What GDP Should Be

Ever wonder why markets seem to just shrug it off when GDP is revised? Like the Q1 2014 results, which
were just recently revised downward to an annualized -1%?

We know which side the headlines are on.

"US Economy Slams On the Brakes After Q1 Revision!"

"US Economy One Quarter Away From Recession!"

"Q1 Gains Wiped Out!"

We all know markets can be pretty irrational and sentiment-driven in the short term. Wouldn't they oscillate wildly on this news?

Well, no. For 2 reasons:

1. Our measurement of GDP is flawed.

2. It's reality is already reflected regardless of the revision.

As a lot of us learned in school, GDP is a measure of total economic output, the most complete one we have. It totals up government spending, business investment, net exports, and consumer spending (the biggest part).

There are a couple of flawed assumptions with this. One is that imports are counted as a negative drag on growth. It's a throwback to the old mercantilist mindset of exports = good, imports = bad. It makes more sense to have total trade (exports and imports together, absolute value) accounted for in GDP.

Import demand is still demand.

If for instance, Americans buy more goods from abroad than they sell/export, that would be considered a negative the way GDP is calculated. But people haven't stopped spending! Unless you looked under the hood of GDP, you'd think "the consumer is getting tapped out!" (which they've been saying for decades).

And what about P2P direct selling, such as sellers on etsy or third-party Amazon members? Even though they pay taxes and spend money, that activity isn't entirely accounted for in GDP.

For equities though, buying and selling among companies has already been reflected in their P&L (on which stock prices are based). That's why the Q1 GDP revision, which seems like bad news on the surface, wasn't such a negative for stock prices.

Companies and investors already knew, even if the official GDP figure didn't.

Just because these revisions happen all the time doesn't mean you should ignore GDP, only be aware of
its limitations--as we should for all statistics.

 
Best Response

To your imports point, that is captured in the C + I + G part of the equation I believe. The demand for goods that are imported would be captured in what we buy to produce goods. Given that GDP is designed to measure how much we, as the United States, produce in goods and services a year; if we have to import finished goods then we don't produce them and as such they shouldn't count in our GDP simply because we don't produce them here. I'm not sure that I would look at GDP to get my indication on consumer spending. More relevant would be credit metrics (revolving, non-revolving etc) housing startups, retail sales, and on and on. I'm not certain P2P selling should count, because all that represents is a transfer between two private parties (akin to the example that black markets are always left out in this type of calculation).

I agree that the measure is probably flawed to an extent, especially considering how globalized the world has become and just how vast and complex economies have become. Want to get really mad? Look at all of the numbers that we revise because of 'Seasonal' adjustments. I've always laughed as statistics that end up getting revised like crazy or other measures which get adjusted for weather or other factors. That just asks to be manipulated, just like any other number that comes out.

I tend to look at economic indicators like grades, with an assumption that there will always be some inflation/ambiguity in them (Insert real vs. nominal gdp joke here). Thus, I worry about the trend of GDP and some of the components rather than the overall number. I could care less if we grow at 4% annualized one quarter, I want to see it stay around 3-4% over a period of time. I also think that these large indicators have become a sentimental haven, where people view the numbers with far too much emotion and trade on them as such.

 

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