Governments are not engaged in a systemic conspiracy to alter economic data after it has been collected. To get a multitude of individuals agreeing on how to fudge information would be far too difficult to control. Instead, it is much easier for a small group of government officials to simply change the formula for calculating the data points that they desire to manipulate to make the information seem more palatable.
For example, since the world completely abandoned the gold standard back in 1971, governments have repeatedly tinkered with the CPI formula in order to convince the public that prices are vastly more stable than they are in reality. And now, since the developed world is suffering from anemic growth rates due to a massive debt overhang, governments have turned their attention to changing the way GDP is calculated.
Starting this year, the government of Italy will add the mafia's "contribution" of goods and services to its GDP. In fact, illicit activities like smuggling, prostitution and narcotics will now factor into the growth calculations of the U.K. as well. Analysts expect this accounting change to boost Italy's GDP a couple of percentage points each year. And another study found that America's underground economy was worth about $2 trillion annually. That's more than 10 percent of our legitimate GDP. Therefore, you can bet that the U.S. isn't far behind in adopting Europe's new GDP formula.
The U.S. already performed a little hocus pocus on the GDP numbers back in July of last year. The government made a significant change to the gross investment number, which now includes; research and development spending, art, music, film and book royalties and other forms of entertainment as the equivalent of tangible goods production.
GDP numbers have been chronically subpar in the U.S. since the Great Recession supposedly ended. Growth increased just 1.9% for all of 2013 and posted a negative 1% during Q1 of this year. And much the same can be said to describe the GDP data over in Europe as well, as they also have endured subpar and/or negative growth. As further evidence of the deteriorating growth condition, on June 10th the World Bank lowered its global growth forecast and cut U.S. growth to just 2.1% for 2014, from the previous estimate of 2.8%.
Therefore, our government leaders have sought to tinker with the formula more and more until they can produce the desired result they want to portray. Look for official government data on both a nominal and real GDP basis to become even more overstated in the future. Logically speaking, investors can also count on metrics such as debt and deficits as a percentage of the economy to appear much more benign than reality would otherwise present.
However, governments cannot so easily alter the most important metric in relation to the health of a sovereign nation. While it is easy for politicians to embellish the stated level of economic activity and growth, they are unable to increase the revenue to the government without actually extracting and redistributing private wealth through taxation. This means that the revenue available to service national debt will remain unaffected, no matter what formula the government comes up with to calculate GDP. The consequences of this will be devastating as an unprepared public is lulled to sleep with rosy debt metrics; but gets crushed when the bond bubble bursts due to insufficient revenue that is falling sharply in relation to interest payments on government debt.
Officials can triple count illegal activity if they so desire. But since it is illegal, by definition no additional revenue can be directly derived from it-especially from an arbitrary level of illicit activity made up by the government.
The sad truth is that economic growth will continue to disappoint and should worsen throughout the year, after perhaps a marginal bounce in Q2. One of the main reasons why there will be no sustained economic recovery is because the stimulus derived from the massive decline of interest rates has already accrued to the economy.
For example, corporations have been able to generate increasing profits, and individuals were able to reduce debt service expenses through the continuous refinancing of debt. To further illustrate this point, mortgage application are down 17% year over year. This is because the pipeline of people who have the ability to refinance their mortgage or that can qualify to purchase a home has already been vastly drawn down. With the refinancing and first-time buyers' market pipeline mainly exhausted, the housing market's support to the economy is fading. Now that interest rates have leveled off at rock bottom, after falling sharply for over 30 years, the tremendous tailwinds of ever-reducing borrowing costs have abated.
As the economic fundamentals continue to deteriorate, look for official government data reports on inflation and growth to become more imaginative and creative. But here's a brief reality check for investors:
- Debt levels have exploded in recent years and have now reached intractable levels in the developed world
- Central bankers-the supposed protectors of our purchasing power--have devolved to the point of now artificially providing zero and even negative nominal rates, with the expressed desire to push real interest rates further into negative territory
- Asset bubbles now extend beyond real estate and are now also prevalent in equities and bonds as well
- The middle classes are being eradicated through inflation, falling real incomes and debt
Another sad reality is that we used to live in a world in where asset prices were determined by the unfettered competition of markets. Today, markets have been obliterated by a handful of central bankers competing to provide the lowest interest rate and the greatest amount of monetary manipulation.
But in the end free markets always prevail and the eventual adjustment from the current fantasy world created by central banks and governments will be extremely violent and destructive. The chances are high that the adjustment will begin within the next two months, as the Fed's asset purchases will be nearly halved by the end of July QE. And will end completely a few months after. It is during that timeframe that I believe the gravitational forces associated with the free market reconciliation of asset bubbles begins to take effect.