In the 10 months till the election in November, we are going to hear a lot of rhetoric about economic issues because this election will be mainly about the economy.  Obama will say that his administration inherited a bad situation, which is true.  How did it get so bad?  Obama will blame greed and a lack of regulation.  He and others of his political beliefs will insist that, given the severity of the crisis, the federal government should have done more – more stimulus, more programs.  He will make the case that these programs are working – just not as fast as hoped.

The Republican nominee will assert that the Obama administration simply does not understand how our economy works.  More policies and regulations only dampen growth by making the economic climate even more uncertain. The nominee will assert that his administration will unleash the entrepreneurial growth that is embedded in the American spirit.

You may believe the former or the latter or believe in a mixture of these two points of view. 

To help understand the big picture, let’s climb high on our flying carpet and look at GDP growth these past sixty years.  From 1947 to mid-2007 we have enjoyed a 3.42% annualized growth rate of real GDP.  According to Census Bureau, our population has grown just a smidge more than 1% per year since 1952.

Using data from the Federal Reserve, below is a chart of actual annualized real GDP and the curve of growth since 1947.  During the 60s, robust manufacturing to supply a recovering Europe and government spending on the Vietnam War helped fuel a higher growth rate.  Democrats ushered in a new era of federal social programs, including Medicare, Medicaid and other social welfare programs.  Prosperity and compassion bred promises.

We’ll come down a bit from the heights and zoom in on the past thirty years.  For some of those years, GDP growth ran slightly above the longer term growth trend.  Consumers increased their borrowing as a percentage of their disposal income, contributing to the above the curve GDP growth.

The recession of the early nineties led to lower taxes for states and municipalities in the middle of the decade.  To balance the books, local politicians negotiated with state and local government employee unions, substituting employee health and retirement benefits – future costs – for pay increases.  Thus, penny pinching bred more promises.

Social Security, Medicare, Medicaid, the Food Stamp program (SNAP), WIC and other transfer programs sprang forth from what is one of the best attributes of human  beings – our compassion. 

In the 1930s, many watched in horror as older people lived their last few years in destitution.  Through no fault of their own, many had lost their life savings when banks had gone under at the start of the Depression. At the time, few lived past 70 years.  Why not create a fund that would collect money from all workers so that a small pension would be available to seniors in their last years? Who would have predicted that social security payments would grow from less than 1% to over 20% of federal spending in 70+ years?

Who knew that spending on a health program for seniors, Medicare, would grow a 100-fold from $5B in 1967 to $500B in 2009?(Source)

How are we going to pay for these promises?  Each year, the administration makes projections when it presents its budget to the Congress.  For the 2012 budget, the Office of Management and Budget (OMB) at the White House projected real GDP for the next 10 years. The chart below is based on those figures.

As you can see, these are not rosy or dour predictions.  They simply follow the same growth curve this country has had since WW2.  But the implications are enormous.  In the past four years, we have had a $6.5 trillion gap between where the economy should be at and where we are at.  The gap during the next five years will be over $10.7 trillion so that in the space of almost ten years we will have “lost” over $17 trillion in real GDP.

During the election cycle we will hear promises of policies designed to kick start growth but they will be empty promises.  How is anyone running for election or re-election going to significantly increase a growth curve that has been in place for 70 years?  Such a change would require some structural changes to the economy and politics of this country. 

In the past year, the Congress has proved that they are incapable of even small change – other than name changes to their local Post Office.  Each Congressperson, each Senator is loyal to principles, to their party, to their constituents, to the special interests that help them stay in office and, as a body, are not capable of making big changes very quickly.  Yet in the next ten months we will hear how one man – yes, one man, the next President of the U.S. – will make those changes happen.  Millions of Americans will vote, hoping that somehow, some magic way, it could be true.  Millions of Americans won’t vote, disgusted with our political process and despairing that there is any hope for constructive, sensible change in this country.  For those Americans who do vote, it will be a 2 for 1 special.  As in most elections, only half of eligible voters vote, effectively giving each voter a free extra vote.

We are going to have to find a way to talk constructively about graduated spending cuts on programs of compassion as well as programs of fear (defense).  Secondly, we need to have sensible discussions of policy changes which will help nudge the GDP growth curve up just a tiny bit.  The economy of this country is like the Titanic.  No one man or woman, no one Congress can make a big change in course – although there is a machinery of political pundits whose job is to convince you that it is so – just like in the movies. Long term trends are powerful forces, difficult to overcome.  I vote for the person who acknowledges that fact and is willing to sit down at the table and talk turkey.    

As we start off the new year, things should start to improve in the U.S. economy.  As I mentioned in my “Year in Review” blog last week, the recession is finally almost over.  Real GDP has finally surpassed the level it was back in 2007.

Another indicator that the recession is almost over – household debt as a percentage of disposable income, or income after taxes.  Household debt includes mortgages, car payments, student loans and credit cards.  As the chart below shows, U.S. households have finally paid down, cut back or defaulted on a lot of debt since 2007.  We started to  reduce our debt load during the recession of 2001 but the 9/11 attacks prompted a wave of patriotic purchasing encourged by the Bush administration and aided by easy home refinancing. (Click to enlarge in separate tab)

We are still short of a healthy 14 million in sales of cars and light trucks but sales continue to increase from the depressed levels of late 2009.

As I noted last week, retail spending is still not back to the levels of 2006 – 2007 but those retail sales were fueled by people charging far more than they could reasonably pay for.  When I look at inflation adjusted, or real, retail sales from 1947 – 2001, the trend line (mine) projects real retail sales in 2011 of about $160B. 

What did we have in 2011?  Over $170B!

Last week I was rather dour in my assessment of this half-assed economy but I was taking a short term view, comparing sales and GDP today to the bloated bubble levels of 2007, an unrealistic comparison.

Construction spending has cratered in the past four years as we wring out the excesses of the past decade.

But when I draw trend lines showing growth we can see just how inflated the construction bubble was from the mid-90s till 2007.

In the past two years we have formed a “bottoming” pattern that indicates that the downward slide in spending has ended.

Well meaning but bad policies, poorly regulated mortgage brokers, consumers eager to get in on the housing gravy train, banks playing 3 card monte with bundled mortgage security products, politicians eager to please and get re-elected – so many factors that led to an overgrown forest.  And then the fire.  Now there are green shoots emerging.

Before you get to singing “Happy Days Are Here Again”, there are some fundamental long term – decades long, long term – concerns and trends that I will look at this weekend after I sharpen my red pencil. 🙂