“Dollar antics”

Matt O´Brien writes “The one thing that could cut the economic recovery short”:

Sometimes bad news isn’t much news. Take, for example, the latest GDP report. It revised the economy’s growth in the fourth quarter of 2014 down from an already disappointing 2.6 percent to an even more disappointing 2.2 percent. But beneath the headlines, the recovery is still chugging along at its slightly-faster-than-before pace. If anything, growth looks a little better than it did before.

Well, maybe. That depends on how strong the dollar gets.

That makes absolutely no sense! The chart indicates that since the bounce back from the through of the 2008-09 “Great Recession”, “non-noisy” (i.e. year on year and year over year) growth has been monotonously stable!

Dollar Antics_1

Then Matt O´Brien goes on to “explain” why it all depends on the dollar strength:

The best way to tell that is to strip out the up-and-down inventory and net export numbers, and to only look at consumer spending, government spending, and private investment—and over a year, not a quarter, to smooth out any weird weather effects, like last year’s polar vortex-induced slump. That’s called final sales to domestic purchasers, and, as you can see above, it just ticked up to 2.9 percent annual growth. That’s the best it’s been the whole recovery. That should mean that a lot of today’s growth will continue tomorrow, that the economy is finally getting a little bit of momentum that might not be a boom, but is the closest we’ve been to one in a long time.

Unfortunately, he has the wrong definition of ex inventory and ex net export RGDP. It´s not Final Sales to Domestic Purchasers (FSDPurch). That definition excludes inventories and exports (which are sales to foreign purchasers) but includes imports (which are sales to domestic purchasers). The other measure of RGDP net of inventory changes is Final Sales of Domestic Product (FSDP), which includes exports (sales to foreign purchasers) but excludes imports (purchases from foreigners).

Does the chart, which compares year on year growth of RGDP and the two alternative measures that exclude inventory changes really indicates that the economy is “finally getting a little bit of momentum”? [Note: For visual comparison, the chart has the same scale as the first chart].

Dollar Antics_2

Matt goes on:

But the strong dollar might cut that short. Now take another look at the chart. It’s not often that final sales to domestic purchasers is growing so much more than GDP itself. That’s because inventories and net exports bounce around enough that they should—there’s that word again—make GDP grow faster at least every now and then. But what if the dollar keeps getting stronger, and the trade deficit keeps getting bigger? Then the gap between final sales to domestic purchasers and GDP might become more of a permanent feature than a passing one, and we might not even get a mini-boom. That’s a real risk now that the dollar is up 12 percent the past six months, and only looks like it’s going to keep going up as the Fed gets ready to raise rates while the rest of the world is cutting them. To give you an idea how big of one, net exports just took 1.2 percentage points off growth.

Here, the idea that he appears to convey is that the dollar is an exogenous variable that is set on “cutting the expansion short”! Poor dollar. Like other prices, it´s not only “not guilty” but actually “innocent”, being determined by fundamental factors. Prominently among those are the relative growth of the US economy and the US interest rate differential (which also depends on relative US growth). Also, remember that while many countries are going into negative rates, the Fed appears in a hurry to raise them!

On the often-mentioned “negative” contribution of imports to growth, picture this exchange (which is not fictitious):

“The economy grew robustly. If it weren´t for the strong rise in imports growth would have been even higher”.

“But why was import growth so strong”?

“Because the economy grew robustly”

Back to Matt:

That’s been the story of the recovery: one step forward and one step back. Whenever one part of the economy takes off, like consumer spending has now, another falls off, like net exports. The difference now, though, is that, for the first time, you can see the potential for the recovery to break out of this cycle, and finally take two steps forward. Cheaper oil is helping households, austerity is over, and lower unemployment means that, at some point soon, residential investment should break out of its doldrums as young people move out of their parents’ basements. But there’s only so far these things can growpeople can’t keep spending more unless they save lesswhich is why we can’t afford for the trade deficit to be a persistent drag on GDP.

Everything’s in place for a boom. Everything except the dollar.

Wow! Other prices (oil) are brought into the “fray”! Really, reasoning from a price change is a “national vice”! The same can be said about reasoning from a “GDP component change”.

Here´s the non sequitur: To spend more, people must save less, but if they save less (and the government doesn´t save more) the trade deficit will remain, according to him, “a persistent drag on growth”!

One thought on ““Dollar antics”

  1. It’s interesting to watch people talk themselves in a circle. He’s got all the right pieces: strong dollar, disappointing growth. But then he just whizzes right by the point that the Fed is getting ready to raise rates as if that is just background noise, which leads to some absurd reasoning when trying to explain the witnessed phenomenon. One might think that with all of the puzzle pieces in front of him that it might don on him that the rate hike just doesn’t make any sense.

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