GDP Numbers Can Hide Real Economic Damage

According to the mainstream narrative, the US economy is quickly recovering from the downturn caused by lockdowns in response to COVID-19. And while the downturn was sharp and painful, it really didn’t cause any long-term economic damage. Good times are ahead! After all, just look at the booming GDP numbers.

And therein lies a problem. The GDP doesn’t really give us a good picture of what’s going on in the economy. In fact, the way the number is calculated actually hides economic damage.

Gross domestic product measures total spending on “final goods and services” in the economy. As economist Patrick Barron notes in an article at the Mises Wire, it elevates the Keynesian concept of “aggregate demand” as the most important economic measure.

But GDP does not give us much insight into production and it tells us nothing about savings.

In fact, the Keynesian worldview spurns savings. According to “the paradox of thrift,” saving actually harms the economy, particularly during a downturn. If people start saving money in mass, it can create a “death spiral”  from the reduction in consumer spending. Barron offers an example.

Individually, savers may be better off, they say, but collectively the economy suffers. For example, the new auto that we savers do not buy, rather keeping our old one in good repair for a few more years, denies the automakers and all who work for them the money they need to continue production. Layoffs and plant closings ensue. The reduction in aggregate demand ripples outward, bankrupting more and more support businesses and their employees. This is the simplistic Keynesian view of savings.”

But as Barron points out, saved money doesn’t just disappear down some black hole. Savings become capital investments. They fund the development of long-term production processes that will yield more wealth in the future. While saving may mean fewer automobiles produced and sold today, savings will lead to products and services that otherwise would have never existed. In simple terms, saving today sets the foundation for prosperity tomorrow.

By and large, GDP ignores this aspect of the economy as it focuses almost exclusively on spending on final goods and services. Simply spending money doesn’t mean we’re better off.

Keep in mind, GDP also captures government spending. In other words, trillions of dollars in stimulus spending will juice GDP. While it may make the economic numbers look good, I’m not convinced that printing money out of thin air and spending it on the priorities of politicians and bureaucrats really benefits the economy in a fundamental way. Imagine if I went out and spent thousands of dollars on beer and hookers. If we’re measuring my family’s economic health based solely on spending, it would look pretty good. But digging more deeply into the economic health of my family would tell a different story.

Barron points out two other critical flaws in the GDP measure.

First, it fails to capture spending on longer-term and intermediate-term production. In fact, it mostly measures retail sales. For instance,  intermediate goods, the goods that are inputs for final products, are not generally included when calculating GDP unless they are added to inventories.

Headlines that retail sales are up are supposed to generate confidence that all is well with the economy. But is it? If you and I spent all our savings and even borrowed more, we would soon find ourselves in the poorhouse. But Keynesians would say that our individual financial difficulties were good for the economy. Anybody buying that? I certainly hope not!”

Most significantly, GDP captures price inflation and calls it economic growth. In fact, the entire GDP metric is designed to measure price increases, not actual increases in the production of goods and services. Barron provides an example.

In the past month or so the price of a gallon of regular gasoline in my home state of Pennsylvania has gone up from just under $2.50 to around $3.00. That’s a 20 percent increase in price. Since gasoline consumption changes little in the short run, selling the same volume of gasoline at a higher price causes GDP to go up. But our standard of living just went down! Our increased dollar spending on the same amount of gasoline had to come from somewhere. We had to cut back somewhere else, either some other consumption item or, most likely, a reduction in savings. Whereas government says that the increase in GDP means that we are better off, actually we are worse off.”

Real GDP is adjusted using what is known as the deflator, so the number ostensibly factors in inflation. But like the CPI, the deflator is a number based on a “basket of goods.” As Boundless Economics explains, “Unlike the CPI, the GDP deflator is not based on a fixed basket of goods and services; the ‘basket’ for the GDP deflator is allowed to change from year to year with people’s consumption and investment patterns. However, trends in the GDP deflator will be similar to trends in the CPI.”

This should give us pause. These government numbers used to calculate inflation have a track record of understating actual price increases. Government officials and central bankers keep telling us that inflation is muted based on CPI. But a trip to the grocery store tells a different story. Simply put, you can’t trust these numbers.

Inflation properly defined is an increase in the money supply. We’ve seen that in spades over the last year. In fact, the money supply has increased at a record pace. As Barron explains, “If the money supply increases, eventually this increase will work its way into the price structure. It can do nothing else.”

M2 stood at $7.215 trillion in 2008, then was juiced to $15.419 trillion by January of last year. It now stands at $19.384 trillion. That’s a 169 percent increase, and tracks well with inflation in asset prices like stocks and housing. The $1.9 trillion third stimulus program will add dollar for dollar to M2 initially. If the banks pyramid more lending on top of this increase in their reserves, M2 will continue to grow beyond the $1.9 trillion. This is exactly what the government wants, because it will goose GDP.”

Barron points us toward an important lesson – don’t be fooled by government statistics, especially GDP, that the economy is recovering nicely from the pandemic.

The COVID-19 lockdowns have caused immense damage to the economy. Government money printing may goose GDP, but It will do nothing to compensate for the deadweight loss that millions have suffered.”