Gross Domestic Problems

The Plow Horse Speeds Up
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Fictitious Wall Street villain Gordon Gekko famously declared, “Greed is good.” I think actual Wall Street titans would mostly disagree. They would change one word. Instead of “greed,” they would say, “Growth is good.” That is Wall Street’s real mantra. Growth is the magic elixir we all need.

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The question, if we define growth as good, is how do we measure it? Presently we use gross domestic product, or GDP. But GDP is showing its age in the 21st century. The measure was actually invented in the late 1930s when President Roosevelt needed some way to prove that his policies were working. And at 85 years old, the old formula may be nearing time for retirement.

The only way for Roosevelt to show that his policies were working was to put government spending inside the GDP number. There was vicious fighting among economists over whether he should be allowed to do so. Many economists even argued that military spending should not be included in GDP because it didn’t produce anything. And it’s true that overreliance on GDP has often sent policymakers and business owners in wrong directions. We need a better yardstick.

First, we must next decide what, specifically, a newly formulated GDP should measure and how – and that’s a thornier question than you might think. Today we’ll wrestle with that question and with some of the implications of changing how we measure growth.

These are exactly the types of pressing questions we will be attempting to answer at my upcoming Strategic Investment Conference. By “we,” I mean the hand-selected, A-list cast of economic, investment, and geopolitical powerhouses who will speak, and the audience that will respond to them. And for SIC 2018 we really do have an all-star group, including “bond king” Jeffrey Gundlach, hedge fund titan John Burbank, renowned historian Niall Ferguson, and some 20 more brilliant minds. At SIC you will get their latest and best thinking. Better yet, SIC is small enough that you can usually find the speakers in the hallway or after hours and interact with them.

In addition, there are a couple of hundred “core” SIC attendees who come every year. They represent a remarkable range of talent, experience, and wisdom. Some of them really ought to be on the stage. Instead, they’ll be sitting with you, and you’ll find them friendly and ready to swap ideas. We’ve seen countless business relationships form at SIC, and many more will happen this year. I hope you’ll join us, March 6–9, in San Diego.

Now, let’s see how we can fix the GDP problem, starting with where we are right now.

The Plow Horse Speeds Up

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Brian Wesbury, chief economist at First Trust Advisors, has been calling our present recovery phase a “plow horse economy” for several years. It’s not fast or impressive, but it’s not stopping, either. He’s been mostly right, too.

Last week Brian said that the horse is now breaking free.

We’ve called the slow, plodding economic recovery from mid-2009 through early 2017 a Plow Horse. It wasn’t a thoroughbred, but it wasn’t going to keel over and die either. Growth trudged along at a sluggish – but steady – 2.1% average annual rate.

Thanks to improved policy out of Washington, the Plow Horse has picked up its gait. Under new management, real GDP grew at a 3.1% annualized rate in the second quarter of 2017 and 3.2% in the third quarter. There were two straight quarters of 3%+ growth in 2013 and 2014, but then growth petered out. Now, it looks like Q4 clocked in at a 3.3% annual rate, which would make it the first time we’ve had three straight quarters of 3%+ growth since 2004-5.

That was Monday. On Friday the Commerce Department released its first 4Q GDP estimate at 2.6%. The estimate will likely change, but for now it looks like Brian was a tad bit optimistic about Q4. But you should read his outlook anyway, because he breaks his estimate down to the components of GDP to show how he arrived at 3.3%.

The GDP formula is C + G + I + NX, where

C = Consumer spending
G = Government spending
I = Private investment
NX = Net exports.

Net exports is exports minus imports, so it’s a negative number for a country like the US that runs a trade deficit.

To get GDP, you just estimate the change in each component, weight it by the appropriate amount, and add the components together.

That’s easy enough, but the calculation ignores whether those are the right components and how to define them. The result is a lot of potential distortion. For example, very little happens to GDP if you do your own housekeeping. You consume some cleaning products, but your labor doesn’t count, no matter how long you scrub. But the labor does count toward GDP if you hire someone and pay that person to do the exact same work while you take a nap. The hired labor “produced” something of value, and you did not.

To an economist, a barrel of oil selling for $100 has the exact same effect on GDP as two barrels of oil selling at $50. Silly, but that’s the way the accounting works.