I warned last week that a recession and higher unemployment were about to hit the U.S. economy. On Tuesday, the Bureau of Economic Analysis cut their estimate of growth in the third quarter ending September from 2.5% to 2%. Then on Wednesday, the Federal Reserve rocked financial markets by forcing America’s 31 largest U.S. banks to “stress test” balance sheets to determine their capability to withstand an 8% drop in the economy; which would cause home prices to plunge by 21%, and unemployment rate to jump to 13%.

I illuminated in my report that U.S. Bureau of Labor Statistics has been under-counting unemployment by at least 2%. For a nation reporting 154.4 million workers; this means the 13.9 million reportedly unemployed should actually be 17 million. Given only 12.8 million were unemployed at the 1933 peak of the Great Depression, when the undercounting and the Fed’s stress test are added the total is 23.2 million unemployed; almost double the Great Depression.

Formerly bullish top bank analyst Dick Bove in an Bloomberg interview commented on the Fed:

“By taking these draconian views of what could happen in the market, if they in fact force the banks to defense themselves against the outlook that they’ve put up, they’ll cause a recession,”

Consistent with my prediction that the booming production of capital goods would fall hard next year after the expiration of the 100% “bonus depreciation” tax credit; the bad news parade picked up steam this week with reports that U.S. durable goods orders fell 0.7 percent last month and initial jobless claims came in higher than Wall Street analyst’s predictions.

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When I introduced the concept of regime uncertainty in 1997, attempting to improve our understanding of the Great Depression’s extraordinary duration, I anticipated that many people—especially my fellow economists—would not welcome this contribution. Their primary objection, I ventured, would be that the concept remained too vague and, most of all, that it had not been reduced to a quantitative index of the sort that modern mainstream economists customarily work with, especially in their empirical macroeconomic analyses.

My argument did not lack evidence, however, and I regarded the agreement of several different forms of evidence as an important element of the argument’s force. The evidence I adduced with regard to changes in the yield spreads for high-grade corporate bonds of differing maturities seemed to me both systematic and especially compelling, though not decisive because alternative explanations of those changes might be offered. (I considered several such explanations and rejected them as unpersuasive in one way or another.) Recently, in my application of the concept of regime uncertainty to help us understand better the persistent economic troubles since 2007, I again advanced several different kinds of evidence, including as before an analysis of changes in the yield curves for high-grade corporate bonds. This time, too, the evidence is consistent with the underlying argument.

Nevertheless, the argument scarcely gained widespread assent, and most analysts either ignored it completely or, like Paul Krugman, dismissed it as a fairy tale—in his view, the sort of wholly fictitious notion that would be peddled only by think-tank whores in the pay of Republican plutocrats. (I trust that everyone who knows me will see how closely I fit this template.)

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Commentators and pundits, some of whom ought to know better, continue to harp on the idea that the recession persists because consumers are not spending. Every Keynesian seems to believe that because consumers are in a dreadful funk, only government stimulus spending can rescue the moribund economy, given (to them, at least) that investors will not spend more because the Fed, having already driven interest rates to extraordinarily low levels, cannot use conventional policies to drive them any lower and thereby elicit more investment spending.

People, please look at the data. They are conveniently available to one and all at the website maintained by the Commerce Department’s Bureau of Economic Analysis, the outfit that generates the national income and product accounts for the United States.

According to these data, real personal consumption expenditure recovered from its recession decline by the fourth quarter of 2010. Continuing to grow, it now stands (as of the most recent data, for the second quarter of 2011) even farther above its pre-recession peak.

Real government expenditure for consumption and investment (this concept does not include the government’s transfer spending, such as unemployment insurance benefits and social security benefits) is also running higher than its pre-recession level. In the second quarter of 2011, it was running more than 2 percent higher (recall that this is “real,” or inflation-adjusted spending; nominal spending has grown substantially more).

The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase, but because the true driver of economic growth—private investment—remains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its pre-recession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the “capital consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

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If any one thing estimated in the Commerce Department’s National Income and Product Accounts may be described as the engine of economic growth, private domestic business net investment is that thing. This variable has such tremendous importance because, if accurately gauged, it tells us better than any other measure how many resources are being devoted to building up the private business capital stock and improving it by innovation. An economy that has anemic private business net investment almost certainly will falter soon, if it is not doing so already.

Notice that every aspect of this awkwardly named variable is critical.

• First, it has to do with private investment, not so-called government investment. The latter, which looms fairly large in the official accounts, ought never to have been labeled as investment, because it comes about not as a result of wealth-seeking motives and rational economic calculation, but as a result of political motives, calculations, and actions that often clash with the creation of real wealth, rather than contributing to it.

• Second, we are looking here at business investment, excluding what the Bureau of Economic Analysis calls private “household and institutions” investment, which has somewhat murky underlying objectives, determinants, and consequences.

• Third, we are examining net, rather than gross, investment. The latter includes a large element of expenditure aimed merely at compensating for the wear and tear and obsolescence of the existing stock of private business capital. For example, even at the most recent peak for gross private domestic business investment, in the third quarter of 2007, it was running at $1,661 billion (annual rate), whereas net private domestic business investment was only $463 billion (annual rate), or about 28 percent of the total. (The investment data cited in this article are taken from Table 5.1, Saving and Investment by Sector, in the National Income and Product Accounts, accessed 02/16/11.)

It is obviously important that businesses compensate for ongoing depreciation of their existing stock of capital goods, which includes structures, tools and equipment, software, and inventories. But unless firms do more than make up for depreciation, they do not expand their productive capacity except to the extent that they can embed improved technology in their replacements for worn-out or obsolete capital goods. In general, economic growth requires net investment, and more rapid economic growth requires a greater rate of net investment.

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President Obama has asked Congress for an additional $50 billion in “stimulus” money to finance infrastructure projects. The theory is that the additional spending will cause businesses to boost production to meet this demand. Producers will add jobs, triggering increases in consumer spending that will ripple through the economy and fuel a stronger overall recovery.

Unfortunately, however, such government pump-priming hasn’t worked in the past, and there’s no reason to believe it will work now.

Sure, consumer spending accounts for approximately 70 percent of America’s gross domestic product, and increases in consumer spending would provide the economy with an immediate boost. But a drop in consumer spending is not what ails the economy. In fact, as a percentage of GDP, consumer spending actually increased during the downturn, the Commerce Department’s Bureau of Economic Analysis reports—from approximately 69.2 percent of GDP in the fourth quarter (October-December) of 2007 to approximately 71 percent of GDP in the April-June quarter of 2009.

So the conventional wisdom—that a sharp decline in consumer spending caused the economy’s downturn—is wrong.

What did cause the downturn? The answer is: a sharp decline in private investment.

In fact, the ups and downs of the business cycle are always driven by investment spending, not by consumption spending.

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Private saving and investment are the heart and soul of the dynamic market process. Together they provide and allocate the resources used to augment the economy’s productive capacity, generate sustained long-run economic growth, and thereby make possible a rising level of living. Economic crises interrupt this process by discouraging investors and causing them to consume their resources or to employ them in relatively safe, low-yielding ways. Absent entrepreneurs willing to take the great risks that characterize investments in great technological and organizational innovations, the growth process fades into economic stagnation or even decline.

The present recession starkly displays this characteristic crisis-related abatement of the economy’s investment process. Indeed, the decline of private investment during recent years has been much greater than most observers realize. Consider the following data, taken or derived from the most recently revised National Economic Accounts prepared by the Commerce Department’s Bureau of Economic Analysis (Tables 1.1.5, 1.1.6, and 5.2.6).

In 2006, gross private domestic investment reached its most recent peak, at $2.33 trillion (in constant 2005 dollars), or 17.4 percent of GDP. After remaining almost at this level in 2007, this measure of investment fell substantially during each of the next two years, reaching $1.59 trillion, or 11.3 percent of GDP, in 2009. This decline is severe enough, but it does not give us all the information we need to gauge the extent of the investment bust.

The greater part of gross investment consists of what the statisticians call the capital consumption allowance, an estimate of the amount of money that must be spent simply to offset wear and tear and obsolescence of the existing capital stock. In a country such as the United States, with an enormous fixed capital stock built up over the centuries, a great amount of funds must be allocated simply to maintain that stock. In recent years, the private capital consumption allowance has ranged from $1.29 trillion in 2005 to $1.46 trillion (in constant 2005 dollars) in 2009. Thus, even in the boom year 2006, about 60 percent of gross private domestic investment was required merely to maintain the economy’s productive capacity, leaving just 40 percent, or $889 billion in net private domestic investment, to augment that capacity.

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Each summer, Wall Street strategist Byron Wien convenes a meeting of high rollers to discuss the outlook for investment. This year’s meeting brought together fifty individuals, including more than ten billionaires.

Their expectations, as reported by CNBC, are gloomy:

“They saw the United States in a long-term slow growth environment with the near-term risk of recession quite real,” said Wien, in a commentary to Blackstone clients. “The Obama administration was viewed as hostile to business and that discouraged both hiring and investment. Companies and entrepreneurs were reluctant to add workers because they didn’t know what their healthcare costs or taxes were going to be.”

Add this report to the many similar ones to which my colleagues and I have called attention over the past two years.

Of course, for mainstream macroeconomists, such evidence means nothing. In fact, they hold it in complete contempt because (1) their formal mathematical models do not have a variable called “regime uncertainty,” and (2) even if they could be persuaded to take this factor into account, the canned data on which they rely—the product of the Commerce Department’s Bureau of Economic Analysis, for the most part—do not supply them with an “official” data set for their analysis. What you can’t measure, according to their “scientific” credo, does not exist. Their de facto motto (of which I have more than once been on the receiving end) is: you’ve got no formal model; you’ve got nothing.

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That’s because when the entire country is hurting and the private sector continues to lose jobs, bureaucrats are being hired.

The following chart makes that case. Since the beginning of the recession (roughly January 2008), some 7.9 million jobs were lost in the private sector while 590,000 jobs were gained in the public one.  And since the passage of the stimulus bill (February 2009), over 2.6 million private jobs were lost, but the government workforce grew by 400,000.

Plus, as you know, according to the latest numbers from Bureau of Economic Analysis, the average federal civilian worker now earns double what private-sector workers earn when factoring in wages and benefits ($119,982 vs. $59,909). And the gap is increasing.  According to Chris Edwards of the Cato Institute, in 2000, the average federal worker earned 66 percent more in total compensation than the average private-sector worker. By 2008, that ratio had risen to 100 percent. That’s serious money.

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Study this USA Today chart and cry:

According to USA Today:

“Overall, federal workers earned an average salary of $67,691 in 2008 for occupations that exist both in government and the private sector, according to Bureau of Labor Statistics data. The average pay for the same mix of jobs in the private sector was $60,046 in 2008, the most recent data available.”

And let’s just add insult to injury:

“These salary figures do not include the value of health, pension and other benefits, which averaged $40,785 per federal employee in 2008 vs. $9,882 per private worker, according to the Bureau of Economic Analysis.”

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