For better or for worse, the GDP is the main number we use to measure the growth of our economy. Economists and stock market analysts point to real GDP rising to 3.1% annualized in Q4 2010 to show that the economy is in recovery and the stock market looks promising.
But as I pointed out in an article called Government Numbers, not all GDP is created equal. The most common method of calculating GDP is by tallying up the expenditures on personal consumption, private investment, government spending (federal, state and local), and net exports. It can be expressed be the formula:
GDP = C + Inv + G + (eX – iM)
Let’s examine those components closer to get a feel for what they mean for the economy moving forward.
Consumption can be good or bad. If an increase in consumption comes from increased salaries due to productivity growth that is a good sign. If consumption comes from diminished savings and borrowing, it means less consumption in the future.
Growth in the investment component of GDP is a very positive sign for future growth as companies invest in capital equipment to make their business more productive in the future.
Government spending can be good up to a point. Maintaining infrastructure such as highways, enforcing the law and protecting the country from invasion are necessary for a strong economy. Beyond that (and I believe we are well beyond that) increasing the size of government detracts from economic growth. It is important to remember that any money the government spends into the economy, it must first take from the economy in the form of higher taxes, borrowing or printing.
Positive net exports mean a country is growing its wealth. Unfortunately, the U.S. has been in the negative 2% - 6% of GDP range for over a decade.
The chart below shows these components as a percentage of GDP for 2000 and 2010. The consumption component is up slightly mostly due to increased borrowing. Private investment is down. Government spending is up, and net exports have held steady detracting roughly 3.5% from GDP. None of these facts are good signs.
Components of GDP ($Billions) | ||||
| 2000 | 2010 | ||
GDP | 9,951.5 |
| 14,660.4 |
|
Consumption | 6,830.4 | 68.6% | 10,349.1 | 70.6% |
Gross Investment | 1,772.2 | 17.8% | 1,827.5 | 12.5% |
Net Exports | -382.1 | -3.8% | -516.4 | -3.5% |
Government | 1,731.0 | 17.4% | 3,000.2 | 20.5% |
Data from BEA |
|
|
|
|
However, it should be noted that the government spending does not include transfer payments such as Social Security, Medicare, Corporate subsidies and bailouts like Tarp. Instead, those government expenses are counted as personal consumption or private investment when they are spent in the market. The chart below shifts the “social benefits” such as Social Security and Medicare paid to persons, back to the government to reflect what I would consider a more accurate picture of what government spending contributes to GDP. I would argue that a majority, if not all, of those transfer payments are spent back into the economy shortly after they are paid.
Components of GDP With Social Benefits Shifted to Government ($Billions) | ||||
| 2000 | 2010 | ||
GDP | 9,951.5 |
| 14,660.4 |
|
Consumption | 5769.1 | 58.0% | 8050.2 | 54.9% |
Gross Investment | 1,772.2 | 17.8% | 1,827.5 | 12.5% |
Net Exports | -382.1 | -3.8% | -516.4 | -3.5% |
Government | 2792.3 | 28.1% | 5299.1 | 36.1% |
Data from BEA |
|
|
|
|
This chart presents an even more dire picture as it shows that the government component of GDP is larger and growing faster than we are led to believe.
The charts above reflect the changes to GDP components over the past decade, but what can we expect for future GDP growth?
The prospects for consumer spending do not look good because Americans are deep in debt, have little savings, and the equity in their homes has vanished. The headline unemployment number is at 8.8% but U6 unemployment, which includes involuntary part-time workers and short-term discouraged workers, is closer to 16%. If we add long-term discouraged workers it’s above 20%.
The prospects for private investment are bleaker. A glut of houses still remains on the market so new home construction has rightfully slowed. Manufacturers are at 75% capacity utilization and their profit margins are being squeezed due to rising input costs and poorer customers, so they are less likely to invest in new equipment while they’re not even using what they have now.
Net exports are a relatively small part of GDP and have been stubbornly staying negative. While the net exports improved in 2009 to negative $386 billion from negative $710B in 2008, they worsened in 2010 to negative $516B.
State and local governments are facing serious budget issues in the wake of decreased tax revenues and rising pension shortfalls. Many states have been force to cut expenses dramatically including laying off workers, and more cuts are likely to come.
That leaves the Federal Government as the only hope of growing GDP. As I stated in the Government Numbers article, “Government can only spend what it taxes, borrows or prints. Higher taxes would put downward pressure on an already fragile recovery and wouldn’t bring in much more revenue. Borrowing is becoming harder as our lenders realize that real interest rates are negative and that our debt is almost 100% of a GDP bubble. That leaves printing as the only means of growing government spending and thus nominal GDP.”
If the Fed stops printing money at the end of QE2, the Federal Government will be forced to borrow at much higher rates which would devastate banks and homeowners with adjustable mortgages, or be forced to cut government spending, the last lifeline for GDP. Thus, the GDP must shrink, which means the stock market has nowhere to go but down. If the Fed continues to print money to keep real interest rates negative by buying up Treasuries, the GDP may rise nominally, but real GDP would fall in inflation adjusted terms and could even precipitate a collapse of the dollar. In either case, the outlook for the stock market is bearish regardless of what the sanguine GDP growth forecasts tell us. The only question is, will the market suffer a sharp crash when interest rates spike up, or a long, slow decline against real purchasing power?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.