Lies, damn lies and GDP statistics

Alasdair Macleod – 30 July 2011

Earlier this week preliminary figures for the UK’s second quarter GDP were released, showing that the economy grew at an annualised rate of 0.2%. Both politicians and markets have become slaves to these statistics, the former prepared to alter economic policy to bolster them and the latter attaching significant importance to them. But how important are they actually?

GDP numbers reflect the final consumption of both private and public sectors, to which are added the trade balance and business investment for a given period. This is then deflated to reflect price inflation of all goods and services, and seasonally adjusted. However, there are several problems with this approach.

Firstly, the economic activity associated with the intermediate stages of production is not adequately reflected in GDP, which imparts a statistical bias in favour of consumption, and against production. Over time, this has the effect of driving production abroad, to where the factors of production are more readily available, skewing the economy towards consumption and a dependency on service activities.

Secondly, an increase in government spending financed by deficits raises GDP: socialist governments have used this fact to engineer headline growth. By this trick, Gordon Brown, as Chancellor from 1997 to 2007, was able to make it appear as if the economy was growing at a faster rate than his critics expected. But this “growth” came at a long-term cost to Britain’s economic health.

And thirdly, the easiest short-term fixes for adverse trade balances and business investment are a “competitive” currency and freely available bank credit. The effect of these inflationary policies has been to destroy savings, which are the bedrock of a stable economy.

As if this wasn’t bad enough, the GDP deflator further conceals the gap between statistics and reality. Put simply, so long as money and bank credit expand at a faster rate than the deflator, GDP will grow purely from the extra cash in the economy. For governments, this is an incitement to monetary inflation: never mind the reality that Weimar Germany, for example, was collapsing in the early 1920s – statistically it would have been growing strongly until money itself finally “died”.

The least we can do is adjust GDP to better reflect the economic reality of our situation. In the UK’s case, nominal GDP is shown as growing 49% between 2000 and 2010, but if you strip out the increase in central government, that falls to 41%. But the real shocker comes from deflating the private sector by the increase in M1, which represents cash in circulation and sight deposits. Instead of growing at a price-deflated annual average of 1.3%, GDP actually falls by an annual average of 3%.

This result arises from looking at economic performance in strictly sound money terms. We can only conclude that monetary inflation is very effective at concealing hard economic truths, and that the UK has actually been in a slump for some time. And the UK is not alone, because the USA’s GDP numbers are similarly inflated.

No wonder unemployment is so high; no wonder the economic miracle we were all promised has been a mirage. And any recovery will only be a statistical aberration resulting from the difference between monetary and price inflation. No wonder the sterling price of gold is knocking on the door of £1,000 per ounce: it’s a wake-up call that things are not as good as they seem.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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