Cutting Through the Hot Air -- Part I

 | Feb 10, 2013 | 6:00 PM EST
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"But if thought corrupts language, language can also corrupt thought" -- George Orwell, 1984

 The fiscal debate is about to heat up considerably in the next two weeks. Perhaps it will even melt some of the massive snowfall that accumulated over the Northeast this weekend. Certainly the hot air emanating from Washington will become intolerable, especially as both sides accelerate their use of Saul Alinsky-style negotiating tactics ("Rule 13: Pick the target, freeze it, personalize it, and polarize it.")

As is always the case in controversy and debate, language becomes both a tool for manipulation and a source of deception. Here, in no particular order, are some thoughts regarding the frame of debate -- as well as how "they" are trying to manipulate your thought process, and then your investment implications. 

Grotesque Domestic Product 

Economists have a well-established definition of gross domestic product that misdefines economic output and distorts analysis. The classic definition, of course, is: 

GDP = C + I + G + (X-M) 

GDP = private consumption + gross investment + government spending + (exports − imports) 

Economists have never explained why "government spending" should be considered economic output, other than to plead that government's large size impacts the economy. The challenge is that government is a "cost center," as a businessperson would describe it. Some level of government constitutes a necessary expenditure for a functioning society, just as every company must have accounting and human resource departments. They aid in the administration of the business, but they are not "value-added." If a business has sluggish sales, does management propose adding bookkeepers in the accounting department, or do they hire more product engineers and salespeople? 

GDP is better redefined as follows:  GDP = C + I + (X-M) - G 

In business terms, we would call this the country's profit-and-loss statement, or P&L. Growing government expenditure does not boost the economy; it puts a greater drag on the private sector, just like bloated general-and-administrative cost reduces the bottom line of a business. 

If you bought into my definition, you would be cheering the fourth-quarter GDP report. While it nominally was negative under the classic definition, this was due to falling government expenditures, which in fact are good for the economy. Under my definition, the fourth-quarter GDP would be seen as showing healthy positive growth.

* * *

"If you want to keep a secret, you must also hide it from yourself." -- George Orwell, 1984

Bending the Curve

Both sides of the budget debate are already deep into discussing how we will cut trillions, nearly all of which will be in future spending. I am starting to wonder if they actually believe their own nonsense, as the saying goes.

Is there even the slightest shred of credibility to the idea that, in 2013, we will somehow "promise" to cut spending 10 years out? If it does, then shouldn't this Congress and administration be executing the budget decisions made 10 years ago, in the 2002 budget? I have yet to hear anyone mention those projections, nor any projection from any budget from any previous year. Every Congress from 2014 through 2023 will ignore any spending "decisions" made this year, so any discussion of future spending is a decoy to cover up the fact that spending is not being cut now

Here is what the Congressional Budget Office projected in 2001 -- the latest data available. The budget from that period anticipated outlays rising to $2.6 trillion in 2011, with a surplus in every year! 


CBO Original 2001 Revenue and Outlay Projections
Source: Congressional Budget Office


What really happened was that outlays came to $3.1 trillion, causing a $1.3 trillion deficit, instead of an $889 billion surplus. 


CBO Actual Revenue and Outlay Projections
Source: Congressional Budget Office


In this Pew Trust analysis of the CBO's incorrect projections, we see the "miss" in deficit/debt projections was due primarily to legislative actions. 

Why CBO's Debt Projections Changed between 2001 and 2011

There are very few guarantees in life, but I can guarantee with 100% certainty that the 10-year projections being thrown around today will be wrong. More important, I can 1,000% guarantee that future Congressional sessions will in no way be bound by current projections, nor even care what they were. A debate about "bending the curve" and future spending is a decoy to avoid any meaningful spending cuts now. Even the dreaded sequestration would only reduce 2013 spending by $53 billion, or 0.3% of GDP, according to Goldman Sachs. It's utterly meaningless. 

Stay tuned for part 2 of this article, where I'll debunk a bit more of this misleading discourse -- and spell out how you should invest accordingly.

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