US Output Gap

[santafe2]

After 6 years the US output gap is about 60% closed. This is not the same as EJ's proprietary chart but it should give us a good idea of how difficult it is to recover from massive amounts of mal-investment even if the Fed piles huge amounts of cash in our system for us to re-mal-invest.

The economy is like nature, you can fool yourself but can't fool it. For example, we can pretend we have 5% unemployment by counting the unemployed differently than we did in the past, (U3 vs. U6), but the economy doesn't really care. One of the things that I marvel at in the US is that our tax dollars buy public reports that contradict most of the lies our media and politicians tell us but almost no one is willing to take the time to dig into them.

The US media won't criticize our politicians because they don't want to criticize their employees. Our politicians won't criticize the US media because who needs an angry boss when you've got a job with excellent pay and benefits...and, you can vote for your own pay raises as long as the boss is happy.

If we take a linear point-of-view with regard to our progress closing the output gap, one would come to the conclusion that it may close in another 4 years. The question of course is do we have 4 years before the next bubble bursts or the next major crisis? That, in my opinion, is a lot to ask of any system.

[GRG55]

Re: US Output Gap

After 6 years the US output gap is about 60% closed. This is not the same as EJ's proprietary chart but it should give us a good idea of how difficult it is to recover from massive amounts of mal-investment even if the Fed piles huge amounts of cash in our system for us to re-mal-invest.

The economy is like nature, you can fool yourself but can't fool it. For example, we can pretend we have 5% unemployment by counting the unemployed differently than we did in the past, (U3 vs. U6), but the economy doesn't really care. One of the things that I marvel at in the US is that our tax dollars buy public reports that contradict most of the lies our media and politicians tell us but almost no one is willing to take the time to dig into them.

The US media won't criticize our politicians because they don't want to criticize their employees. Our politicians won't criticize the US media because who needs an angry boss when you've got a job with excellent pay and benefits...and, you can vote for your own pay raises as long as the boss is happy.

If we take a linear point-of-view with regard to our progress closing the output gap, one would come to the conclusion that it may close in another 4 years. The question of course is do we have 4 years before the next bubble bursts or the next major crisis? That, in my opinion, is a lot to ask of any system.

Some random observations and thoughts:

1) If we backed out the enormous amount of post-GFC capital that went into the US domestic hydrocarbon industry the output gap would almost certainly be measurably wider today. The oil and gas industry is one of the few with the capital intensity to absorb the vast amount of liquidity that gushed forth in the aftermath of the GFC - most of the rest went to inflate resource and other assets in EM nations. Now that the liquidity cycle is reversing (rising US$ since the start of taper is the key indicator) it is these capital sponges that are getting squeezed the most.

2) Unemployment coming out of any recession is due to a mismatch between the skills the workforce has versus the skills the economy requires. The economy in the USA has changed pretty dramatically in one generation. It takes time and money to retool and retrain so coal miners can install solar systems. ;-)

3) Similarly some of the measures of GDP or potential growth will lag the changing economy; the forecast extrapolation of potential GDP implying some constancy in how that GDP is calculated.

4) If many of the "conventional" ways of creating economic growth (and national wealth) are now obsolete (such as our friend the coal miner) then what are the ways in which we will create growth and national wealth now? I had an interesting debate over Christmas dinner with the son of good friends who were guests at our table. He works for a boutique eastern USA based PE firm; specializes in data security software technology investments. The debate centred around the question of whether the money and people developing data security technologies are "creating wealth" or merely protecting existing wealth (by protecting their clients valuable proprietary data & derived knowledge from being stolen or tampered). Certainly from the standpoint of his PE clients and his firm (and also himself, given how he is compensated) he is "creating wealth" if his investment choices are successful in growing sales and income. But is this activity resulting in merely a shift in slices of the national economic pie (selling protection in a socially more acceptable way than the Mafia), or a real increase in overall national economic wealth and GDP?

5) Notwithstanding all of the above, maybe the whole concept of an output gap is now completely irrelevant given how dependent the USA economy has become on serial asset bubbles.

[lektrode]

Re: US Output Gap

Some random observations and thoughts:....
...
5) Notwithstanding all of the above, maybe the whole concept of an output gap is now completely irrelevant given how dependent the USA economy has become on serial asset bubbles.

just like the one in 'healthcare' ?

of course this depends on who's numbers you wanna believe; as in 'change' they can believe in...)

[santafe2]

Re: US Output Gap

Some random observations and thoughts:

1) If we backed out the enormous amount of post-GFC capital that went into the US domestic hydrocarbon industry the output gap would almost certainly be measurably wider today. The oil and gas industry is one of the few with the capital intensity to absorb the vast amount of liquidity that gushed forth in the aftermath of the GFC - most of the rest went to inflate resource and other assets in EM nations. Now that the liquidity cycle is reversing (rising US$ since the start of taper is the key indicator) it is these capital sponges that are getting squeezed the most.

I suppose the OPEC near-monopoly got a bit greedy and bought the peak oil rhetoric. Then Bernanke and friends create mountains of free debt in cheap US dollars and enterprising NA oil dowsers get very creative with massive amounts of OPM. NA oil production moves up by 5MM barrels a day...who the hell saw that coming besides you and a few of your friends in the oil patch. Saudi's get tired of playing that game and want their ball back. Oil moves down in price quickly, US dollar moves up and debt is no longer free. Does that mean the output gap stops closing? I don't think US consumers can take on enough iPhone 6S debt to cover the difference.

)2 Unemployment coming out of any recession is due to a mismatch between the skills the workforce has versus the skills the economy requires. The economy in the USA has changed pretty dramatically in one generation. It takes time and money to retool and retrain so coal miners can install solar systems. ;-)

Ah, the modern barbarous relic. Coal miners will give it up about as quickly as central banks gave up the original.

)4) If many of the "conventional" ways of creating economic growth (and national wealth) are now obsolete (such as our friend the coal miner) then what are the ways in which we will create growth and national wealth now? I had an interesting debate over Christmas dinner with the son of good friends who were guests at our table. He works for a boutique eastern USA based PE firm; specializes in data security software technology investments. The debate centred around the question of whether the money and people developing data security technologies are "creating wealth" or merely protecting existing wealth (by protecting their clients valuable proprietary data & derived knowledge from being stolen or tampered). Certainly from the standpoint of his PE clients and his firm (and also himself, given how he is compensated) he is "creating wealth" if his investment choices are successful in growing sales and income. But is this activity resulting in merely a shift in slices of the national economic pie (selling protection in a socially more acceptable way than the Mafia), or a real increase in overall national economic wealth and GDP.

I've gone back and forth in my career. Sometimes working for "the mob" and other times trying to do work that may offer a positive influence on society. A particularly dark period was the late '90s when I managed teams of engineers charged with deploying software to assist several of the big banks in proving they were no longer redlining credit card approvals. In the dark ages before wide use of the Internet, credit card applications were paper based and if your zip code was wrong, you didn't get a credit card. The Feds sued and the banks needed to resolve the problem.

I worked for a startup that almost by accident, had the right solution. The software worked, maybe too well. The Feds were happy and the big banks were happy to have the Feds looking elsewhere. But there was an awful outcome. Once the big banks had to accept a few applications from poor neighborhoods, they realized they'd been ignoring an excellent profit center in high risk, high interest credit. They bought up the "sleazy" providers of sub prime revolving credit and streamlined it, then perfected the business. It works so well today that it almost doesn't matter if you pay off your credit card or not. The bank makes more if you pay but it's still profitable when you don't pay.

[ProdigyofZen]

Re: US Output Gap

The Fed uses the HP Filter to smooth the macro time series of potential GDP. This is how they came to the conclusion in an October research paper that their version of the Output Gap was going to close by the end of December 2015.

This is why they raised rates.

It is a misstep on their part.