Friday, September 30, 2011

Measuring Financial Productivity

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

"An Absolute Zero" discussed the relationship of credit growth to economic growth. (The measurement used in the article was the change in non-financial domestic debt divided by the change in nominal Gross Domestic Product.) The productivity of credit has sharply deteriorated over the past 30 years. In fact, the additional credit creation today may actually be a cause for economic shrinkage rather than growth. It is making us poorer.

There are other ways to look at the efficiency of finance. I would like to hear from anyone who has given this some thought.

Josh Friedlander, friend and Online Editor of Absolute Return magazine, has already chipped in. Josh writes: "I really loathe GDP." That makes two of us. If given the opportunity, I would ban the government from calculating GDP. Josh goes on to ponder whether GDP "probably [gets] some rise simply from the transfer of (newly issued) government securities from one place to another.... [B]ut maybe this is exempt from GDP." I don't think issuance of government securities changes total GDP, but would like to hear from someone who knows.

Josh asks whether I've "done this analysis as a ratio of debt to government revenue. Agreed, taxes change, but that's how I'd value the U.S. if it were a business."

The tables I found for tax receipts are organized by fiscal year. Some more research would surely turn out monthly figures which would be comparable, but my entire staff is draped in black so unable to function. Some Red Sox thing.

Back to the measurement used: the change in non-financial domestic debt divided by the change in nominal Gross Domestic Product. There are at least two advantages to using GDP in this comparison. First, it is widely recognized as a measure of growth. Second, since it is a widely publicized economic number it is manipulated - to the government's advantage. Thus, the measure of financial efficiency used in "An Absolute Zero" understates the deteriorating relationship of new debt to economic growth. It is better to err on the conservative side.

Error in such comparisons must be accepted. There is no perfect measurement. Economic numbers are always estimates and patterns within the object being measured change over time. The employment figures, for instance, are not an exercise in counting every working noggin in the country. Cutting-and-pasting from the Bureau of Labor Statistics website: "The confidence interval for the monthly change in total non-farm employment from the establishment survey is on the order of plus or minus 100,000... there is about a 90-percent chance that the "true" over-the-month change lies within this interval."

Now, for those who watch Bubble TV, think of all the hoopla when the employment numbers are announced each month. What an exercise in fatuity. (Bill King - The King Report - just reminded his readers of an August 19, 2009, story in The Onion: "CNBC: Anyone Who Owns a Suit Can Come on Television" From the story: "'Just come on down, run a comb through your hair, and if you're here by 8 a.m., we'll have you on Squawk Box at 8.15 making stock picks. But don't forget your suit!'")

Modern Kremlin watching includes the change in relative importance of economic numbers. GDP, the monthly employment figures, and the CPI are ascendant. Thus, they should be treated with the greatest skepticism. Income is rarely mentioned. Given that income, as a whole, have not risen since 2008, it is wise of the government mandarins to ignore it. The media's reason for not pursuing such a hot lead is a mystery. At least The Onion is publicizing the root of the problem.

A descending figure is productivity. In the late-'90s, an exhilarating productivity announcement (+0.1% was all Bubble TV needed) was good for a $50 boost to Webvan and This was Fed Chairman Alan Greenspan's doing, in a complicit alliance with heralded economist Michael Boskin. (See "Economists Serving Their Political Masters") The torturous destruction of GDP and productivity can be reviewed in "The Government's New Math: 3.5% - 5.1% = 1935." Chapter 12 of "Panderer to Power" is devoted to the subject.

Today, the quarterly productivity announcement is barely discussed. Again, this is for good reason, from Washington's point-of-view. Productivity is falling. Non-farm business productivity per hour fell -0.6% in the first quarter and by -0.7% in the second quarter of 2011. If this were 2000, Webvan might have gone out of business three weeks sooner. As an aside, I don't think we can measure productivity today. It may have revealed some trends when a large proportion of America's work was shipped from River Rouge.

Comments on how to measure the change in the efficiency of finance over the decades are welcome. This includes the return on capital, and on equity, even though one only need be alive to see the obvious deterioration in how we allocate our capital investments.