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Atle Willems, CFA
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Atle Willems is an independent economic analyst and equity investor with a long-term view investing in undervalued listed shares with solid operational track records and sensible balance sheets. He holds a master's degree in finance with distinction from Nottingham University Business School, a... More
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  • Removing This Driver Of GDP Per Capita Sends The U.S. Economy Right Back To 1998... 0 comments
    Jun 5, 2014 3:35 AM

    (Orignally published on 30 May 2014)

    ...but with substantially more government debt.

    The revised U.S. GDP figures for Q1 2014 was reported yesterday showing that Real GDP decreased at a seasonally adjusted annual pace of 1.0%.

    Nominal GDP for the quarter on the other hand increased at a seasonally adjusted annual pace of 0.27% compared to previous quarter. Compared to Q1 20013 Nominal GDP increased 3.42%.

    (click to enlarge)

    Of this nominal growth, Personal Consumption Expenditures made up 73.0%, the highest since Q4 2011. Gross Private Domestic Investment made up 24.7% of the growth, the lowest since Q1 last year while Government Consumption Expenditures & Gross Investment and Net Exports made up the rest (-1.4% and +3.8%, respectively).

    The annualised seasonally adjusted Nominal GDP for Q1 came in at US$ 17,101.3 billion. This was the highest GDP figure ever reported and 15.2% higher than the pre-recession high from Q3 2008.

    (click to enlarge)

    The Real GDP figure meanwhile came in at US$ 15,902.9 billion, the second highest ever (beaten only by previous quarter) and 6.05% higher than the pre-recession high back in Q4 2007.

    Now, Real GDP is calculated through adjusting Nominal GDP for price inflation. While the latter is a money-value measure, the former is supposedly a measure of the quantity of total output.

    But what happens if the nominal figures are adjusted by the increase in the money supply, that is, the monetary inflation, instead of price inflation? Below I will use the M2 as a measure of monetary inflation, i.e. money supply growth. Why in the world adjust the figures this way you might ask. The reasoning is straight forward: all else remaining the same, the more money in circulation (i.e. the higher the quantity of money) the higher Nominal GDP will be - as the money supply expands, GDP expands with it as all transactions are measured in money. As more money in circulation does not create more real goods available (if it was that simple we could all stop working and just turn on the printing press), it's only affect can be to redistribute purchasing power and drive prices higher than they otherwise would be.

    During the last twelve months ending March, the M2 money supply increased 6.09%, since the end of 1999 it has increased 142.5%. Since Q4 2008, the money supply has increased 38.7% and today represents 65.1% of Nominal GDP. This compares to 55.2% in Q4 2008 and 51.7% in Q1 1981. Since 1981 it has averaged 53.1%. The current figure of 65.1% is the highest ever reported based on data since 1981. Since bottoming at 45.2% in Q3 1997, the quantity of money has swallowed an increasing share of Nominal GDP. As an increase in the quantity of money does not create wealth (if anything, it destroys it as it allows governments on fiat standards to expand beyond what it could do through taxation other than monetary inflation) this trend is bad news indeed and makes the Nominal GDP figure even less useful as a measure of economic growth. This increasing share of GDP by the money supply also helps explain why the U.S. economy is in such a bad state even as Nominal GDP is growing and despite Real GDP being at its second highest ever reported.

    (click to enlarge)

    The difference between Nominal and Real GDP is the GDP Deflator. The chart below shows the significant difference between the growth rates in the deflator and the money supply, the latter growing substantially quicker.

    (click to enlarge)

    So, removing the increase in the money supply from Nominal GDP yields the following money supply adjusted GDP figures:

    (click to enlarge)

    The data shows that the current money supply adjusted Nominal GDP number is the lowest since Q2 2009 and 14.71% lower than the peak from Q4 2007. It also shows that the current number is virtually unchanged from 10 years ago. Compared to Q1 2013, the adjusted GDP figure fell 0.95%.

    The U.S. population however continues to grow and the country, with a population of more than 317 million, is today the most populated it has ever been. This means the money supply adjusted GDP figures reported above is even worse on a per capita basis.

    (click to enlarge)

    The current figure of US$ 23,889 per capita is the lowest it's been since Q4 1998 and it's still getting gradually worse almost every quarter. Of course, the U.S. federal debt and the Fed balance sheet was substantially smaller back then. Compared to Q1 2013, the adjusted GDP per capita dropped 1.65% in Q1 this year and is now 18.74% lower than the record high from Q3 2007.

    In conclusion, the money supply adjusted Nominal GDP figures point a bleak picture of the progress in the U.S. economy. It also perhaps helps explain the ever growing federal debt (the economy is simply not generating enough income to balance the budget, though of course perhaps it never can given the high level of spending) and the still high unemployment figures. It also indicates that monetary policy injecting ever increasing quantity of money in the economy does not improve the underlying money supply adjusted GDP figures.

    Just as both Nominal and Real GDP numbers are not accurate measures of economic growth (due to insufficient data and as it only measures final output), or lack thereof, the adjusted numbers suffer the same weakness. In addition, not all money supply growth necessarily ends up in items forming part of GDP. However, assuming this relationship is fairly steady over time, and the fact that increases in the money supply will by itself drive GDP up and as an increase it the quantity of fiat money in an economy has nothing to do with wealth, it's perhaps not unreasonable to conclude that the adjusted measure help explain economic developments better than both Nominal and Real GDP.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Themes: Economy, Macro
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