Yesterday we came across a Reuters report on the rather pedestrian, to put it mildly, third quarter GDP report. Reported “real” GDP was greatly helped by the GDP deflator once again declining sharply, coming in a full percentage point lower than in the second quarter (1.2% instead of 2.2%). Perceptive readers have probably noticed this pattern already: weak GDP numbers always tend to coincide with outsized declines in the deflator.
A basic problem in this context is that “price inflation” in terms of a general price level cannot possible be measured; or let us rather say, such a measurement simply makes no sense, neither mathematically nor logically.
The main problem is that there is no fixed yardstick which can be used for measurement, as the value of money depends on supply and demand just as other goods do. In other words, one continually changing magnitude is measured with the help of another continually changing magnitude. This is basically nonsense. Moreover, there is an array of heterogeneous goods and services with an array of prices. Adding up cars, potatoes, movie tickets, rents, and so forth, making an “average” out of the result and calling it the “general level of prices” is absurd.
Just as various new calculation methods that have been adopted over the years have resulted in CPI and similar indicators (PCE is used for deflating GDP) becoming ever lower on average, the same methods have resulted in ever higher real GDP numbers. Needless to say, both effects have the side effect of tending to flatter the government’s economic policies and the Fed’s monetary interventions. Surely that is just a coincidence (cough cough).
The effects on GDP are such that it is fair to say that we are dealing with a complete fantasy number. Whatever it reflects, it is not reality and its connection with “economic growth” seems almost coincidental. This is beside the fact that GDP fails to account for the vast bulk of the economy’s production structure, as we have often discussed in these pages. If one wants to know about the actual distribution of economic activity, one needs to consult gross output data.
One effect of this is that many people erroneously assume that consumption is the biggest part of economic activity. It should be clear purely from a common sense perspective that this cannot be true: if we were to continually consume more than we produce, we would soon be living from hand to mouth.
We have provided an extensive discussion of the pure fantasy numbers that make up GDP on occasion of the last revision of the calculation (even more fantasy numbers were included, which once again ended up flattering…oh well, you know the drill). We strongly recommend that readers take the time to check said article out in its entirety: “The Mirage of Economic Growth”. Here was just want to quote a few passages discussing especially glaring examples of GDP components that essentially consist of completely imaginary numbers:
“There are for one thing so-called ‘imputations’. These represent the ‘imputed value’ of services consumers get for free even though they apparently shouldn’t. For instance, if checking services are offered for free by banks to customers opening a current account with them, then the government adds the supposed value of these free services to GDP. Note here that no money has actually changed hands, but what is added to GDP are in fact money terms.
Another area in which imaginary numbers play an ever bigger role is the ‘hedonic indexing’ applied to all sorts of goods, something that has an especially large effect on all things to do with information technology. Here is an example from the second quarter of 2003 illustrating the effect (we have chosen this time period randomly, mainly because we happen to have the exact data at our fingertips. It should be pointed out though that the error in this data series compounds over time). In Q2 of 2003, actual spending on computers increased by $6.3 billion, from $76.3 billion to $82.6 billion.
If simply ‘every monetary transaction’ were added to GDP, then this is the number that would have been added, and thereafter it would have been massaged by the ‘deflator’. If not for hedonic indexing, that is. Before we tell you, try to guess how big an increase in spending on computers the government actually added to GDP in this instance. Was it 20% larger? 30%? Maybe even 50%? Hold on to your hat.
The number added by government to GDP instead of the $6.3 billion in actual additional spending was $38.2 billion. In other words, almost $32 billion in completely imaginary money that no-one ever spent or received, with the total number used by the government amounting to more than 6 times the actual spending growth was used for the calculation of ‘real GDP’. It should probably be renamed ‘unreal GDP’.
And this is actually just a small slice of what is wrong with GDP. As we always stress, GDP is easily the by far most useless aggregate economic statistic that exists.
Why Calculate It At All?
Given that GDP is such a dubious statistic (the same is true of many other economic statistics as well actually), why even bother calculating it? Well, who is doing the calculation is actually already a strong hint. In an unhampered free market economy, it seems highly unlikely that a lot of time and effort would be wasted on compiling such statistics. Academic researchers (primarily historians) may have some interest in “macro” type data, and if this demand were strong enough to make the endeavor economically viable, someone would no doubt provide them.
Other than that, there may also be some private demand for certain industry-specific data, but even that demand would be highly dependent on whether fractional reserve banking and the associated credit expansions would actually be tolerated in such a hypothetical unhampered free market economy (as we have previously pointed out, there is a strong argument to be made that the practice of fractional reserve banking represents a flagrant violation of property rights).
For instance, a recent article at Wolf Street discusses the year-to-date collapse in the US load-to-truck ratio (another one of those recent “everything is awesome” economic statistics). This kind of data would undoubtedly be interesting to trucking companies and diesel engine makers. However, the extreme cyclicality of the ratio is solely a result of the business cycle (the companies in this business are undoubtedly fully aware of any purely seasonal effects). The business cycle in turn has monetary causes, i.e., it is a result of credit expansion. As Mises has pointed out, all attempts to assign non-monetary causes to the business cycle fall flat on even the most cursory examination.
The US load-to-truck ratio, via Wolf Street.
The only reason to compile assorted macro-economic statistics is for a) propaganda purposes and b) more importantly, to provide a justification for government meddling with the economy. Often they describe the atrocious results of previous interventions, which are then used as the justification for even more interventions. The Federal Reserve operates exclusively on this principle for instance. It first mucks the economy up, and the results are then presented as the reason for doing it all over again, only on an even grander scale.
This is something Sir John Cowperthwaite, the former governor of Hong Kong, was well aware of. When a UK delegation of bureaucrats and politicians came to visit him, they asked whether he could provide them with Hong Kong’s unemployment data. Cowperthwaite essentially told them (we are paraphrasing): “Sorry, we don’t collect such data. They would merely tempt government to meddle with the economy”. Amen.
Sir John James Cowperthwaite, the former governor of Hong Kong. When he started out in this job, the place was a sleepy fishing village largely made of wooden huts. Today it is one of the most free and richest economies in the world, something Sir John’s refusal to meddle with Hong Kong’s economy certainly had a lot to do with.
Photo via Wikimedia Commons
Let us briefly get back to the above mentioned Reuters article on the Q3 GDP report. It contains a few interesting/funny details.
“U.S. economic growth braked sharply in the third quarter as businesses cut back on restocking warehouses to work off an inventory glut, but solid domestic demand could encourage the Federal Reserve to raise interest rates in December.
Gross domestic product increased at a 1.5 percent annual rate after expanding at a 3.9 percent clip in the second quarter, the Commerce Department said on Thursday.
The inventory drag, however, is likely to be temporary and economists expect growth to pick up in the fourth quarter given strong domestic fundamentals.”
Several paragraphs later, we are informed that inventories actually didn’t decline, except in selected sectors; overall, they merely grew at a slower pace than previously:
Businesses accumulated $56.8 billion worth of inventory in the third quarter, the smallest since the first quarter of 2014 and down sharply from $113.5 billion in the April-June period. There were declines in manufacturing, wholesale and retail inventories.
This was described as “healthy purge” by one observer! We believe the actual “purge” is actually still ahead. The article of course couldn’t fail to neglect mentioning the “consumption is everything” fallacy:
“The blow from inventories was, however, blunted by bullish consumers, who are getting a tailwind from cheaper gasoline and firming housing and labor markets. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, grew at a 3.2 percent rate after expanding at a 3.6 percent pace in the second quarter. A measure of private domestic demand, which excludes trade, inventories and government spending, rose at a sturdy 3.2 percent pace.
“The consumer remains the main engine of economic growth. We expect this dynamic to remain in place,” said Jesse Hurwitz, an economist at Barclays in New York.
Sure enough, in GDP accounting, consumption is the largest component. However, this is (luckily) far from the economic reality. Naturally, it is not possible to consume oneself to prosperity. The ability to consume more is the result of growing prosperity, not its cause. But this is the kind of deranged economic reasoning that is par for the course for today: let’s put the cart before the horse!
Lastly, Reuters’ interview partners appear not have noticed the irony of the following statement:
“A separate report from the Labor Department showed new applications for unemployment benefits last week hovering near levels last seen in late 1973.”
Does anyone still remember what happened right after “late 1973”? We recall that what was then the worst recession and bear market since the Great Depression started more or less immediately after these seemingly uplifting data were recorded. As we have pointed out previously, extreme lows in unemployment claims are historically a contrary indicator (see also this chart). It seems that was true in 1973 as well.
Finally, it is mentioned that “trade was not a drag” on GDP this time. The idea that trade surpluses and trade deficits add to, resp. detract from economic growth is a mercantilist fallacy. Again, it is true in terms of GDP accounting, but it has been known for some time already that the balance of trade is not a yardstick of a nation’s prosperity. This is yet another part of this statistic that doesn’t make much sense.
“With the dollar strengthening, export growth decelerated in the third quarter. The drag was, however, offset by a slowdown in imports, especially automobiles, leaving trade’s impact on growth neutral.”
US citizens should of course be glad that their currency is strengthening for a change at the moment. Contrary to the poor rubes in Europe and Japan, who are increasingly impoverished by their central bankers having declared open season on the currencies they issue, they are actually gaining a little purchasing power. This means they must produce less to obtain the same amount of goods from abroad as before. Only the morons running modern central banks can possibly believe that this is a bad thing.
GDP remains as useless a statistic as ever. The attempts by assorted observers to make sense of these data are almost comical in their futility. Similar to many other macro-economic data series, there may be some usefulness to GDP data in terms of allowing historical comparisons, but even the historical trends have to be taken with a grain of salt given the many changes that have been implemented over the years in the calculation methods of various adjustment factors. Moreover, as Mish has pointed out, the initial guesstimate of the number is going to be revised several times, which makes it even more meaningless.
In a truly free market economy, there would be little point in bothering with such data beyond their possible historical interest. One must never lose sight of the fact that today’s widespread data obsession is in fact mostly driven by the fact that an ever larger share of the economy is subject to government interference and various forms of central planning.
Charts by: St. Louis Federal Rserve Research, DAT/Wolf Street, Chartstore
Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to “The GDP Illusion”
Most read in the last 20 days:
- Alan “Bubbles” Greenspan Returns to Gold
Faking It Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. […] The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. — Alan Greenspan, 1961 He was in it for the power and the glory... Alan Greenspan gets presidential bling...
- End of an Era: The Rise and Fall of the Petrodollar System
The Transition “The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros. The sooner the better.” Ron Paul A new oil pipeline is built in the Saudi desert... this one is apparently destined for the Ghawar oil field, one of the oldest fields in Saudi Arabia...
- Writing on the Wall
Time to Sell... Maybe BALTIMORE – Yesterday, the S&P 500 hit a new all-time high. And the Dow just hit a new record close as well. If you haven’t sold yet, dear reader, this may be one of the best times ever to do so. It's still flying... sorta. Meet Bill Bonner's tattered crash flag Image credit: fmh We welcome new readers with a simple insight: Markets are contrary, pernicious, and downright untrustworthy. Just when the mob begins to bawl most loudly...
- A Fully Automated Stock Market Blow-Off?
Anecdotal Skepticism vs. Actual Data About one month ago we read that risk parity and volatility targeting funds had record exposure to US equities. It seems unlikely that this has changed – what is likely though is that the exposure of CTAs has in the meantime increased as well, as the recent breakout in the SPX and the Dow Jones Industrial Average to new highs should be delivering the required technical signals. The bots keep buying... Illustration via...
- The Central Planning Virus Mutates
Chopper Pilot Descends on Nippon Readers are probably aware of recent events in Japan, the global laboratory for interventionist experiments. The theories of assorted fiscal and monetary cranks have been implemented in spades for more than a quarter of a century in the country, to appropriately catastrophic effect. Amid stubbornly stagnating economic output, Japan has amassed a debt pile so vast since the bursting of its 1980s asset bubble, it beggars the imagination. A...
- Destination Mars
Asset Price Levitation One of the more preposterous deeds of modern central banking involves creating digital monetary credits from nothing and then using the faux money to purchase stocks. If you’re unfamiliar with this erudite form of monetary policy this may sound rather fantastical. But, in certain economies, this is now standard operating procedure. The “Tokyo Whale” Haruhiko Kuroda explains his asset purchase madness with a few neat little slides. Photo credit:...
- America Has Become a “Parasitocracy”
Dread and Denial So, let’s return to the discussion you can’t have with your congressman, your mailman, or your barmaid. It’s the important one. It concerns what the Fed is really up to. Eight years after achieving independence, a State modeled after the British merchant state was established in the US. It took a while for the Deep State to consolidate itself within it, a process that was accelerated greatly in the run-up to and aftermath of WW I. Illustration by Ana...
- Fat People for Trump!
Alphas and Epsilons BALTIMORE – One of the delights of being an American is that it is so easy to feel superior to your fellow countrymen. All you have to do is stand up straight and smile. Or if you really need an ego boost, just go to a local supermarket. Better yet, go to a supermarket with a Trump poster in the parking lot. The protest vote attractor with the funny hair. Image credit: Liberty Maniacs Trigger warning: In the following ramble, we make fun of...
- Long Term Market Perspectives
Methuselah Tree When looking for a good theme for this post I pondered for a while and then decided to use a picture of a bristlecone pine, which are widely considered to be the oldest living trees in the world. Ye olde bristlecone Photo credit: Kosta Konstantinidis You can find them near the Nevada/California border and if you wind up traveling in the area then I strongly recommend that head over to Bishop and from there head up high up into the White...
- EU Sends Obsolete Industries Mission to China
“Tough Negotiations” The European press informs us that a delegation of EU Commission minions, including Mr. JC Juncker (who according to a euphemistically worded description by one of his critics at the Commission “seems often befuddled and tired, not really quite present”) and European Council president Donald Tusk, has made landfall in Beijing. Their mission was to berate prime minister Li Keqiang over alleged “steel dumping” by China and get him to cease and...
- The Real Reason the “Rich Get Richer”
Time the Taskmaster DUBLIN – “Today’s money,” says economist George Gilder, “tries to cheat time. And you can’t do that.” It may not cheat time, but it cheats far easier marks – consumers, investors, and entrepreneurs. Tempus fugit – every action humans undertake has to take time into account. In the economy, interest rates serve as the signal and regulator of the inter-temporal structure of capital. In an unhampered free market economy, they tell...
- Gold is not Going to $10,000
One Cannot Trade Based on the Endgame The prices of the metals were down again this week, -$15 in gold and more substantially -$0.57 in silver. Stories continued to circulate this week, hitting even the mainstream media. Apparently gold is going to be priced at $10,000. Jump on the bandwagon now, while it’s still cheap and a bargain at a mere $1,322! All aboard... or maybe not? It all depends on what one wants to achieve – there's many a slip 'twixt the cup and the...