GDP: friend or foe?

I attended the British Association for the Advancement of Science Conference in Birmingham in 1977, and even then economists were asking whether GDP was a useful measure. The example I remember was eating more sweets and consequently visiting the dentist more often.

Should we be quite so concerned about goosing GDP with quantitative easing etc, or is it just a trap to make us continue misallocating resources?

Okay, what's going to keep us up so high?

Every little thing's gonna be all right

Dr Mark Perry reckons it's all been on the up-and-up since 1929. Yes, production has become more efficient over time. But can it be quite as rosy as it seems, when the last quarter-century has seen an explosion of debt?

Where in the World?

Birinyi Associates give their forecast for GDP growth in 2009:

My plan: a $15 trillion dollar bailout.

US nonfinancial debt (second quarter 2008) is $32.4 trillion dollars. This pie chart gives a breakdown of the debt by type. US GDP in 2006 (est.) was $13.13 trillion - let's guess it's $14 trillion now. Thus debt as a proportion of GDP is about 230%.

This graph shows that the 50-year mean ratio of such debt to GDP is 120.1%. So to get back to a long-term average, DEBT MUST HALVE. As I said in a reply to a comment today, it's like a game of musical chairs, but taking away half the chairs in one go.

In fact, an almost perfect fit would be to cancel all the mortgage debt in the USA - just to get back to the level of debt averaged over the last 50 years.

And Marc Faber is saying the bailout will need 5 trillion, not $700 billion.

Hmmm....

Why don't we get really bold: $32.4 tn debt x 46% in the form of mortgages = $14.9 trillion. Give everybody their houses free of debt, make future loans on domestic property illegal. Yes, there'll be inflation, but the liberated houseowners will be able to afford it.

Will the banks be ruined? They're ruined now. Will the government have to nationalise them? They're doing it now.

These are revolutionary times. We may not be able to scourge the moneylenders from the temple, but at least we can chase them out of our houses.

Yes, the result's a house price crash, if you can't pump up the price with phoney-baloney money. But no debt, so so what?

The banker has inflated everything so you have to borrow to have anything. He's made himself indispensable, like a pusher of addictive drugs standing outside the school gates, giving away samples to get you hooked. He's your "friend", your "main man", who'll make you "well".

Bankers and their pet traders have become insanely rich by making you poor. Your assets are big on the outside and hollowed-out by debt on the inside; it's why they call it a bubble.

Do you know your enemy?

Bank lending - can somebody please help?

In the edited-out part of my recent letter to the Spectator, I pointed out that since 1963, average RPI has been c. 6.5% and the long-term real growth of GDP is said to be 2.5% p.a., so let's say nominal GDP growth has increased by 9% - my maths is up to that.

But over the same period, Bank of England stats show an annualised average increase in M4 bank lending of c. 13.5%, which suggests that lending grows at 4.5% p.a. above GDP. If that's right, UK bank lending as a proportion of GDP doubles every 16 years.

Can that be right? And what about the ratio of credit to the total of all national assets? Is that increasing, too? Because it looks as though eventually, the banks must own everything.

I reproduce below a graph from a mid-August post on Marc Fleury's blog. This shows the long-term ratio of total credit to GDP in the United States, and the current level of indebtedness seems to be way, way above the Great Crash situation in 1929.

Somebody please put me right and/or direct me to authorities and information sources.

My mind keeps saying, "This cannot be right, surely everything is sort of normal, really, we'll muddle through." I find myself discounting even McCain's Churchill quotation ("This isn't the beginning of the end of this crisis. This is the end of the beginning") and the politicians' use of the word "meltdown" to bounce Congress into accepting the bailout package proposals. I have spent years warning about a possible crash, but I've never, I think, allowed myself to get apocalyptic. I prefer my disaster movies to stay safely in the cinema.

So, how bad is it really, and does the banking system really have a tendency to acquire everything?

Banks, usury and slavery

In the UK, GDP is said to trend long-term to an increase of around 2.5% per year, hence also the Monetary Policy Committee's figure for inflation target-setting.

Since 1963, the M4 money supply has grown by an average of slightly under 13.5% per year. So that would be about 11% p.a. relative to GDP.

This means that bank lending, as a proportion of GDP, doubles every 7 years.

How long can this continue? How long before we are completely robbed and enslaved? Or am I asking a fool's question?

Why the sea is salt, and why we are drowning in cash

We are said to be heading for a recession, so I had another look at Bank of England statistics for M4 - money supply as measured by private lending by financial institutions.

Since June 1963, there has NEVER been a quarterly period when M4 contracted. In fact, here are the only times in the last 44 years when UK quarterly monetary inflation ran at less than 5% p.a. equivalent:

As you see, mostly it was the nineties, with one instance in 1975 and three times in the sixties. The average rate for the whole series up to December 2006 is 13.47%. So the hand-mill never stops grinding.

But should it? Wikipedia gives an account of recession and the Great American Depression, and notes that during the latter period the money supply contracted by a third. Great for money-holders, bad for the economy and jobs.

This page points out that we tend (wrongly) to think of a period of economic slowdown as a recession, and says that technically, recession is defined as two successive quarters of negative economic growth. By that measure, we haven't had a recession in the UK (unlike Germany) for about 15 years - here's a graph of the last few years (source):

And then there's the stockmarket. It doesn't seem to reflect the real state of the economy - until you shift the lines, when for example the S&P 500 turns out to be a fair predictor of changes in GDP, as shown in a graph in a 2005 entry from this blog ("Capital Chronicle", by RJH Adams):

The same post also provides a brilliant graph of a measure of fair value for investors, known as Tobin's Q. Look at the wonderful opportunities presented by two world wars and the economic shock (blamed on oil prices, but maybe the causality is the wrong way round) of the 70s:

Mind you, looking at Wikipedia's Tobin's Q graph, the median market valuation since 1900 seems to be something like only 70% of the worth of a company's assets. Can that be right? Or should we take the short-sighted view of some accountants and sell off everything that might show a quick profit?

Nevertheless, it still feels to me (yes, "finance with feeling", I'm afraid) as though the markets are over-high, even after taking account of the effects of monetary inflation on the price of shares. And debt has mounted up so far that a cutback by consumers could be what finally makes the economy turn down. Not just American consumers: here is a Daily Telegraph article from August 24th, stating that for the first time, personal borrowing in the UK has exceeded GDP.

The big question, asked so often now, is whether determined grinding-out of money and credit can stave off a vicious contraction like that of the Great Depression. Many commentators point out that although interest rates are declining again, the actual interest charged to the public is not falling - lenders are using the difference to cover what they perceive as increased risk. Maybe further interest rate cuts will be used in the same way and keep the lenders willing to finance the status quo.

Some might say that this perpetuates the financial irresponsibility of governments and consumers, but sometimes it's better to defer the "proper sorting-out" demanded by economic purists and zealots. History suggests it: in the 16th century, if Elizabeth I had listened to one party or another in Parliament, we'd have thrown in our lot with either France or Spain - and been drawn into a major war with the other. We sidestepped the worst effects of the Thirty Years' War, and even benefited from an influx of skilled workers fleeing the chaos on the Continent. If only we could have prevented the clash of authoritarians and rebellious Puritans for long enough, maybe we'd have avoided the Civil War, too.

So perhaps we shouldn't be quite so unyielding in our criticisms of central bankers who try to fudge their - and our - way out of total disaster.