Thursday, December 12, 2013

Enron Style Accounting & the 1.7% GDP Announcement By Rick Kelo

Enron Style Accounting & the 1.7% GDP Announcement
By Rick Kelo

When things don't pass the sniff test, there's always a reason.  Famously a little over a decade ago one of the nation's largest companies crashed and burned.  Enron had been using some "creative accounting" to make itself look more profitable than it was.  Every time the company experienced a dip in profit it changed the accounting method it used to make itself appear more profitable or make the company look like it was growing more than it was.  In preparation for the fiscal cliff debate the Bureau of Economic Analysis has decided to engage in a massive revision of its accounting terms.  Overnight this week GDP became a full 12% larger than it was when we went to bed the night before... and so did the growth.
Yesterday I leveled an accusation against the Congressional Budget Office for lying on their statements of how many jobs the stimulus created.  Really they haven't lied to us so much as tricked us because they disclose their methodology, but they disclosed it in a very obscure way hidden in 1 sentence of an entire announcement, then presented job growth numbers in a way as to dupe stupid American journalists everywhere.  Sadly the CBO knows that group is made up of English majors not accountants or attorneys.  As such don't read the fine print.
So, while I'm in the mood to point out massive errors & omissions in the fine print the Bureau of Economic Analysis gave me cause several days ago to point out their approach to reporting the GDP.  
Earlier this week the BEA announced a 1.7% annual rate of GDP growth in the second quarter of 2013.  This is recession indicating growth rate, but that's not the interesting point.  The interesting point is what else the BEA announced that did not make it into the news story.
Going all the way back to 1929 the BEA decided to revise the accounting treatment of a couple items (R&D and pensions).  The change this produced is the biggest effective revision to the GDP calculation ever!  And it has gone totally unnoticed.  I'll just fill in the next question you're wondering: yes the revised accounting makes GDP growth suddenly much larger than it was before.
Changes in definitions (mainly accrual accounting for defined benefit pension plans, which credits households with the value of accrued benefits from these plans) raise personal income and personal saving
GDP. Current-dollar GDP was revised up for all years (1929–2012). The upward revisions to current-dollar GDP mainly reflect the recognition of additional expenditures -- for R&D; for the creation of entertainment, literary, and artistic originals; and for an expanded set of ownership transfer costs -- as fixed investment (see "Revision Analysis for GDP, 2012"). The new accrual treatment for government-sponsored defined benefit pension plans results in revisions to current-dollar GDP through revisions to supplements to wages and salaries for government employees (specifically, employer contributions for employee pension and insurance funds); these revisions are upward for 1929–1978, downward for 1979–1991, and upward for 1992–2012.
~ Bureau of Economic Analysis, National Income & Product Accounts, July 31, 2013
Now, you're no doubt asking yourself... so what?  The accounting revision changes GDP over that time period by $1.8T, which over our new total GDP of $15.4T is an overnight 11.6% jump in GDP.  However, because of the reporting & data for the particular items the BEA chose to "update" the newly higher GDP is especially improved in recent years.  Here's one representative example:

In the revised estimates real GDP increased 2.8 percent in 2012; in the previously published estimates, real GDP had increased 2.2 percent.
~ Bureau of Economic Analysis, Technical Note, July 31, 2013
Meh.  What's a 0.6% increase due to some accounting tricks?  Well its not actually a 0.6% increase, 2.8% is a 27% larger GDP growth than 2.2%.  I think the impact is starting to become clearer.
Meet the New GDP, Same As the Old GDP
Now allow me to make a caveat to my statements at this point.  Unlike the actions of the CBO in reporting unemployment numbers, this announcement by the BEA was not revealed only through a very tiny, vague reference to how it was being calculated.  It was announced on the BEA website for all to see.   However in my scanning of the world of news I have not seen a single mention of this new calculation method since and I have certainly not seen anyone yet analyze it to point out the incredible jump in GDP this revision makes appear.
The Significance
I'm going to moralize a bit and be someone dogmatic.  Things change, and as better information and techniques become available we update old ones.  The BEA's's evident reply if questioned about this massive accounting change would be along those lines I have no doubt.
It is not the BEA that I am concerned with, it is the common American.  When the US economy has fallen below a 2% growth rate for 2 quarters in a row it has always signaled a recession.  The exception was 2007 when, after 2 quarters below 2% growth, GDP came back up... for 1 quarter before the recession hit.  (Hey, I didn't say it was much of an exception, just that it was an exception).  I mention this because the 1st quarter US GDP growth was 1.1% so we are now in very dangerous territory from historical stand-point.
Either way, by taking Enron's approach of making ourselves look more profitable than we are we do not fool the economy.  We only fool the common man who turns on the news and hears the economy is growing.  He hears that GDP came in at 1.7% when everyone had predicted 1.0% so we must be doing BETTER than expected.  Except we aren't doing better than expected, we just moved the goal post.
I hope we have not moved the goal post in a way that prevents people from recognizing a possible recessionary threat approaching.

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