The economy has been in bad shape for years. Polls indicating that Americans are unhappy with the economy have emanated from the press for the last six years like a steady drumbeat.
Facts
America's real growth rate over the past five years ranks near the top of all 15 countries on The Economist's list of developed nations. Two of the countries ahead of the U.S.--Australia and Sweden--are large commodity exporters and benefited from significant growth through price increases.
Source: Real GDP growth for the Economist magazine's list of developed countries was confirmed with IMF data. At the end of 2004 and 2005, the Economist actually showed the US. growing faster than all other
developed countries. The IMF later revised the estimates downward and
the lower growth figures were used to develop these charts.Additionally
- Unemployment has been near historic lows--a little above half that of most European countries--for years.
- New job creation has been strong. In November, 2007 a new record was set for the longest string of uninterrupted job growth months in U.S. history.
- Productivity growth has averaged 20% higher than Europe.1
The U.S. economy performed well or extremely well on all the most important measures from 2002 through 2007. Low unemployment and new job creation are important for obvious reasons. However, growth of the nation's Gross Domestic Product is generally considered the most important measure of economic health, because in the long run it correlates perfectly with prosperity.
If you would like to learn more about GDP, scroll to the bottom of this page.
Assessment
While soft spots exist in any economy, one can not suggest with intellectual integrity that the U.S. economy was a disaster under the Bush administration. In fact, the truth is just the opposite. Since informing the public about the economy is an important part of the press's responsibility, repeatedly broadcasting polls about Americans' disappointment with the economy amounts to publishing their own failing report card.
Yes, in 2008 the combination of credit issues related to a real-estate bubble and crippling oil shock did finally manage to slow the strong economy. Another criticism is that real wage growth has not kept pace with real GDP growth. This is true to some extent, but real wages have grown, and the growth rate will catch up over the long-run: it always has, in the U.S., and other free enterprise systems.
For
most people low unemployment trumps real wage growth. The most important thing a country can do for its people is make sure that those who want a job can get one. If you doubt that, you may
want to contact someone in Germany or France and ask whether they would prefer
their economy or ours. Unemployment in the Euro Zone countries, however,
averaged 60% higher than U.S. household unemployment rate from 2001 to
2007.
The individual years provide a time-lapse lesson in economic stimulus policy. In 2002, the year after the Bush administration cut tax rates, the U.S. grew +1.5, which placed it in the top third of the pack in a year that the U.S was recovering from the 9/11 induced recession. In 2003, growth increased to 2.5%, making it fourth on the list of 15.
This is no small achievement, as it is generally harder for large things to grow by a certain than small things small
things. See explanation at the bottom of this page.
In 2004, the U.S. economy grew by 3.6%. You may remember the mantra from some of the political candidates during that election year: This is the "worst economy since Herbert Hoover." If you put that in quotes and Google the phrase, you'll get more than 1,300 results. But, once again, that sort of rhetoric is so far from the facts it's almost laughable. As the year 2004 closed, the IMF and the Economist magazine actually showed the U.S. growing faster than all other developed countries. The figure was later revised downward.
Take a look at the charts on these pages. The press was reporting on polls saying that the American people are dissatisfied with the economy, so when candidates repeated the same doom and gloom scenario over and over, somehow it seemed to be true. Yet, the fact is, in 2004 the economy was strong and getting stronger despite political predictions of doom. If one doesn't see the potential danger in this particular perception/reality gap, then it ought to at least be clear that the mere possibility that such an incredible discrepancy could exist between public opinion and truth, is in itself dangerous. Such a huge and widespread public misconception could obviously lead to grossly misguided national policy decisions.
In 2006 and 2007, the U.S. economy grew at the fairly healthy growth rates of +2.9% and +2.2%. But the pace of growth of a number of European countries moved ahead of the U.S. What happened? Europe, taking cues from U.S. success, cut taxes throughout most of Europe!.
As this book goes to press in mid-2008, we are again
hearing similar predictions of doom, while the underlying economy continues to
be resilient. "Mortgages for everyone" clearly hasn't worked. It is causing problems for Wall Street, but "main street," or mainstream corporate America, continues to move forward.
Since
there are developing countries with faster growth rates than the ones shown in
these charts, we need to take a moment to explain how the countries on this list
were chosen. The financial publication, The Economist, has for many years
published economic statistics for two groups of countries--developed countries
and emerging countries. The list shown here is the complete list of developed
countries for which a year-to-year comparison is shown.
Comparing the growth rates of developing economies like, for example, India or Singapore, each of which grew 8% in 2007, but are a small fraction (8% and 1% respectively) of the size of the U.S. economy, would not give useful comparisons. These countries are able to grow faster because they are, for the first time, becoming a part of world trade. Thus they are able to grow more rapidly because they are simply allocating their resources more efficiently than before, and they are able to borrow on the technology and business process innovations of the developed countries that have paved the way for them. We're quick to say, however, that China is a special case, and we will deal with that country's remarkable growth in more detail in section 2.
Assessment: When Perception Becomes Reality
One thing that politics and the financial markets have in common is that "the perception of reality" tends to become reality. In 1996, Alan Greenspan, then chairman of the Federal Reserve Bank and the nominal guardian of the U.S. banking system, said in a speech on central banking that the equity markets were "irrationally exuberant" and had separated themselves from reality.
Despite that observation, the markets continued even higher for nearly five more years before eventually dropping. Literally hundreds of billions of dollar were made by those who stayed "irrationally exuberant" until the third quarter of 2001. In 2002, under intense pressure from current events and other factors, the market finally collapsed.
When Greenspan made those remarks in 1996, the NASDAQ index of stocks was at 880.In 1999 the NASDAQ had traded as high as 4700, which was a gain of 430%. The momentum was strong, and perception was reality. By October 2001, the NASDAQ was trading down, at 790, a five year drop of 10%. The market psychology was based largely on hype; however, it remained real and very strong for a while. But eventually the reality shifted, and the facts had to rule.
In politics, if enough people believe in a politician or a political theory they can make that belief a reality by putting those people or ideas into positions of power. Whether that belief gives you Adolf Hitler, Soviet-style communism, or Richard Nixon does affect the reality. But if the facts are that the perception is wrong, the reality they've created will eventually adjust to truth. In that case, a dictator like Adolf Hitler will self destruct, communism will fall on its own sword of economic inadequacy, and Richard Nixon's inability to play by the rules will eventually destroy him.
In early 2008, Bear Stearns, an investment bank that had been around since 1923, was put out of business by fear of what might happen. Jimmy Cayne, the company's chairman, saw his $1 billion of stock fall to a value of $20 million. Alan Schwarz, who had become president in 2007, watched his company simply disappear. What happened was a typical "run on the bank." Banks and investment banks have hundreds of billions in securities on their balance sheets that are funded on a day-to-day basis. They are secure but highly leveraged entities. Even with plenty of equity, careful risk controls, and a solid record of profitable business dealings, the day the bank can't finance their daily position in securities markets is the day they are effectively out of business.
I know that personally. In 1991 when I was a managing director for the investment bank Salomon Brothers and running one of their European businesses, the company endured a near-death experience. A group of Salomon Brothers traders in New York had conducted illegal activities to profit from a U.S. Treasury Bond auction. They had successfully made dozens of millions of dollars by the activity, but were eventually caught.
An indictment of the firm would have shut down the entire multi-billion dollar company. The market responded immediately and, because of the potential risk involved, funding for the company dried up. Quick action and support encouraged by the Treasury and the U.S. Federal Reserve saved the company. But, because of just a few people in one location, a global, multi-business American financial standard bearer almost disappeared. Once again, the perception of weakness became reality.
Markets go up and down, and the business cycle continues. Dynamic, growing capitalism creates what the Austrian economist Joseph Schumpeter called "creative destruction." The markets become overly enthusiastic and over commit capital during optimistic cycles. Then they become overly negative and destroy good businesses during the down cycles. The good news is that this sort of volatility creates dynamism, with new winners and better opportunities in each cycle. As the old joke goes, the stock market has completely and accurately discounted six of the last three recessions--meaning that the market often mystifies the naysayers. Despite the prophets of doom on Wall Street and beyond, the economy in the first decade of the twenty-first century remains stronger than many people think, and with some perspective we can see that fact. Whatever the current emotional state of the financial wizards and the 24/7 financial news analysts, the economy remains strong, and America is still number one.
If Joseph Schumpeter was right and the cyclical nature of the markets creates positive momentum, we will see this positive long term impact eventually in the mortgage markets as well. The explosion of sub-prime lending over the past several years has put many homeowners at risk as they stretched to buy homes that were expensive compared to their income. News of a larger than normal number mortgages going into default as these homeowners ran into financial difficulties led predictably to the perception of accelerating weakness. The "creative destruction" that hit the markets at that point led to the destruction of a lot of bank capital; but after all was said and done, many people who could never have bought a home without a sub-prime boom ended up owning a home.
Even in the midst of the turmoil, it's a safe bet that America will continue to move toward a higher ratio of home ownership in the months and years ahead. We don't know that for a fact just yet, but we can see that the underlying economy is strong, and that's a good sign. And what we do know is that, whatever the current weakness, over time American resilience will prevail. During the last seven years the American economy has outperformed the majority of developed countries, and that momentum is a sure sign of strength.
--Dennis Keegan, author
Gross Domestic Product (GDP) is simply the total value of all goods and services produced in the nation's economy. It is by far the most common measure of a country's economic growth. This is because over the long run the material standard-of-living correlates closely with the value of goods and services that a society produces.
Gross Domestic Product is the most important measure of economic activity, and real (inflation adjusted) long-term growth in GDP is the clearest signal of strength. For individuals to improve their income and wealth over time, the whole community must produce and earn more. As productivity increases, income and wealth increase for individuals as well.
In most countries, the real increase in GDP generally comes from two sources; population growth and productivity growth. However, if GDP increases with population growth alone, the nation may get richer while the average citizen maintains essentially the same level of income and wealth. This means that GDP growth must exceed population growth for individuals to increase their own incomes.
For a country to maintain GDP growth above population growth, the productivity of each hour worked must increase. When this happens, employers can afford to pay more for that hour of work. The increased value added, then, generally comes from one of three sources:
- Innovation: An idea that uses the same amount of labor to make a better product can increase productivity significantly. An obvious example of innovation is computer power where, for example, a single Microsoft Excel spreadsheet can produce, in a moment, the work that would have required hours of clerical manpower twenty years ago.
- Capital Investment: The second major source of productivity growth involves an investment of both physical and mental resources. One man with proper training and skill in the use of an agricultural harvester can manage thousands of acres of farmland, producing many tons of grain. Fifty years ago, the same task would have required dozens of farmers and hundreds of laborers, to produce many fewer bushels of grain.
- Comparative Advantage: What comparative advantage means is that two countries by reallocating work between them can, in aggregate, produce more goods with less labor, meaning higher of productivity.
A good example of this would be a situation in which the U.S. focuses more labor on making Boeing aircraft and Caterpillar tractors to sell to China. China, in turn, makes more Power Ranger and Star Trek action figures. The U.S., with a higher level of education and capital resources, makes investment-intensive goods, while China, with less investment in intellectual and physical capital, makes products that are genEerally more labor-intensive but less-intellectually intensive. This is, in fact, what's actually happening today.
For
example, if something grows +2 units from 100 to 102, this represents an
increase of +2%. If something grows from 10 units to 12, the same growth of +2
represents a +20% increase. The
It’s about time someone wrote this book.