Why Investors Should Ignore GDP

The great Canadian economist Reuven Brenner has likened macroeconomic calculations to dangerous mythmaking that sustains "the illusion that prosperity is necessarily linked with territory, national units, and government spending in general." Truer words have rarely been written, particularly when we consider how very much our economic health is related to productivity outside our borders.

Simplified, with the only closed economy being the world economy, our productivity accrues to individuals outside the United States, and foreign productivity similarly accrues to our own economic well-being. National economic statistics presume a war among the economically productive based on country borders, when in fact the world is an increasingly integrated economic whole.

Despite the illogic of government economic statistics, Gross domestic product (GDP) is still generally accepted as a useful measure of U.S. economic performance. The problem here is that many of the inputs used to calculate the number create inaccurate readings that can overstate or understate our economic health.

To begin, there's very little evidence that GDP or GNP correlate with stock-market performance. Indeed, writing about GNP in his 1984 book, Losing Ground, Charles Murray wrote that the "average annual growth rate from 1953 to 1959 was 2.7 percent, noticeably lower than the average annual growth of 3.2 percent from 1970 to 1979." Despite the economy's allegedly greater performance in the ‘70s versus the ‘50s, the S&P 500 rose 255 percent in the 1950s against 17 percent in the 1970s.

Economics writer William Greider noted in his 1987 book Secrets of the Temple that President Jimmy Carter "presided over one of the longest and most expansive periods of economic growth in postwar history" in terms of GDP, but this was hardly reflected in an S&P that gained only 24 percent on his watch. According to economist Richard Rahn, real GDP rose 32 percent during Ronald Reagan's presidency versus 31 percent under Bill Clinton, but despite the Reagan economy's slight outperformance, the S&P rose 121 percent under him against 208 percent during Clinton's presidency.

The disconnect between GDP and stock-market performance makes sense once we consider some of the inputs that drive GDP upward. Put simply, frequently what adds to GDP increases is inimical to true economic strength.

Take government spending. When the federal government increases spending, this registers as economic growth in the GDP calculation. The obvious problem here is that spending is a tax, and when governments spend, they are removing capital from the private sector which, if left there, would fund real economic activity.

Heavy spending during Reagan's presidency, while arguably justified given the Cold War, perhaps explains to some degree why stocks didn't perform as well under him as they did under Clinton. With Washington having expanded its take of private sector capital, it could be said that this weighed on productive economic activity overall. Nosebleed spending under George W. Bush and Jimmy Carter also partially explains mostly positive GDP growth that didn't show up in market returns.

It's also true that economic activity, regardless of whether it's profitable or useful, expands GDP. In that sense it's being said right now that increased domestic auto production driven by government bailouts will goose U.S. GDP in the near-term.

So while our level of economic health will at least appear more sound thanks to increases in U.S. made cars, the greater reality is that the production will detract from profitable investment elsewhere, and it will decrease our long-term economic productivity for us pursuing work that would be better left to others. That GM and Chrysler presently only exist thanks to the taxpayer strongly suggests that their production will offer nothing in the way of positive economic returns irrespective of its positive impact on GDP.

GM and Chrysler are symbolic of inneficient economic activity that is additive to GDP calculations, but that is economically retarding at the same time.  Growth in productivity is what matters, or better yet increased output at a lower cost.  Since GM and Chyrsler destroy capital as evidenced by them being wards of the state, what looks good according to GDP is economically enervating. 

But it's with our alleged trade "deficit" that GDP calculations prove the most perverse. What we as a nation import is the ultimate compliment because it signals a high degree of economic productivity on our part. For those who doubt this, compare the amount of imports that reach the United States versus what Mexico receives in total and on a per capita basis.

Unfortunately, when it comes to GDP, the less we import, the better. So if our trade "deficit" declines, meaning we're being less economically productive, GDP rises. It's also true that due to high levels of foreign investment stateside - meaning foreigners are paying us an even greater compliment through investment in our companies, debt and land - we've traditionally been able to import even more of that which is not in our economic interest to produce. 

All of this speaks to a positive economic outlook, but in GDP terms a lower level of economic growth is the calculation. Looked at today, the fact that we're importing less in the way of goods and investment - a negative economic signal - will actually register as economic growth due to the bogus nature of our GDP measure.

Most important, we must remember how very "Soviet Union" GDP figures are. Indeed, the Soviets and Chinese weren't so much lying about economic growth during their years under the thumb of communism, as output was and is only part of the equation. No doubt both countries produced a great deal of "stuff" during the Cold War years, but they did so in incredibly wasteful ways.

For one to take GDP seriously is the equivalent of an investor only buying shares of companies that generate a lot of revenue. No doubt revenue matters, but the more important calculation has to do with whether the revenues gained are achieved profitably. Absent profits or the presumption of future profitability, revenue doesn't mean a whole lot.

So while rising GDP figures certainly can signal overall economic health, they don't always correlate with strong market returns due to the greater importance attached to the kind of economic activity engaged in on the way to output. GDP is a Keynesian number of the past that doesn't account for profitable economic activity aided by economic specialization outside these fifty states.

In short, GDP is a number unworthy of serious thought for presuming the existence of borders in what is an increasingly borderless world economy. Market returns have suggested as much for decades.