The Right Perspective: Understanding What’s Going On - or - The Correct way to view GDP

Reggie Middleton's picture

Guest post by Mordecai Grun:

In order to invest it's important to understand the economic fundamentals. In the long term it's like gravity, there's no way to escape whatever is really the truth. This holds true in Bearish and Bullish markets.

Economists and investors alike are looking at the GDP number as a way to understand whether the economy is growing and by how much. However not all GDP is created equal. It is important not only to look at the GDP but also to look at where it's coming from to assess its quality. Take, for example, the following two neighbors. One is a hard working immigrant that earns 100,000 in annual income, but lives in a simple home and is saving 40%of his income for retirement, his children's education and to have cash available for any future business opportunity that may come his way. His neighbor is in the public sector also earns 100,000 per year however he just took on a mortgage to purchase a brand new home for 800,000 and between credit cards is living on 135,000 per year (Spain 2000-08). Obviously from a GDP perspective the latter is creating way more GDP, but from a sustainability and quality perspective the reverse is true. In a theoretical world, growth in GDP would come from improved productivity and investment. However, in reality, GDP growth can come from a variety of sources. Increases in consumer debt, public sector debt, asset price inflation (ex. housing or equity markets, Bond Markets), foreign money entering the country to purchase assets, are all sources of GDP.

Under any of the above scenarios simulucrum of what seems like quality GDP will also be created. For example during the housing bubble auto sales and manufacturing were also very high. In short, since lenders and manufacturers increase supply with demand they really don't look at where and how the money is created or where it comes from. The same is true for government. As state taxes, for example, grow during a boom the politicians raise their spending (actually outpacing the growth rate of the boom) and don't question whether it's possible long term to have so many real estate agents during a housing boom or to sustainably have retail sales growth outpace economic growth. When the inevitable blow comes everyone is surprised and acts as if economic depressions are unpredictable, sort of like tornadoes.

So, let's analyze what current GDP really looks like. Let's assume 1 trillion in Deficit spending (includes all levels of Government) and 1 trillion in QE and assume the banks have increased their lending by the QE amount. Yes, I know these figures are not precise and that the banks may be hoarding liquidity, however from the froth out there it actually seems like the QE maybe having a multiplier effect at this point and while not precise it is ballpark. As such at a 15 trillion dollar economy and a GDP growth of 3% the true GDP would be a negative -10.3%. This does not include the multiplier effect of all the QE and the fiscal deficit. For example, now the auto and retail sales and manufacturing inudstries are very strong. Had there been no QE or public sector debt increase there's no question that services and the manufacturing sector would be doing much worse. Thus making the GDP even more negative than the -10%. SCARY!!

In short had we consumed only what we produced and not printed money, things would be very ugly out here right now. This goes a long way to explaining the angst still felt on main street USA. The fed is very aware of this and therefore very reluctant to take the foot off the gas. The hope is that this will act like a starter to an engine and once it purrs it will go on its own. This has never yet been tried and done successfully, at least to my knowledge. It should work when there's a confidence or liquidity crisis, but won't work when there's a structural mathematical reason the economy is doing poorly.

From this vantage point the US has not been producing real, healthy GDP growth in a long time. Most growth in GDP prior to 2008 was just an increase in household debt and asset inflation spending due to the increased valuation in housing and bonds (and now equities) due to the shift to ultra-low interest rates . Take these factors out and we certainly would be in a significant recession since at least 2001 and perhaps earlier.

What are the structural defects to the economy? As we illustrated earlier policy makers don't know or understand the sources of economic activity and their sustainability or quality. One such example is the tremendous amount of US manufacturing that was shipped overseas pre-2008 . This was barely a political issue, due to the fact the economy was going strong and unemployment was low. In short, who cares about 15 dollar an hour furniture factory jobs when mortgage brokers are making 300 thousand plus? So to the trade deficit does not matter when trillions of foreign money is pouring into US assets. Commodity production? Always a dirty and unneighbourly affair, why go through the mess if everyone is happy and making hay? Import duties to protect domestic production? VAT taxes to balance the budget? Policies that promote more people in the work force? Policies that create low cost electricity and energy? Why go through all this when everything is hunky dory?

At present the policies in place make it extremely difficult to PRODUCE things here or increase productivity. The trade deficit and high fuel prices (even when going to domestic sources) and a government and service sector that is too large for the productive economy are like air being let out of the balloon while it is being pumped.

So how long can this go on for? It's anyone's guess, however since most of the Global Economy is doing, or will be doing fiscal stimulus and QE, combined with the fact that we are the world's reserve currency this may go on for quite a while. Though a bond market where the fed purchases most or all of treasury issues may happen sooner rather than later.

What does this mean for investors? The bull market in equities may still have a long course to run and as in the previous housing or other bubbles the market insanity can go higher and longer than anyone sane can imagine. Especially in this case where as the QE kicks in, government debt will go down and GDP up. Even manufacturing may have a strong run as a spinoff of all this misplaced optimism and debt. It will feel almost as if the economy is healing.

Many market participants are concerned that QE will end. This is having a negative impact on precious metals and commodities and to a much lesser extent equities. However, if this thesis is correct, long term we are in for infinite QE. The Fed may taper down for a short while, but the economic results will be so dire, that the fed will reintroduce QE with a double dose. Even to the extent of buying treasuries at significant percentages below the true inflation rate. This will lead to huge increases in precious metals, real estate, and some inflation resistant equities, while being a big drag on corporate debt, or any bonds that the Fed isn't buying. The Fed will put a floor on treasury prices by promising to purchase at a certain price. Basically the premise of this article is that eventually either massive inflation, or a severe recession/depression or a fundamental productive economic shift needs to take place. Given the choice , QE Fiscal stimulus and eventual inflation are ahead of us.

Unfortunately the fundamental shift that needs to take place namely that we produce MORE than we consume and SAVE the difference and invest it in productive assets has not taken place. Nor are there any policies being put in place that would encourage this.

Gravity will hit at some point and the later it will be the harder. So enjoy the party as it really is a good one and their handing out free spiked fruit punch. But stand near the exit so that when the floor begins to buckle you step out of the way.

Disclosure: I am long GLDSLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Reggie's Take



Mordecai said "Basically the premise of this article is that eventually either massive inflation, or a severe recession/depression or a fundamental productive economic shift needs to take place. Given the choice , QE Fiscal stimulus and eventual inflation are ahead of us."

Well, that's given the choice. In reality, many of us really don't have a choice, particularly when someone else is pulling the purse strings. Not given the choice, the prognosis is as I have said throughout 2010 and 2011. Hmmm... What happens when wages and earning assets go down in value as input prices increase? I have warned of the stagflationary scenario several times in the past as the most likely outcome of the battle between the deflation camp and the inflation camp.



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moneymutt's picture

I think Mordecai Grun's analogy of households is oversimplistic and so tired. It focuses on a single family unit whose actions have no significant effect on the overall country's economy and as typical, it as overly focuses on govt debt/overspending and not on private debt, such as overspending of private actors, asset speculators, financial firms, businesses. If an individual family cuts back, like the immigrant, but everyone around him keeps spending, the families job or business prospects will stay good even while they save money. Govt has no such lack of effect on overall economy.

Veiwing govt spending thru the lense of business would be a slightly better analogy, though still limited. Businesses can take on healthy debt and unhealthy debt. Kudos to business with profits and savings to re-invest into improvements, expansions but its silly to say businesses shoudl never take on debt or that all debt taken on by a business is a bad move. Often debt can allow them to profitablt expand or improve efficiencies, at key moments.

In contrast, debt like that created in many a leverage buy-out, not so great, It's usually a very bad deal for long-term sustainbility and profits of companies. Debt to upgrade equipment, put in solar panels, develop software, research etc, may be a very good thing and may pay back quickly or set up business very well for long-term success.

Govts also make investment in their economies: public works, education, training of work force, basic research that private sector, water and electric districts, and policing, regulating, defense, that keeps things peaceful, predictable, safe, trustworthy  etc...If the internal rate of return is good on this type of govt spending, debt can make sense.

Private or govt debt spent on running up price of assets, like real estate, wasteful acitivity that provides nothing of value, creating sectors, like Wall STreet that are just parasites making money while creating no value for their fellow humans, that is bad debt. Debt to assist people in effiicently producing things and services that are valuable and helpful to eachother, that is good spending.

And in regards tot he overfocus on govt debt, remember, private debt swamps govt debt, and private debt is created whole cloth from bankers' ledgers...first they lend, then they run around to find reserves, to show they have small percentage of what they lent in assets. Reserves lag lending, see Aussie Econ Steven Keen et al...So banks create or destroy money depending on their mood and are unforutnately happy to lend into specualtive ponzi schemes when they are growing, such as stock market or real estate bubbles. That is not good debt. Lending to a business so they can build a more efficient factory, probably good private debt.

But even if we stayed focused on govt debt, govt is not like an individual family or a business. Govt spending is a big portion of many economies, and take away that spending, (some of which can be going to good investments and providing value to ctiizens) and that country's economy contracts. See austerity implemented in Europe...$1 in cuts in govt spending does not necessarily result in $1 of savings. Fire a govt worker, lose the value of their services, lose the tax revenue on their income and spending, incur the cost of their unemployment insurance, food stamps, lose the money they spent into economy to support other private workers. lose those private workers taxes, incure their social safety net costs etc...

Imagine it this way. If a business owner grew and made food for his livelihood and his employees were 40 percent of his customer base and nearby towns were the rest of his customers and then he lowered their wages, he would also lose sales, from his employees, and also from nearby town folks that used to sell furniture and cars to his employees and buy food with the money they made. It be worse yet if he was also in the  insurance business and had to cover employees unemployment insurance claims. Not that getting efficient  and smart and only spending on good investments isnt important, but individual actors and households can cut back and save without harming their revenue from a business or job, a govt cuts back and it loses revenue. If govts cuts back enough, they can start to be like a business that does not make needed investments, doesnt upgrade factory, computers, software, doesnt train employees, fires sales people, eventually these cuts lead to revenue losses.

So the needed question about govt spending is: does this spending from taxes or debt, return more in value than it costs, is it an investment that gets a return for country or not? The results of austerity in Europe show that cutting $1 dollar by firing a govt worker doesnt necessarily save $1, the European cuts have been matched by even more drastic loss of economic acitivity and tax revenue, so even tho they have suffered great pains from cuts, their deficits have not reduced.

After WWII, when US was in high debt from the war, we built the interstate freeway system, airports, offered free or very low cost tuition public college educations, paid for GI's education, implemented the Marshall Plan to rebuild Europe etc. WE could have foregone all that, paid down debt more, but high economic acitivty of US, no small part from exporting to Europe, made the deficits easily erasable while govt spending on domestic programs was increasing.

Needless to say, there is lots of economic study on this issue, slightly outside the mainstream....but the damn household analogy of an individual actor is still used....overly simplistic, leads to bad policy decisions....we have computers now, we have big data, we have modeling software that can be checked to real can dyanmically, not just statically model things like mainstream economists still do....its really not that hard to figure what taxes and cuts net the least improvement in deficits and which net the most...and then figure if any of the cuts or taxes are worth it, like a businessman owning a family-held company, interested in the long-term sustainability, and success of that business would do.he wouldnt fire half the employees and expect to make same profit long-term...rather he would be strategic.....


123dobryden's picture

so do i understand it correct? is the technology and improvements in productivity, funny enough, the only thing that keeps this zombie system alive? 


Going Loco's picture

I am in the habit of taking a quick peek at the end of long posts before reading them. In this case I saw " I am long GLDSLV." and it saved me the bother of reading the rest.

cynicalskeptic's picture

Reggie, Reggie, Reggie..... you may have broken some of your 'coinditioning' and 'programming' and are seeing much of the world without filters but 'GLD and SLV"!?!?!?     Do you still think paper anything is as good as - or can possibley 'represent' the real thing anymore?  

thisandthat's picture

So much for reading before commenting...

At the top of the post it says clearly "Guest post by Mordecai Grun:" and at the bottom, there's a big, fat, bold "Reggie's Take".

You two fail at basic reading and commenting skills.

dontgoforit's picture

Take your vacations now, boys - they're won't be any money left come September.

Tombstone's picture

Reasonably solid, Reg.  You cannot have much growth in GDP when you are transitioning to a welfare based/steal from the rich/freebie giveaway economy.  The fact that more people have joined the legions of disability takers verses those that have become employed says it all.  I think we really could be in a negative GDP state.  And, the FED has no clue because they are persuing a forever failed policy; central planning and the attempt to create wealth with fake dollars.  All that QE has no basis for true wealth because there are no assets or production supporting the vast majority of it.  It's a piss-poor way to run an economy.

massornament's picture

Very much agree but... 'transitioning'? We have been there for an awful long time and it's not just welfare recipients or people pretending to be on disability insurance... it's also the unions, the corporations and pretend-capitalists, the too-big-to-fail bankster-fraudsters, anyone who has profited on fed-induced bubblenomics, politicians and their cronies, Mark-freakin-Zuckerberg and rigged IPOs... everyone and I mean everyone has been gaming this rigged system for a long time.

mogga71's picture

Have to echo the previous comment.

Reggie, your opinions are very valued on here but FFS will you get somebody to sort out your website.  Its shocking from a presentation point of view.  The content is very good ... just so hard to read and find stuff sometiimes....and very slow at times.





DOT's picture

I think Reggie is hosting on his phone. That being said, other than lay-out  clutter I've had no problems.      ;)

AT's picture

Poor sucker is long GLD. Feel sorry for him. Guess he didn't get the physical only memo. Doesn't understand as much about the world as he thinks.

Winston Smith 2009's picture

Reggie, enjoy your stuff and agree with it, but whatever HTML editor you are using nearly always results in issues when using either the latest Firefox and Chrome browsers.  Might be just the cut and paste process if that's what's used to submit your columns here.