are you supposed to make sense of all that? You need to know what is going on, but you have jobs and cannot spend your day poring over economic statistics. You rely on economists, like us, to provide the real story. But even then, you will get different stories depending upon exactly who you ask. Why is all this so difficult? Largely because economic analysis and forecasting is much more art than science which means that, like art, beauty is often in the eye of the beholder.
GDP. Is GDP the best measure of the pace of economic activity? A recent letter to the editor in The Wall Street Journal discussed the concept of Gross Domestic Income (GDI). It is an alternative measure of economic activity. Think of it this way. You can measure GDP from the income side or the production side. If we live on an island and have one firm that manufacturers refrigerators. You could ask consumers how many refrigerators they bought last quarter. We might say we bought 10 at $1,000 apiece. Hence, our GDP would be $10,000. Or you could go to the manufacturer and he would tell you that he produced 10 of them for $1,000 apiece which would make GDP $10,000. You get the same answer. But only in theory. It does not work in the real world. Why? The real world is messy. The manufacturer may have produced some refrigerators and kept them in inventory. He may have manufactured additional refrigerators and shipped some overseas. We may have bought some foreign-made refrigerators. And in the real world we simply do not have the ability or the money to ask every consumer or every businessman that question. Furthermore, some data is only available with a considerable lag. Hence, the number crunchers are forced to make estimates based on the data that have been reported.
For example, in the first quarter after an initial estimate and two revisions, GDP growth was reported to be 2.0%. Relatively anemic. But GDI grew 3.6%. Steamy. So, which is correct? Nobody knows, but it obviously makes a difference. The Commerce Department also publishes an average of the two which it believes is the best estimate of all. But it is hard enough to dissect the published GDP figure and all its components. How in the world are we going to interpret three different estimates of the same thing? Economists are fond of saying, “On the one hand” followed by “on the other hand”. Perhaps you can now understand why they might want to do that.
Retail sales. Then there is the challenge of adjusting the data for normal seasonal movements. Department and general merchandise stores make most of their sales for the year during the holiday period. For example, the Census Bureau expects department store sales to jump 75% between October and December, but then decline by a similar amount in January. It makes no sense to publish changes of that magnitude, so Census tries to adjust for “normal” seasonal movements. But if our spending habits change ever so slightly from one year to the next, it means that the published data can show some dramatic changes in the November through January period. Every economic indicator is adjusted for this seasonality, but the statistical method of doing so is essentially an educated guess based on history.
Employment. Another favorite release is the monthly employment report. But there are two measures of employment. One is known as “payroll employment” which gets the most attention. There is a separate measure of employment that is calculated separately as part of the unemployment rate. It is known as “civilian employment”. The first comes from asking a sample of employers how many people were on their payroll last month. The other comes from an entirely different survey conducted by BLS employees who knock on people’s doors and ask if they had a job last month. The answers can be wildly different. A classic example occurred in February of this year. Payroll employment rose 324 thousand in February. Civilian employment rose an astonishing 785 thousand. Both strong numbers, but one was more than double the other. The numbers can vary widely from month to month but, over time, they grow at roughly comparable rates.
So, how are YOU supposed to interpret all this? First, look beyond the headline number and focus instead on the most recent three months to get some idea if the trend is changing.
Second, look at other economic indicators. If second quarter GDP growth is strong, is that strength confirmed by other economic indicators? There are roughly 25 different indicators released each month. If only one is strong beware of interpreting that indicator too literally. But if 15 or 20 of the 25 indicators show strength, you can be reasonably certain that you are getting an accurate assessment of what is happening.
Third, figure out what Fed officials are saying. Why? Because they have 1,000 economists who dig more deeply into the numbers than any of the rest of us could possibly do. Having spent some time in the Fed system, I have found Fed economists to be some of the smartest people in the business. Perhaps even more important, it is their analysis that really matters. The FOMC members will make their decision about interest rates based on the Board staff’s interpretation of what is going on. Your view and my view are irrelevant.
Fourth, listen to your favorite group of economists. Why? Because we will delve more deeply into the numbers than you can do on your own. We hope we are a part of that group. But, the unfortunate reality is that economists can read the same report but reach widely divergent conclusions.
Finally, put all this information together and draw your own conclusions. After all, it is your business to run, your investment portfolio to manage. You are the only one that can make those decisions. Become an economist.
You may have hated economics in school because it was so theoretical. But, in my experience, economics is about 20% theory and 80% common sense. And the fact of the matter is that you already are an economist – you simply do not think of yourself as one. You talk knowledgably all day long to your co-workers, your boss, your employees, your friends, and your spouse about the economy. You know firsthand what sales in your firm are doing, you talk about the stock market, you know whether your firm is hiring or laying off workers, you know whether you plan to boost investment spending, you can sense when the inflation rate is picking up or slowing down, you have a good idea what interest rates are likely to do. That makes you an economist.
Want to know what is happening? Look in front of your own nose.
Stephen Slifer
NumberNomics
Charleston, S.C.
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