3 Economic Myths ... Busted!

Meerkat populations have been dwindling because of the danger they face from highly venomous scorpions in their breeding grounds.

Unless you are a zoologist or a big fan of the television show Meerkat Manor, you probably don't know that the sentence above is completely untrue -- meerkats are actually immune to the venom of the scorpions in the Kalahari. Without prior knowledge, though, it would have been difficult to figure out that what I wrote is utter bunk, since I wrote it declaratively and I managed to get it published for you to read. And it seems to make sense.

The average American does not have an advanced degree in economics, nor should they. But in the world we live in, a pretty thorough understanding of economics is often essential to ferret (or possibly meerkat) out the facts from what we hear in the news.

Here are three myths that feel like sandpaper on my brain when I hear them perpetuated in the popular -- and sometimes less-popular -- media.

Myth 1: Spending by the U.S. government is the only thing keeping us from the abyss -- and that's not sustainable.

Reality: Don't get me wrong, I love blaming the government just as much as the next guy. Whether it's a stubbed toe or bad weather, it seems there's never a bad reason to shake your fist at Uncle Sam.

But alas, the numbers simply don't support blaming government spending for creating an unsustainable economy. Thanks largely to a hefty amount of defense spending, the government's share of the economy reached nearly 30% in the 1960s, but it's steadily fallen since then and made up just more than 18% of GDP in the first quarter of 2009.

I'm sure that defense contractors like Lockheed Martin and Boeing (NYSE: BA  ) would love it if the government ramped defense spending to past levels, but I think they may be out of luck in that regard.

And then there are those who would like to see the government make up a much smaller portion of the U.S. economy. That's a subject for another article (potentially in a political publication). For now, the point is that government spending is well within the bounds of where it's been for a long time.

Myth 2: Consumer spending on superfluous items like big-screen TVs and Coach purses has been driving the U.S. economy, and is now set to ruin it.

Reality: Right about now I'm sure companies like Coach (NYSE: COH  ) and Best Buy (NYSE: BBY  ) wish there were a problem with excessive spending on discretionary items. But job losses and concerns about where the economy could be headed have caused many consumers to scale back their discretionary budget, and this has many investors spooked.

There is reason to be concerned about consumer spending, as it makes up more than 70% of GDP. And there's likewise reason for near-term concern if you're considering an investment in a company like Starbucks (Nasdaq: SBUX  ) ; as long as the recession stretches on, consumers are likely to be cautious about discretionary spending.

However, the concern that the entire U.S. economy is perched atop a massive mountain of unsustainable discretionary spending is simply untrue. As a percentage of total consumption spending, purchases of clothing and accessories declined from nearly 15% in 1930 to about 9% in 1970 and sits at around 5% today.

How about those TVs and home theatre setups? Back in 1930, spending on video and audio goods made up 1.3% of consumption expenditures. Today? Just about 1%.

And it would also appear that Americans haven't been stuffing their garages full of new cars. New autos made up as much as 5.4% of consumption spending in 1950 and have declined to just more than 1% today. Guess that makes the General Motors situation a little more understandable.

Myth 3: The U.S. had a vapor economy built on the false revenue of financial institutions like Goldman Sachs and Lehman Brothers.

Reality: Given the spasms that the entire financial system went through as Lehman Brothers failed, AIG (NYSE: AIG  ) failed in all but name, and JPMorgan Chase (NYSE: JPM  ) and Bank of America (NYSE: BAC  ) had to absorb nearly a basketball team's worth of defunct (or nearly defunct) companies, it would seem only right to blame them for just about everything.

To be sure, the financial industry has earned plenty of blame for its role in the banking meltdown. But the idea that the financial sector has created fictional production and inflated overall GDP simply misses the mark.

Economic production comes from a witch's brew containing things like labor, capital equipment, technology, and land and other natural resources. Try as they might, even the most talented financial alchemists can't turn money into labor or land that isn't already there. So the financial industry may have been stimulating economic production by making sure people had access to money -- which is generally a good thing -- but it can't create fictional economic activity.

So fear, but not too much
I don't expect that debunking these myths will result in green shoots bursting forth and sending the economy and stock market into full-blown recovery. There can be confounding factors that create enough friction in the economy that we don't produce at or even near full capacity -- a situation that we're experiencing now.

The silver lining, though, is that the U.S. economy isn't an old jalopy in need of a complete overhaul. We actually have a large, very flexible economy that I believe will show its true mettle as we continue to work through the near-term problems. And as we do march onward from repulsive to recovery, those that have invested in top-flight companies that have been doing the right things during lean times will be rewarded.

Think I'm completely off base? Got a myth of your own that you've debunked or would like to see debunked? Chime in below in the comments section!

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Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy has debunked the myth that a disclosure policy can't sing opera in a flawless baritone.


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  • Report this Comment On July 29, 2009, at 11:39 AM, ChannelDunlap wrote:

    Meercat Manor - Actually not such a bad show. I as a little sad when I initially believed your introduction :(

    Nice job with the rest of the article, too. I enjoyed it.

  • Report this Comment On July 29, 2009, at 12:02 PM, dbackroyal wrote:

    The writer must not drink coffee. He said spending at Starbux is discretionary spending. To most people, coffee is an absolute necessity in the morning, otherwise good article.

  • Report this Comment On July 29, 2009, at 12:15 PM, JTShideler wrote:

    -Myth 1: Spending by the U.S. government is the only thing keeping us from the abyss -- and that's not sustainable.

    You did a decent job of making the argument that government spending could continue at today rates and were smaller as a % of GDP in the 60's but did not make an adequate argument about the first part (Spending by the U.S Government is keeping us from falling into the abyss)

    Productive government spending to fight the Communist Menace is one thing but throwing good money after bad is not a good use of resources. Taking money from Taxpayers that make up 70% of the economy to give it to the government that makes up 20% doesn't make a lot of sense unless what the government is spending money on is required which in my opinion is not and would be another good discussion for the political magazine.

  • Report this Comment On July 29, 2009, at 12:32 PM, TMFKopp wrote:

    @dbackroyal

    I actually drink more coffee than I care to admit to. However, I try to stay thrifty and make it at home (though, comically, my coffee mug is from Starbucks!).

    Come to think of it, if it weren't for a few cups of coffee, I never would have made it through all the Bureau of Economic Analysis data that I used for this article...

    @JTShideler

    That myth is tricky because it's really tough to talk about it without veering into politics. The primary point was to say that recent government spending hasn't escalated beyond what has been sustainable in the past (and is actually less of a share of GDP than in the past).

    As for where the spending goes, I won't say that doesn't have economic implications, but I'll leave the debate on that to the folks that put an (R) or a (D) after their name.

    Matt

  • Report this Comment On July 29, 2009, at 12:34 PM, pondee619 wrote:

    Dear dbackroyal :

    Coffee may be absolutely necessary in the morning. I believe that it is, and from my view of the office coffee pot (which I brew each work day) many, many others believe so too.

    Starbucks, however is discretionary spending. For the price of an empty Starbucks cup, we brew a pot for the office. For 30 cents a day, each, you , and your co-workers, can have an unlimited supply of coffee. Just bring your own mug from home.

  • Report this Comment On July 29, 2009, at 12:48 PM, Deepfryer wrote:

    All you've got to do is set your automatic coffemaker to brew a fresh pot every morning, and you'll have it waiting for you as soon as you wake up. It's faster, cheaper, and more convenient than going to Starbucks.

  • Report this Comment On July 29, 2009, at 12:49 PM, plange01 wrote:

    the US is in a depression people are using food stamps at cvs and obama is busy trying to be a celebrity!caught up in the spotlight! at this rate we are going to have a midterm presidental election ....

  • Report this Comment On July 29, 2009, at 1:01 PM, TrojanFan wrote:

    Regarding myth #1, there is another really salient bearish point that your article fails to sufficiently address.

    Using the CBO's own forecast of the US annual deficit, at the trajectory that we're on the publicly traded portion of US government debt is on a path to exceed 100% of GDP in less then 10 years!!

    That is a gargantuan problem. For many other developed and developing economies that has been a threshhold at which marginal borrowing becomes difficult and best and financially suicidal at worst.

    To summarily dismiss a US government debt default within the next 10-20 years as utterly impossible strikes me as simply naive.

    As many retirees can tell you, it is where the market is at on the TERMINAL date that matters. If you are of an age that you'll need to be spending your retirement money within that 10-20 year window of time, I would say that you need to be thinking long and hard about layering on incremental equity risk while the threat of future dollar devaluation remains.

    Investing in individual stocks, perhaps, because you have a lot more control over your investment. Believe it or not, I actually view stock investing to be LESS risky then fund investing for this reason. Funds, because of their diversification, have much more inertia and are much more exposed to macroeconomic forces then smaller, more nimble, microeconomic objects like individual business firms (especially smaller sized ones). It's much easier for a single firm to swin upstream then an entire fund of 300 companies or more.

    So while I'm not entirely pessimistic I do view our present situation with a healthy dose of skepticism and cynicism. I think most investors will be well served by doing the same and not giving into hope and blind optimism. I would say that caution is recomended until a clear path out of our current fiscal dilemmas presents itself. This market has become utterly euphoric. 660 on the S&P may have been an overcorrection, but not nearly as much of an over correction as most of the bullish pundits (including those on this sight seem to promote).

    In my opinion, the S&P 500 would be fully valued at around the low 800 range and since you always want to buy at AT LEAST a narrow discount to fair value, you'd be a fool to buy the index anywhere above 780 in my opinion. Be patient, you will get a chance to buy at those levels again before this cycle is over.

    If you just wait and horde your cash, I suspect that you'll be glad you did.

  • Report this Comment On July 29, 2009, at 3:10 PM, FleaBagger wrote:

    Your dismissal of "Myth #3" is absolute nonsense.

    "Economic production comes from a witch's brew containing things like labor, capital equipment, technology, and land and other natural resources. Try as they might, even the most talented financial alchemists can't turn money into labor or land that isn't already there. So the financial industry may have been stimulating economic production by making sure people had access to money -- which is generally a good thing -- but it can't create fictional economic activity."

    Mm-hm. That's exactly the point. Because they can't turn the money they (along with the Fed) generate out of thin air into actual, useful goods, they lend that fake money for interest, appropriating goods and services out of the productive parts of the economy and into their personal consumption. The economic activity that they stimulate is We The People giving them our land and the fruit of our labor, as Thomas Jefferson predicted would happen if we give private banks power to control our currency.

    "Myth #3" is not entirely true, but the financial sector (with the consent and prodding of various parts of our government) sucked a lot of the goods and labor out of productive uses and poured it into a "witch's brew" of unsustainable development projects, while they paid themselves huge bonuses with the money they effectively stole from us.

    But that's probably not important. Economic activity is economic activity, after all. There's no difference between wasteful, unsustainable projects fueled by fraudulent money and sustainable projects funded by actual savings. It's all economic activity, after all.

  • Report this Comment On July 29, 2009, at 6:17 PM, RobertC314 wrote:

    On #2 - where IS the discretionary spending going? With all the categories decreasing something new must be eating up all our hard-earned cash.

  • Report this Comment On July 29, 2009, at 8:38 PM, TMFKopp wrote:

    @FleaBagger

    "Economic activity is economic activity, after all. There's no difference between wasteful, unsustainable projects fueled by fraudulent money and sustainable projects funded by actual savings. It's all economic activity, after all."

    Sarcasm duly noted.

    The point, however, is that the economic capacity is still there. Perhaps resources were mis-allocated over the past few years, but if that was the case we could consider an even more optimistic scenario where our economy is able to greatly benefit from a reallocation of resources that over time will help expand capacity.

    @RobertC314

    "where IS the discretionary spending going? With all the categories decreasing something new must be eating up all our hard-earned cash."

    Well just to clarify we're talking about all consumer spending as opposed to just discretionary -- which is hard to suss out since, for example, some clothes are absolutely necessary while a 14th pair of Jimmy Choos is definitely not.

    But to answer your question, the single biggest area that's gobbled up consumer budgets is healthcare. In 1930 4.1% of consumer spending went to medical care and that has steadily ballooned to nearly 21% today. There are some other areas that have climbed as well, but none with anywhere near the impact of healthcare.

    To put that 21% in perspective, around 15% is spent on food, 5% on clothing, 15% on housing, and 12% on transportation.

    Matt

  • Report this Comment On August 01, 2009, at 3:05 AM, bobfeeblethorp wrote:

    I read up to the point that you said:

    "How about those TVs and home theatre setups? Back in 1930, spending on video and audio goods made up 1.3% of consumption expenditures. Today? Just about 1%"

    That's where I gave up. How silly can you be? I consider myself an amatuer investor, but even I can spot the difference between 1930 and 2009 when it comes to television, which was a budding novelty in the 1930's and therefore resulted in first time purchases of televisions. What an utterly ridiculous comparison. Besides, how much of a difference is .3% ?

    It's true... anyone can prove anything using stats.

  • Report this Comment On August 01, 2009, at 6:01 AM, memoandstitch wrote:

    "To put that 21% in perspective, around 15% is spent on food, 5% on clothing, 15% on housing, and 12% on transportation."

    Those categories add up to 68%. That leads me to conclude that 32% of consumer spending is discretionary (bigger than anything you mentioned so far!). Is there any non-discretionary spending besides what you mentioned? Education?

  • Report this Comment On August 01, 2009, at 6:21 AM, memoandstitch wrote:

    and your argument for Myth #2 is totally flawed. When you look at old forms of discretionary spending, it must go down, no surprise. Why not give data on computers? In 1930, 0% of consumer spending goes to computers/notebooks/internet. In 2009, probably 1-2% goes to computers and accessories. Also some fraction of air travels is discretionary.

  • Report this Comment On August 03, 2009, at 12:39 PM, TMFKopp wrote:

    First off thanks for all of the comments. I have no special access to data, it's all publicly available from the Bureau of Economic Analysis and you can all see the same data I used by visiting -- http://www.bea.gov/

    @bobfeeblethorp

    "That's where I gave up. How silly can you be? I consider myself an amatuer investor, but even I can spot the difference between 1930 and 2009 when it comes to television, which was a budding novelty in the 1930's and therefore resulted in first time purchases of televisions. What an utterly ridiculous comparison."

    I'm not quite sure what you're trying to argue here. The point of the consumer spending myth was to say that US consumers are not overspending on highly discretionary items. The point I'm arguing is simply that televisions and other AV equipment make up a smaller % of consumer spending than in the past. The "why" of the decline is not the subject.

    "Besides, how much of a difference is .3% ?"

    In 2007 0.3% came to $29 billion. I don't consider that chump change. But again, the point is that spending on AV equipment as a % of total spending has fallen, which counters the argument that US consumers are overspending on that kind of gear.

    @memoandstitch

    Here are the primary components of consumer spending:

    Food - 15%

    Clothing - 5%

    Housing - 15%

    Household operation (utilities, furniture, dishware, etc) - 10%

    Medical care - 21%

    Personal business (bank and broker fees, legal fees, insurance, etc) - 8%

    Transportation - 12%

    Recreation (AV equip, computers, books/mags, boats, amusement parks, gambling, etc) - 9%

    Education - 3%

    Religious and charity - 3%

    Foreign travel - 1.2% (netted out by foreign travelers spending in US)

    (I rounded so it doesn't quite add to 100%)

    "and your argument for Myth #2 is totally flawed. When you look at old forms of discretionary spending, it must go down, no surprise. Why not give data on computers? In 1930, 0% of consumer spending goes to computers/notebooks/internet. In 2009, probably 1-2% goes to computers and accessories. Also some fraction of air travels is discretionary."

    You're correct about the computers -- nothing was spent by consumers on computers in 1930 and in the most recent numbers 0.7% of consumer spending was on computers and related equipment.

    Of course the issue at play in #2 was whether we're overspending on discretionary consumer goods. Without a baseline of comparison on computers it's tough to say whether we're really overspending.

    Also, given the benefits that computers offer (access to information, ability to track budgets and prepare taxes, easy communication, online banking and bill paying) is that a category that we really want to key on as worrisome discretionary spending? TVs and purses sure (again, IF they were elevated), but I'm not so sure I want to argue against spending on computer equipment.

    I'm also not sure why you would consider designer clothing and big-screen TVs "old forms" of consumer spending. It seems to me that both discretionary areas are pretty darn popular today.

    Matt

  • Report this Comment On August 04, 2009, at 12:33 PM, DevinLM wrote:

    "Productive government spending to fight the Communist Menace is one thing but throwing good money after bad is not a good use of resources."

    This is part of the whole all-government-spending-is-wasteful-except-defense argument, which I've never really understood. So defense spending for the most part seems to go into massively expensive weapons (aircraft, ground vehicles, bombs, etc.) that usually sit idle for long periods of time and often are never used. In the best case scenario, these weapons are actually used, but this generally involves their fairly rapid destruction. Now, it's true you do get a multiplier effect from the defense contractors who take the income from the weapon and go buy another yacht or whatever, but the actual asset being purchased serves little productive good. This was especially true in the Cold War when we were simply stock-piling weapons to make sure we always had a bigger pile than the other team. Naturally, there's a political value to warfare and preparation for warfare, but I fail to see the economic value of such activity. It seems warfare is about the most economically unproductive activity we can engage in since it mainly involves destroying assets.

    On the other hand, when government spends money on infrastructure or education or even health care, these seem like economically productive ways to spend money. When the government invests in communication or transportation infrastructure, it makes commerce easier and thus provides a jolt for the economy by allowing more economically productive transactions to take place. When the government invests in education or health care, it's making American citizens more productive by ensuring they're smart & healthy. Even government transfer programs like food stamps and social security have at least the same multiplier effect as money spent on bombs. In both cases, the government has not gained a "productive" asset for its money, so the only positive economic multiplier comes from the recipient of the money turning around and spending it.

    Obviously, not all government spending is productive...after all there's that massive 1% of spending that goes to earmarks that we always hear so much about. And, of course, defense spending was a major rationale behind some of the government's best investments (interstate highways, Internet, satellites...though all of these items eventually moved onto non-defense budgets as they became more valuable as commercial assets than military assets). On the whole, however, I don't understand the notion that all government spending is wasteful unless it's defense spending. Maybe somebody here can make an economic (not political) defense of this notion.

  • Report this Comment On August 05, 2009, at 12:37 PM, ZCBee wrote:

    How does one separate economics from politics? They are so intertwined that to make any comment about one you must admit the implicit connection of the other. I know that limits must be placed on everything, including writing articles or responding to them, so I will go to a site that focuses on the other to get the other half of the story. Good article and nice debate and comments that followed. Thanks!

  • Report this Comment On August 05, 2009, at 2:55 PM, TMFKopp wrote:

    @ZCBee

    Really separating the two is very difficult if not impossible. What I didn't want to get into here is debating specific governmental policies but rather lay out some facts/numbers on the economy that may be overlooked by a lot of media commentary.

    But you're absolutely right -- to take it to the next level you really do have to step into the realm of political ideology.

    Matt

  • Report this Comment On August 05, 2009, at 3:00 PM, TrojanFan wrote:

    @ DevinLM

    Well, without your political sovereignty all the sum of the value of the legal titles to all those valueable economic assets you supposedly own (financial assets, real estate, intellecual property or otherwise) aren't even worth the recycled value of the paper they are printed on! Just ask anyone who lived through the Nazi conquest of Europe less then a century ago and they can tell you all about that.

    We are blissfully naive to the realities of human nature here in the US because of our charmed history, our superior military might and the expansive oceans that have insulated us so well from enemy threats.

    In this sense, defense is govenment's most fundamental purpose. There are a myriad of opportunistic enemies to our state out there that given the chance would storm our shores and seize everything we have by force if they could.

    Despite idealistic aspirations to the contrary, human beings are still animals whose behavior is governed by animalistic Darwinian impulses. We lull ourselves into a sense of civility during good times, but when people around the world are starving for basic necessities like food and energy like they were starting to last year before the financial system and price levels collapsed then all bets are off.

    Defense spending should always be our #1 priority, both politically and economically. If you let your guard down long enough someone will seize your sovereignty from you and the value of your assets will go to zero over night because you won't own them any more. The new state will.

    I guarantee you that there are private think tanks in places like Russia and China that just run simulated war games all day long like Rand does here in the US looking for tipping points of tactical advantage when offensive military strikes against us become a net sum gain to them. You're naive to think otherwise.

    That's just the defensive end of the argument. There is also offensive advantage to empire expansion. Think of plundering resources for instance. There is surely economic benefit in that.

    This may not be a palatable notion to accept, but it is a pragmatic reality of the world in which we live.

  • Report this Comment On August 05, 2009, at 3:31 PM, OptionsFanatic22 wrote:

    @ TMF Kopp

    I like your article and thank you for posting it. I agree with several posters about some of the flaws in your argument, but I like the premise.

    My comment pertains to myth #2 when you mention the following:

    "And it would also appear that Americans haven't been stuffing their garages full of new cars. New autos made up as much as 5.4% of consumption spending in 1950 and have declined to just more than 1% today. Guess that makes the General Motors situation a little more understandable."

    While Americans aren't spending their money on new automobiles, you can't compare 1950 to present day. In 1950 cars were still somewhat of a "new" & "hot" commodity. Now with over 62 million registered vehicles in the U.S. and appox. 6.4 million unregistered functioning vechicles there isn't this "need" or strong desire from a new car. This data is from 2005 and came from the U.S. Department of Transpotation Statistical Records Office.

    Someone might be willing to buy a used car that is still relatively new. There are many reasons as to why buying new cars is down and you are correct that people are saving their discretionary income, but the comparison with 1950 isn't very logical as that was a time when cars were relatively new. Almost 60 years later, with that many cars in the U.S. of course the percentage of consumption spending will be down.

  • Report this Comment On August 05, 2009, at 7:31 PM, TMFKopp wrote:

    @OptionsFanatic22

    Thanks for the comment.

    Of the data that I'm looking at, 1950 is a high point so it's the most favorable comparison for what I'm trying to say. But I didn't have to use 1950.

    The most recent data shows new auto spending as 1.1% of GDP which compares to that 5.4% in 1950, 3.4% in 1930, 3.4% in 1970, and 2.3% in 1990.

    And to be clear, the argument is that consumers aren't spending like crazy on autos -- it doesn't really matter a whole lot to the argument why that is.

    I would add though, that just because autos are a mature product doesn't mean that there won't be pretty steady demand for new autos. Think about the fleet of autos currently out there as a waterfall and every year you have the oldest cars on that waterfall falling off and needing to be replaced with new cars. Granted demand GROWTH will be sluggish at best, but demand will continue to be there.

    Matt

  • Report this Comment On August 06, 2009, at 2:27 AM, bobfeeblethorp wrote:

    A better comparison would have been to compare first time purchases of televisions in 1930 to first time purchases of iPhones in 2009.

    And see where that leads you...

    It's not that I don't agree with your overall assessment of the current economic situation, it's that I object to using silly stats to prove your point.

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