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The standard measure of our national economic output is the Gross Domestic Product or GDP. Judging economic performance on the formula for GDP virtually guarantees that government will spend money it doesn't have, whether that money comes from taxing, borrowing, or as is currently in vogue, simply printing it.
The standard formula for GDP is:
GDP = C + I + NX + G
where C is Consumer spending, I is capital Investment, NX is net exports, and G is Government spending, . Since the performance of our elected leaders is based so much on the performance of the economy, and the performance of the economy is judged by growth in GDP, the easy way for them to get good numbers is to spend more.
The Government component of the formula ought to be seen for what it is, a load on the overall economy and not a driver of it. In order to grow, the government takes resources out of the private economy and uses them up, returning only a portion in the form of its purchases and public sector employment.
The less government spends, the less it takes out of the private economy. Though outside our scope here, a bigger advantage of governments spending less is the decreased burden of regulation they are able to inflict on the private sector when they do.
Self-serving Keynesians use the standard GDP calculation to define success as exactly what they already want to do: spend money.
Clearly missing from the GDP calculation is anything to do with borrowing. Consumers can spend lots of money they don't have to buy necessities or the latest gadget from Apple, but if they do so on credit the money will have to be paid back at some point, and adding interest, at an increased cost.
The GDP model also ignores government borrowing. As Andy Sutton put it at Seeking Alpha back in August, 2009:
If one were interested in calculating a more honest version of GDP, any government borrowing (for starters) would be subtracted. Sure the money is spent on goods, but it is not money that is free and clear. It represents a future burden on growth, and should be treated as such. Just as an example, in FY 2008, the Federal Government ran a deficit of over $400 billion. Taking that off 2008 GDP lops another 2.8% off GDP. Imagine what deduction nearly $2 Trillion worth of borrowing would do to 2009 GDP if it were counted.
We don't have to imagine, as we're living through it. Our government now owes an amount roughly equal to a year's output of the entire economy. With the total of federal, state, and local government spending now running between 38 percent or 41 percent of GDP, and deficits at 40% of that, the borrowing and printing sector of the economy is the part that's doing fine.
States like Illinois and California are unable to print money, but have issued bonds as if printing them were enough to stay solvent. Cities, of which Stockton, CA is the most recent example, are finding that issuing bonds to fund pension and other non-capital expenses is a sure route to bankruptcy court, as well.
To be clear, the government isn't simply running the printing presses. Rather, the Federal Reserve uses its ability to "expand its balance sheet", simply changing the balance in its own accounts. Currently they are buying up long-term government debt and continuing to buy bad debt with this created money, rather than allowing the holders of the results of bad decisions to suffer the consequences.
That shell game is intended to stimulate the private economy, but it isn't working.
In context, the entire focus of the president is warped—not simply because he underestimated the health of the private sector but because he believes that any other sector matters when talking about the economy. It doesn't.
As long as the people in charge of creating the federal budget (or not creating one) have the opportunity to determine their own perceived political and career success by deficit spending, we will have deficit spending. In order to make the economic numbers on which they are judged look good, government officials have to grow government.
If they fail to grow government, we get stories like this: from Jeff Cox at CNBC in April:
Government has become its own worst enemy when it comes to the economy, with public spending putting a damper on growth that otherwise continues at a steady if unspectacular pace.
Cox meant that the lack of government spending was bringing down the overall numbers in the standard calculation.
Friday's gross domestic product report confirmed what a drag government can be: While consumer spending grew at a 2.9 percent clip, state and local governments cut back spending by 1.2 percent on an annualized basis and the federal government pulled back by 5.6 percent.
State and local governments are not driven by quarterly GDP numbers but by the need to balance their budgets. Without a printing press, they have no choice but to cut back when they run out of money. If we focus on the burden on the private economy and not on the arbitrary GDP calculation, it's easy to see that local governments cutting back is a positive development for the nation as a whole.