Taking an Honest Look at GDP Calculation

It doesn’t take long these days to find an economic bull that’s for sure. Whether you turn on the television, radio, or pick up a newspaper, they’re everywhere. The most popular phrase to date has obviously been Bernanke’s ‘Green Shoots’ comment made several months ago. Boy, have we gotten some mileage out of that one.

San Francisco Fed President Janet Yellen became the latest to don the well-worn 3D glasses early last week at the Oregon and Idaho Banker’s Association convention. The following are some of her comments:

We glimpse the first solid signs since the recession started more than a year and a half ago that economic growth may be poised to resume… indeed, I expect that to happen sometime this year.

Again, it all comes back to one’s definition of growth. Yellen, like most mainstream Keynesian policymakers believes in the idea that if GDP rises and that increase is subsequently discounted by some arbitrary deflator, then the balance is ‘growth’. There is a lot more to it than just that unfortunately.

GDP has a number of components and is calculated by the formula below:

GDP = C + I + G +(X-M)

C is classified as private consumption. It is the spending done by consumers on final goods and services. Virtually all consumer spending is counted excluding home purchases. However this component does include rents paid.

I is the investment portion of GDP. However, as one would typically assume, it does not include purchases of stock and/or bonds since such transactions are essentially just changes of title and do not involve capital goods and/or services. Components of I are business investment in capital goods, and purchases of new housing units by consumers.

G represents the government spending portion of GDP. It represents the government’s purchases of final goods, payment of government employees, and investment in capital goods. Transfer payments such as Social Security and Medicare are not included in the GDP calculation.

(X-M) is essentially our trade balance. If we run a trade surplus, then this component contributes to GDP. If we run a deficit, then it is deleterious to GDP. Imported goods are subtracted here because they have already been counted once in C, I, or G since the goods/services came into the country and were purchased in some manner be it as final goods or capital goods.

It is easy to see that there are many factors affecting GDP, and this is where Mrs. Yellen’s comments border on ludicrous. Even those folks who still use two tin cans connected by a piece of string for their communication know the government is borrowing and spending huge sums of money in an attempt to ‘stimulate’ the economy. Much of this spending goes right into GDP. What we have is a situation where the government is trying to pick up where consumers have left off. So if for example consumer spending drops by $200 billion but the government spends an extra $300 billion, we can now advertise (all else equal) that we have economic growth by way of a $100 Billion increase in GDP.

Consider this confirmation of the above from the Bureau of Economic Analysis’ report on GDP released on Friday morning:

The much smaller decrease in real GDP in the second quarter than in the first primarily reflected much smaller decreases in nonresidential fixed investment, in exports, and in private inventory investment, upturns in federal government spending and in state and local government spending, and a smaller decrease in residential fixed investment that were partly offset by a much smaller decrease in imports and a downturn in personal consumption expenditures.

As a side note, BEA has released their comprehensive revision, which generally happens every five years. While the details of the methodological changes are outside the scope of this article, they must be mentioned and considered in the analysis of GDP. Perhaps the most important factor is that BEA is now using 2005 dollars versus 2000 dollars in their calculations, which will tend to overstate GDP since the 2005 version of the greenback was considerably weaker than its predecessor. Consequently, purchasing the same amount of goods required more greenbacks thanks to the diluted value.

If one were interested in calculating a more honest version of GDP, any government borrowing (for starters) would be subtracted. Sure the money is spent on goods, but it is not money that is free and clear. It represents a future burden on growth, and should be treated as such. Just as an example, in FY 2008, the Federal Government ran a deficit of over $400 billion. Taking that off 2008 GDP lops another 2.8% off GDP. Imagine what deduction nearly $2 Trillion worth of borrowing would do to 2009 GDP if it were counted.

I am sure this position will bring argument that debt should not count against GDP, but if the GDP is being used to measure growth and debt constitutes a drag on future growth, then we need to be accounting for it. By the same token, we should also be counting consumer debt against the consumer’s contribution to GDP as well.

When one looks at Ben Bernanke or Janet Yellen’s remarks through the lens constructed above, their comments take on a totally different meaning. Essentially what they are saying is that growth can always be achieved at will by printing money, lending it to the government and having the government spend it. Are we really that far off here?

And true to form, Mr. Bernanke issued some well-couched comments recently regarding the economy. It is remarkable to watch him climb the learning curve of how to speak without really saying anything. A man that was easily pinned down early in his tenure because he was specific has now plunged headlong into ambiguity:

The economy is showing tentative signs of stabilization.

And the classic ‘green shoots’ comment:

I do. I do see green shoots. And not everywhere, but certainly in some of the markets that we've been functioning in. And we've seen some improvement in the banks, as well, certainly in some key cases.

The first part of this quote says it all. Bernanke is basically admitting that those markets which include the mortgage-backed and GSE securities market would still be in shambles if the Fed weren’t in there with its helicopters providing liquidity. How can such an unsustainable path be considered as positive?

Somehow the idea that government, by stepping in and putting trillions of dollars on the taxpayers’ tab – without any invitation to do so – then spending the money and calling it growth defies common sense. The idea of the Fed ostensibly rigging key markets to create even more phony low interest rates for the purposes of continuing a binge that never should have happened in the first place is equally absurd.

It is becoming rather clear that if you want to do well in the land of green shoots that you’d better have a pair of 3D glasses. Hopefully those glasses come with a helmet because we’re going to need it.

Comments

[Dave Wrixon:]

The one thing I got out of this is the fact that mortgages are not counted but rents are. Doesn't this mean a collapse in the housing market actually boost GDP? People that are not buying and not living in cardboard boxes must be renting something even if it is only a trailer home. So GDP gets a massive spur. Of course as the economy recovers one would expect this to provide a massive drag on the GDP figures as well. Of course you might expect a revision in the methodology by then to make things look rosier!

Aug 02 05:40 AM

[capt Brian:]

Good article. It just points out just how figures don't lie, but liars can figure. I think, all one has to do is look around you and see what is going on. If it were not for the government rescuing all the bad guys and poor businesspeople, we would be in a depression caused by our own financial crime lords.

Does this mean I can spend my way out of financial trouble, borrow more and more to pay for the debt I have incurred and never worry about paying it back.

Truth of it is, that could happen to an individual for a while then go bankrupt, well it is no different for a government. They will go bankrupt too no matter how much they borrow, tax or print. The horrible day for Americans is moving closer and closer. Our enemies must be laughing at us and waiting for us to finally self distruct.

Gird your loins, put some real money away, this thing is not in recovery, nor are we seeing green shoots, rather weeds.

Capt. Brian
grins to ya

Aug 02 09:15 AM

[Hazel Hende...:]

Good article and good comments so far. Looking deeper , GDP is a cash flow statement , but doesn't count the almost 50% of additional goods and vital services unpaid and exchanged freely and therfore not included in GDP e.g. community volunteering, electronic barter ( exploding , e.g Craiglist,Freecycle all covered in Barter News barternews.com) , home care for the elderly and sick, etc) . Nor does GDP account for ecological services and assets provided by nature , e.g. forests ,watersheds and recycling of human wastes ). Nor does GDP have an asset account to balance public debt with the assets such investments create: e.g schools, roads , etc. More at beyond-GDP.eu Calvert-Henderson.com and EthicalMarkets.tv click on "Redefining Success and The Unpaid,"Love" Economy"

Aug 02 09:51 AM

[Ferdinand E...:]

I occasionally saw Ms Yellen's name in the so-called learned literature when I was giving dazzling lectures in macroeconomics, and I'm familiar with Mr Bernanke and his works. As a result there are two things that I know. Professor Bernanke would never make the kind of mistake that this author said that Dr Yellen made, and I sincerely hope that Dr Yellen did not make it, since she can spend most of her day reading macro books.

I abandoned macro to become the leading academic energy economist in the world, but I would have abandoned it earlier if any of my students came up with the kind of gibberish in this article.

Aug 02 10:21 AM

[John Lounsbury:]

Andy Sutton - - -

You have tackled a subject that deserves much more attention than it gets. I have been reading Steve Hansen's comments in criticism of GDP methodology, which he has made a number of times in his state of the economy review articles and elsewhere. You, however, have tried to focus on the question in more detail.

I want to try to add to the discussion. Please do not take anything I say as criticism of what you have done, but I do think this subject is more complex than either you or I will sort out in our first pass efforts. Some of the things I thought about as I read you article:

1. Consumption funded by debt (such as government deficit spending) should not be valued in GDP the same way as that funded by "earned" income. I do not think the debt should be subtracted directly, though. It should be subtracted as a discounted value of future cash flows to service the debt. I think this would be much less than the simpler direct subtraction.

2. On the otherhand, income is counted as contributing to GDP (and debt is not), so, to some extent, the criticism is mitigated. I don't want to dismiss your argument, though.

3. You said: "Virtually all consumer spending is counted excluding home purchases." It is my understanding that new home purchases are included and existing home purchases (resales) are not. This includes the economic activity from new home construction and avoids double counting resales. Please correct me if you disagree.

4. Should all debt (not just government debt) be discounted against GDP based on the present value of future debt service cash flows? Should we distinguish between debt assumed to fund consumption vs the debt assumed to fund the means of production? I think that there is far too little attention paid to the "return on debt". Borrowing money to build a factory has a much greater economic value than money borrowed to take a vacation. I have written about this in comments, blogs and articles, but I'm not satisfied that I have really gotten my brain wrapped around enough of the central issues here, at least when it comes to quantitative analysis is involved.

I appreciate the effort you have made to dig into this subject. I hope you view this as a beginning. If you continue to think about this area, I will certainly read anything else you write on the topic in the future with great interest.

Aug 02 10:30 AM

[smcat:]

It's good that you point out the details in case anyone were to miscontrue Yellen's comments versus the real state of economic affairs. But I think you do a big disservice by criticizing it. There is very little new material, policy action in this bailout that differs it from any previous, not just in the U.S. but globally. Do you know how many recessions have occurred all over the world in the last 10 years? So many that its difficult to count. The table is at the IMF web site. And most all have been cured in much the same way. Most have been solved by spending, some more, some less.

And the system is very simple because the dynamics of spending/investing are very simple at heart.

Put 3 guys in a room in their own micro economy with their only info, a newspaper on their own micro economy and no gov spending. While the newspaper talks about how bad things are going (refering to your preferred version of GDP) do you think these guys are going to spend? Are they going to hire? or fire? Are they going to make plans? Maybe they won't even look for opportunities, since it's all so bad. And so on.

All business can't afford to invest today with no end in sight to recovery. Apart from the fact that their board will fire them. But what if we got these guys to spend $1 buck today because things are not that bad, not that good either. Their newspaper tomorrow would show an increase. And maybe they start making plans and so on. At the bottom of the cycle the only consumer is always the government, because no rational consumer will buy when prices look to fall in the next period of time (perpetuating deflation?). There is no incentive. But under price stability what would they do? It's another world entirely.

At the heart of the speding system is that the individual looks out for himself, selfishly.

Your "true" GDP ex government is accurate and informative. But the government has an important role to play. And with all of its flaws spends, not like a business but like a "socially responsible institution." Becuase if it were a business, it wouldn't spend either, because your "true" GDP says the economy is falling off a cliff and they may lose money.

Of course, thanks to the gov we will get out of this mess, like all previous, much much much sooner than if they didnt contibute to GDP. And thanks to the Fed, Janet Yellen included, the economy has stabilized at levels much much higher than was necessary (unemployment 25% anyone? like the 1930s).

And the size of government spending is directly related to the huge dis-incentive consumers/corp.s have to not spend, i.e. this is a huge crisis. Nothing surprising here.

To conclude, GDP is GDP. If you don't like it, do your own calculations and call it something else. Why don't you exclude imports and exports as well? You know that the next GDP prints will also show major contributions from abroad. And if capex imporves but the consumer doesn't in the future, why don't you write an article about how capex is inflating GDP. And then you could cut that out as well. Oh but then you would be left with only the "C". But I guess that already has a name.

Write informative articles. But criticizing what has to be done anyway and what is going to work and the people that have to get that job done and report back to you in public is just cheap propanda at best and at worst naive and uninformed.

Best,
Steven
[e-mail]

Aug 02 10:57 AM

[W.E. Heasley:]

Excellent article. Very good points.

Yellen was in Idaho the other day and basically discount the notion of Monetizing Debt and the link to future inflation. Right.

Yellen is stuck in a 1975 Keynesian Classroom with no intention of leaving her blackboard Keynesian formula world.

One great point you made in the article is:



If one were interested in calculating a more honest version of GDP, any government borrowing (for starters) would be subtracted. Sure the money is spent on goods, but it is not money that is free and clear. It represents a future burden on growth, and should be treated as such. Just as an example, in FY 2008, the Federal Government ran a deficit of over $400 billion. Taking that off 2008 GDP lops another 2.8% off GDP. Imagine what deduction nearly $2 Trillion worth of borrowing would do to 2009 GDP if it were counted.

I am sure this position will bring argument that debt should not count against GDP, but if the GDP is being used to measure growth and debt constitutes a drag on future growth, then we need to be accounting for it. By the same token, we should also be counting consumer debt against the consumer’s contribution to GDP as well.



To back up your assertion “….debt constitutes a drag on future growth…”, if that statement is untrue then why do so many Pundits point to the Consumer Lead Recovery is out of the question due to high levels of debt. In other words, past debt is creating a clear drag on consumption from the Consumer.

Aug 02 11:01 AM

[Alphameister:]

I especially appreciate the comment by Hazel Henderson, which led to my discovery of her referenced website. I think her comment about the exclusion of the barter economy from GDP calculations has become especially pertinent these days when more and more economic activity is being done on a non-cash basis (a trend that seems likely to continue as Obama seeks more tax revenue). I also respect the efforts of her organization to come up with a comprehensive measure of national well-being. I have long held that we live economic lives in which we constantly choose among values available to us, not all of which are material or show up in GDP. I often make choices that add nothing to GDP (or even subtract from GDP) because such choices have greater value to me personally and add to my sense of well-being.

Aug 02 12:01 PM

[reveigel@ms...:]

Some like and think government is the answer to all. Some disagree. I am a disagree person. The government is the cause of most of our problems. It is a parasite and sucks the life out of individuals and businesses through taxes and laws and rules and regulations. And nothing I see or read today indicates government is backing off. Cap & Trade, Health Kill Bill, Higher Taxes, Higher Gas Mileage Laws, Few realistic programs to make us less energy dependent, Ignoring the huge dollar needs for Social Security, Medicare and Prescription Drugs, An ever growing National Debt and the Interest Cost of that debt and my guess is this is just a few of the ways government is going to intrude in our lives. If anyone believes we are on the road to recovery then, in my opinion, they live in a world of make-believe. Add to that the ever growing unemployment and that just adds to our problems. Unemployment benefits are about to end for many, States are in deep financial trouble, the World economy is in trouble, yet some say all is well, it is getting greener. And should we somehow recover, does anyone think Congress, our government and the Fed are going to become balanced budget freaks? And less intrusive and power hungry and less concerned about making promises that, hopefully, will get them re-elected? If so, dream on.

Aug 02 12:05 PM

[ACCOUNTANT:]

I have talked to three of my blue collar factory worker type friends in the past two weeks - each works at a different company in a different industry - none are in industries that benefit from government spending - and all three are currently working massive amounts of overtime. Something must be going on.

Keep in mind all of the cash hitting the economy. Last year, oil was $140 per barrell (an import that gets subtracted from GDP). This year oil has been under $70 (thus a much smaller deduct) and that money is now available to spend on other items. Same thing with home mortgages. As people have refinanced their 6.5 - 7.5% loans down to 5.25% loans, it has freed up significant amounts of money for the consumer to spend on other things. Also, the people that have walked away from huge mortgages and then turned around and purchased housing at a much lower cost - more money available for the economy.

The governments huge deficit doesn't necessarily translate into additional government spending. The current massive deficit is comprised of four components - 1) the "traditional deficit" that we have been running ever since the Bush tax cuts, 2) the decline in revenues to the government due to the recession , 3) the TARP monies - which did NOT go into consumption and would not affect GDP, and 4) the stimulus monies - most of which have not yet seen the light of day. As such, skewing the GDP based in increased deficit spending is probably extremely misleading to the reality of the situation.

Aug 02 01:24 PM

[Austrian Sc...:]

I want to address smcat's ealier comments since he seems to be the one poster defending the current state of affairs:

First, people can't stop spending money even if they think prices in the future will be less because they are get hungrey, their cars fall apart, their wife keeps getting pregnant, etc. The type of spending you're talking about that they can choose to put off in the future is largly just discretionary consumption spending. Like buying a big screen TV, or a Hummer. We don't need to more of this kind of wasteful spending. At the place we are in our economy, we need more saving, and production for sale to our foreign creditors.

Claiming that these kinds of credit easing regimes have helped solve a large number of problems and will solve this one is the same kind of reasoning that getting a another hit of dope, will solve the sick feeling a dope addict gets when he isn't able to get the drug he has become dependant on. All it does is POSTPONE the eventual comedown, or kill eventually person. Or put another way, its like saying the best way to avoid a hangover is to never stop drinking. You can do this for a while, I know people that have tried, but eventually the body just can't take it any more.

Aug 02 01:28 PM

[Dialectical...:]

Dave,
I think you missed that housing purchases were included in "I" (Investment). So the housing collpase would subtract from GDP even while the increased renting added to it.

On Aug 02 05:40 AM Dave Wrixon wrote:

> The one thing I got out of this is the fact that mortgages are not
> counted but rents are. Doesn't this mean a collapse in the housing
> market actually boost GDP? People that are not buying and not living
> in cardboard boxes must be renting something even if it is only a
> trailer home. So GDP gets a massive spur. Of course as the economy
> recovers one would expect this to provide a massive drag on the GDP
> figures as well. Of course you might expect a revision in the methodology
> by then to make things look rosier!

Aug 02 01:41 PM

[Dialectical...:]

I agree that you have to look past certain interpretations of the GDP numbers, but I think the GDP is only one number anyway and can't be made to give a perfect snapshot. GROSS domestic product is by definition not NET productivity, so making a lot of subtractions for debt servicing and such doesn't make a lot of sense to me. That doesn't mean the points made here and elsewhere about what the GDP is really telling us are less valid, only that I think we shouldn't try to toy with the number too much to get it reflect something it was never intended to. In some sense it is really just "gross domestic spending" and so, yeah, if much of that is government spending then that is cause for concern, mostly because it is unsustainable and funded by borrowing.

On Aug 02 10:30 AM John Lounsbury wrote:

>
> 1. Consumption funded by debt (such as government deficit spending)
> should not be valued in GDP the same way as that funded by "earned"
> income. I do not think the debt should be subtracted directly, though.
> It should be subtracted as a discounted value of future cash flows
> to service the debt. I think this would be much less than the simpler
> direct subtraction.
>

Aug 02 02:00 PM

[Fred Linn:]

---------" The idea of the Fed ostensibly rigging key markets to create even more phony low interest rates for the purposes of continuing a binge that never should have happened in the first place is equally absurd."-----------

LOL, my Dad had a word for it. He called it lying.

Aug 02 02:00 PM

[Ryan Erwin:]

Austrian Sc's concern about paying off foreign creditors is exactly right.

Most people here may not be aware that average VAT+Tariff prices in Japan are 5%, in Hong Kong, 0%, in Taiwan about 6%. The USA has no VAT and tariff rates are very low.

However, in spite of China's WTO membership, VAT+Tariff on imported goods averages almost 30% - this in a country where cash (under the table) is the standard way of operating.

If China were to sell of it's dollar supply, China (as the biggest foreign holder of treasuries) would be the biggest looser. Better path would be to go toe-to-toe over VAT+Tariff reductions. If protectionist Japan only adds 5% to foreign goods, how do we accept a WTO member adding 30%?

Aug 02 02:08 PM

[jdl51:]

"Just as an example, in FY 2008, the Federal Government ran a deficit of over $400 billion."

If only it were 400 billion. Bush added an average of $750 billion a year to our national debt with nary a word from his supporters whom seem to be a majority of the posters here. Since Reagan, the past three republican administrations have added over $11 trillion to our national debt with nothing to show for it, yet they claim to be fiscally responsible. We're still operating on a Bush budget until October with over a trillion in deficits when you include TARP and his proposed FY 2010 budget had a $1.2 trillion deficit with the customary exclusion of Iraq/Afghanistan. Now that the country is in serious trouble and the economy needs a kick in the rear from the only entity that can give it that kick, republicans are suddenly against deficits. Too bad they didn't see the light before they gave away trillions to their friends and supporters and wasted it in the deserts of Iraq. The country would be in unbelievably great financial shape if they did.

Aug 02 02:13 PM

[Jeff Nielson:]

In FACT, Hazel, the U.S. government PADS (so-called) GDP by over $2 TRILLION per year - far in excess of what you suggest is "missing" from this calculation. I recommend the superb work of Chris Martenson for more enlightenment there. (www.chrismartenson.com...)

Furthermore, despite an excellent analysis, the author leaves out the additional lying that takes place with U.S. GDP by grossly understating inflation, and then simply adding that un-reported inflation to its GDP "calculation". (www.bullionbullscanada...).

As an example, in the U.S.'s Q2 GDP, real inflation was roughly THIRTY TIMES higher than the "deflator" used to adjust GDP.


On Aug 02 09:51 AM Hazel Henderson wrote:

> Good article and good comments so far. Looking deeper , GDP is
> a cash flow statement , but doesn't count the almost 50% of additional
> goods and vital services unpaid and exchanged freely and therfore
> not included in GDP e.g. community volunteering, electronic barter
> ( exploding , e.g Craiglist,Freecycle all covered in Barter News
> barternews.com) , home care for the elderly and sick, etc)
> . Nor does GDP account for ecological services and assets provided
> by nature , e.g. forests ,watersheds and recycling of human wastes
> ). Nor does GDP have an asset account to balance public debt with
> the assets such investments create: e.g schools, roads , etc. More
> at beyond-GDP.eu Calvert-Henderson.com and EthicalMarkets.tv
> click on "Redefining Success and The Unpaid,"Love" Economy"

Aug 02 02:54 PM

[BullnBear:]

Thank you for taking the time to write and issue this follow up data. It would be nice if data such as this could find a path to the main stream media outlets as well.

The usual less bad information that has become the new normal has the potential to be very damaging when taken at face value or highlighted as good and bullish by the likes of whatever media outlet or “behind the scenes motivator” may be taking place.

I often wonder if we are in a period of time where the markets are driven by well timed news releases and media events as opposed to real data and interpretation.

In my opinion the main driver of the latest bullish sentiment seems to be interpreted data from a few “juiced in” networks that I can’t help but believe are being compensated somehow to provide a bullish opinion.

How else can you explain how so many reporters who by the nature of the business that they are in are supposed to research and dig up all sides of a story? The bulk of what I see these days is nothing but a “canned pitch” that is being thrust on the public at large.

Aug 02 03:43 PM

[Leftfield:]

A former middle class worker could once support a family while one parent stayed home. Now, additional restaurant meals, daycare and barber are added to GDP despite their newfound necessity to the now more-impoverished family.
The evils associated with this system that, not incidentally, raises more taxes on top of the doubling, tripling (after inflation) that have taken place are self-evident in the destruction of the family.
Our government has it's groping hands everywhere now and won't let the system just die that gave us middle-class impoverishment during "prosperity." Expect more funny numbers and taxes on anything and everything including barter.

Aug 02 03:45 PM

[Mad Hedge F...:]

If only the government could be so honest. My favorite coincident economic indicator, the “Boot Index,” is showing that we may be entering a very modest economic recovery. That is the price at which you can buy Asolo’s top line mountaineering boot at the REI member sales. I bought this hiker’s dream for $5 last March (click here to see report) , and yesterday the price had climbed back up to $27. Of course, this is not the full retail price it should be selling for of $280, with tax. Similarly, we should be equally cautious about Friday’s report of Q2 GPD growth of minus 1%, and the downward revision of Q1 from minus 5.5% to minus 6.4%. To say this is an improvement is like taking money out of one pocket and putting it in the other, then booking a profit on the transaction. The hard truth is that consumer spending, business investment, housing, and inventories are still in terrible shape. Consumers are broke and getting broker, a big problem when they account for 71% of GDP. Only massive federal government spending is supporting the economy, and what happens when that runs out? The next $2 trillion in stimulus is going to be a lot more expensive than the first. Sorry, but I remain a skeptic. I’d rather go hiking in the Sierras than put money in the market here.

Aug 02 03:48 PM

[rennert:]

This entire story last fall about how bad things were with the banks seems like a big scam to me. It reminds me much of the Y2K story were Clinton pumped billions into computer companies to avoid a so called disaster. Italy did not do anything like that and they did not have a computer problem. And how fast the technology stocks went down after it was clear that no more money was going to be pumped in after 2000. Every time we have a change in government a new scam appears. Did'nt the S,L crisis happen at one of those times as well???

Aug 02 04:00 PM

[Bross:]

"Gone With the Wind", that's what nobody says. False hope, just as in the spring of 1930. Study some history. Think about the big picture. It doesn't matter what anyone says about GDP. The massive sector that powered the boom, i.e., the first, second and third mortgages, will not return. The investment bankers that fueled the fraud and foisted the fake AAA mortgage debentures known as CMO's, CDO's, etc., on the unsuspecting public, corporations, pension funds, etc., are out of business. The over the counter criminal put option market, the CDS market, that provided false security for the buyers of the debentures is gone forever.

This massive reduction in consumption that is "Gone With the Wind" is not totally understood, yet. The government has hoodwinked the public into thinking it has replaced this demand/consumption with the $787B false stimulus, cars for clunkers, keeping interest rates low, etc. What the government has done is just a drop in the bucket compared to what was lost.

There will be no "V" recovery. There will be no "U" recovery. Sorry, guys, but we are looking at a "hockey stick" that could extend for twenty years, or more. Look at what happened after the summer of 1930. Right now, no one seems to be able to see the forest because of the tree in front of their face.

Go measure GDP any way you feel like it. Argue about one factor's weight versus another factor's influence. Right now, the flappers are still dancing because they have no knowledge of the "They Shoot Horses, Don't They?" dance marathons coming in the future. We are on the road to an incredible decrease in the value of the dollar, or an incredible increase in inflation and/or interest rates. Most likely, it will be some combination of these factors.

Aug 02 07:14 PM

[User 422955:]

People forget that GDP is merely a number made up of other numbers which are, at best, approximations. At worst, other numbers are "dummies," that is they are taken to represent something other than themselves, which would be measured if it only could be measured (but which can't be measured.) If the "actual GDP" is a unicorn at a particular time, then measured GDP is the unicorn, as measured by nearsighted tailors, long after it has become something else.

GDP numbers must exclude the "underground economy." In Italy, this is estimated to be 20% of GDP. In other Western countries, the estimated underground economy is less.

People who complain that the US government is too powerful forget that, in many ways, it is extremely weak. (1) Elected officials depend on large contributions; this makes large contributors (mostly large businesses, but occassionaly groups of smaller businesses or unions) extremely influential. The closest to hand example is health care "reform." (2) Organizations may be extremely influential on some issues (think NRA, right to life, conservation groups) but not on others. (3) instead of three equal branches, executive arms of governments are often more powerful than the legislatures and courts combined.

Aug 02 09:14 PM

[MSimon:]

We are destroying $1 worth of working automobiles. The $1bn will get added to GDP. If we destroyed every house in the country and started rebuilding we would be rich beyond dreams.

This is way more productive than digging and filling holes.

Aug 02 09:25 PM

[MSimon:]

We are destroying $1 bn worth....

Aug 02 09:26 PM

[MSimon:]

"Bush added an average of $750 billion a year to our national debt with nary a word from his supporters whom seem to be a majority of the posters here."

Bush's supporters deserted him in the 2006 election. Or hadn't you noticed?

Of course we traded in a guy who was burning $1 bills for a guy who preferred 5s and 10s.

Aug 02 09:36 PM

[MSimon:]

"Claiming that these kinds of credit easing regimes have helped solve a large number of problems and will solve this one is the same kind of reasoning that getting a another hit of dope, will solve the sick feeling a dope addict gets when he isn't able to get the drug he has become dependant on."

Heroin is less harmful than monetary crack.

Aug 02 09:40 PM

[Steven Hansen:]

Andy, i went past your article yesterday without leaving a comment but John Lounsbury invited me back for another look. as you may know, i am a critic of those who use GDP as THE economic indicator.

although i have a few quibbles about some of the details - your article points out many ways GDP is not measuring the full economy.

before we go throwing out the baby with the bath water, a simple logic test would demonstrate GDP was never intended to me an encompassing measure of the economy. it is a specific economic indicator to be used among many.

it is the punters on wall street and the ignorant media that have convinced us that GDP is the economy.

i read a article yesterday on SA by the califa beach pundit where he graphed velocity of money using M2 divided by real GDP. although i was not sure what that proved (other than an inflation indicator), it did get me thinking.

both M1 and M2 can be argued is money in motion (M1 being the lower limit and M2 the higher limit with the truth somewhere in between). but i cannot think of a good economic indicator to use to understand how many times in a period the money turns over.

as we agree GDP is not a complete measure of activity, i hope that some one has an idea to determine how much money actually moves in a given period.

Aug 02 11:36 PM

[derryl:]

I think Andy is onto something with his idea that adding government debt spending to current GDP is a delusion when the repayment of that debt via future increased taxes and/or reduced government spending must subtract from future GDP. It just depends on what timeframe you use to calculate the 'gains' and losses.

If my business is steadily earning $1 million in annual revenues, then one year I lend my customers $1 million to increase their purchases from me in the next year, did my gross revenue (GDP) really increase by $1 million? Or will my customers have to cut their purchases from me in the next 4 years to $750k annually + a $250K per year repayment of my loan to them?

All I have done is sold forward my future years' business. I have not really 'added' any revenue/GDP into the equation. I nominally added $1 million in year 1 at the expense of a nominal decrease of $250k per year in each of the next 4 years. After 5 years I still averaged $1 million per year in revenues.

Spending borrowed money which has to be paid back does not contribute to any permanent increase in spending, and thus does not contribute to any permanent increase in revenues to whoever receives the borrowed money. This year's gains will be next year's reductions as my customers cut their purchases in order to repay their debts.

I know Ben, Tim and company are desperately tying to reflate US asset prices because US mortgages and other consumer debt are the underlying "value" of 100s of trillions of dollars worth of derivatives that are still floating around out there. But while there still may be a lot of rats following the CNBC and other mass media pied pipers down the road to perdition, there are also a lot of human beings with functioning brains who see this masquerade for what it is.

You can massage GDP and real estate data all you want. Mass media watching rats may be fooled by your clever manipulations. Human being with brains will do 2 seconds of mental arithmetic and see through the ruse.

Aug 03 12:34 AM

[BillyChapel:]

From the 30 or so comments on this article, it seems as though there are two categories of folks: those who believe government is the problem and those who believe it is the solution. And there are those who think GDP is a good measure, and those who think it isn't (for a number of well-stated reasons). I think the point here is the fact that the MSM uses GDP almost solely as a measure of economic growth and as such, its limitations much be pointed out with this in mind.

Aug 03 09:02 AM

[BillyChapel:]

Reading Keynesian macro books is what got both of these guys in trouble. It is my guess that you read them too, and as such it is good you stopped giving those dazzling lectures on how to print money from nothing and run deficits into perpetuity, then attacking those who point out the lunacy of your thinking.


On Aug 02 10:21 AM Ferdinand E. Banks wrote:

> I occasionally saw Ms Yellen's name in the so-called learned literature
> when I was giving dazzling lectures in macroeconomics, and I'm familiar
> with Mr Bernanke and his works. As a result there are two things
> that I know. Professor Bernanke would never make the kind of mistake
> that this author said that Dr Yellen made, and I sincerely hope that
> Dr Yellen did not make it, since she can spend most of her day reading
> macro books.
>
> I abandoned macro to become the leading academic energy economist
> in the world, but I would have abandoned it earlier if any of my
> students came up with the kind of gibberish in this article.

Aug 03 09:07 AM

[Alan von Al...:]

Honest GDP ? - okay, net individual and corporate output of goods and services sold to domestic private or international purchasers, minus Federal, state, and local taxes = net GDP.

Easy to measure. It's the net income we report to the IRS (excluding govt salaries, contracts, and handouts).

Aug 03 05:02 PM

[Alan von Al...:]

Associated Press report: Individual income tax receipts are down 22 percent from a year ago. Corporate income taxes are down 57 percent.

That's what I meant about net GDP, although you'd have to strip out government contracts and salaries to get the real number. Private output has been savaged.

Aug 03 06:29 PM

[Alan von Al...:]

TrimTabs Investment Research estimates that the U.S. economy lost 488,000 jobs in July, considerably more than the consensus estimate of a loss of 305,000 jobs. In addition, TrimTabs expects the Bureau of Labor Statistics to revise its job loss estimates sharply higher for the first half of 2009 based on the latest unemployment insurance survey results.

“While Wall Street is convinced the recession is over, the economy continues to shed jobs at an alarming rate,” said Charles Biderman, CEO of TrimTabs.

h/t Zero Hedge

Aug 05 05:46 PM

[Andy Sutton1:]

Hi John,
You're absolutely right about first passes. It is impossible (and rather impractical) to try to cover all the bases, but rather to lay the groundwork.

You make some good points, particularly on the discounting of the debt used for consumption. I'd be curious to hear what folks think is a 'fair' way of figuring in the impact of money borrowed for consumption since we're in uncharted territory - at least where GDP is concerned. The main reason I chose to suggest removing it completely is simply because it appears obvious to me that the whole intention here is to step in with govt. spending, then call it growth. I know some other commenters consider my condemnation of that to be gibberish, but I don't - especially when our kids are going to be the ones suffering because of this bad behavior.

As far as the counting of housing units goes, I got that information from the "NIPA Primer" which is available in PDF format from BEA. Housing is a somewhat moot point since if you're dealing with owner-occupied housing, rent is imputed the same as if you took your house and rented it to a third party so as not to skew GDP by failing to count certain housing because of the way it is deployed. I could have been a bit more clear in defining the Consumption portion and specifying 'new' home sales as not being included there, but as 'Investment' . My apologies if anyone was misled.

The point on return on debt is also a good one. There is certainly an appreciable difference between borrowed money used to build a factory (which will pay for itself in time) and something such as the cash for clunkers program or a vacation.

I hope that addressed your comments, and I agree that this discussion shouldn't end here. There needs to be further and deeper analysis of this issue since it will obviously be with us for quite some time.

Best,
Andy


On Aug 02 10:30 AM John Lounsbury wrote:

> Andy Sutton - - -
>
> You have tackled a subject that deserves much more attention than
> it gets. I have been reading Steve Hansen's comments in criticism
> of GDP methodology, which he has made a number of times in his state
> of the economy review articles and elsewhere. You, however, have
> tried to focus on the question in more detail.
>
> I want to try to add to the discussion. Please do not take anything
> I say as criticism of what you have done, but I do think this subject
> is more complex than either you or I will sort out in our first pass
> efforts. Some of the things I thought about as I read you article:
>
>
> 1. Consumption funded by debt (such as government deficit spending)
> should not be valued in GDP the same way as that funded by "earned"
> income. I do not think the debt should be subtracted directly, though.
> It should be subtracted as a discounted value of future cash flows
> to service the debt. I think this would be much less than the simpler
> direct subtraction.
>
> 2. On the otherhand, income is counted as contributing to GDP (and
> debt is not), so, to some extent, the criticism is mitigated. I
> don't want to dismiss your argument, though.
>
> 3. You said: "Virtually all consumer spending is counted excluding
> home purchases." It is my understanding that new home purchases
> are included and existing home purchases (resales) are not. This
> includes the economic activity from new home construction and avoids
> double counting resales. Please correct me if you disagree.
>
> 4. Should all debt (not just government debt) be discounted against
> GDP based on the present value of future debt service cash flows?
> Should we distinguish between debt assumed to fund consumption vs
> the debt assumed to fund the means of production? I think that there
> is far too little attention paid to the "return on debt". Borrowing
> money to build a factory has a much greater economic value than money
> borrowed to take a vacation. I have written about this in comments,
> blogs and articles, but I'm not satisfied that I have really gotten
> my brain wrapped around enough of the central issues here, at least
> when it comes to quantitative analysis is involved.
>
> I appreciate the effort you have made to dig into this subject.
> I hope you view this as a beginning. If you continue to think about
> this area, I will certainly read anything else you write on the topic
> in the future with great interest.

Aug 05 10:15 PM

[User 478049:]

If Ben took the "G" (i.e. G=government spending) out of the calculation GDP = C + I + G + (X − M) what would his green sprouts look like? GDP growth as an economic indicator is reduced to a hoax when it inputes the act of Treasury printing money and loaning it to the government to spend (especially when it does so in multi trillion traunches).

Aug 27 01:44 PM