Wednesday, October 9, 2019

Correcting GDP by Monetary Inflation

Let us assume there is an expansion of the quantity of money and credit. This can only become an addition to everyone’s earnings and profits, some of which will be reflected in rising prices and some in a deficit on the balance of trade. Nominal GDP cannot tell us anything about the loss of purchasing power of the currency, but we should correct GDP by the increase in money and credit to get a valid adjustment. But GDP includes exports, but not imports, so we need to capture the excess of imports over exports as well. 

This is because monetary expansion “escapes” to result in a deficit on the balance of trade, assuming there is no matching increase in the general level of consumer savings. America’s GDP adjusted for the increase of money and credit and the effect on the trade balance is shown in Chart 1, taken since the Lehman crisis when the current cycle of monetary expansion began.


While nominal GDP increased from $14,353bn in the first quarter of 2009 to $21,339 in the first quarter of 2019, adjusted for the expansion of broad money and the growing deficit on the balance of trade, it increased by only $642bn, a relatively small increase that can be easily explained by other variables, such as changes in flows between financial assets and non-financials, as well as between other categories included in the GDP compilation and those that are not. It was also close to the level of adjusted GDP in 2010, so has gone nowhere.

The lesson we learn from this is that all the money-printing and expansion of bank credit does virtually nothing to improve the economy. It is like flogging a dead horse that just won’t get up. Furthermore, if the Fed reintroduced massive QE for the next ten years, it would not engender any economic recovery whatsoever.

We have now established that issuing extra money and credit does nothing more than inflate the GDP statistic. The consensus today among both bulls and bears is that the pace of monetary expansion is about to accelerate again, confirmed by policy makers themselves. 

Therefore, nominal GDP will continue to increase, even in the teeth of an economic downturn. It will allow policy makers to claim they have rescued their economy from recession, or even from a prospective slump. The problem is then how to suppress the evidence of rising prices, the natural consequence of an increase in the quantity of money and credit that does not escape into net imports. It is necessary to give the appearance of economic growth.

Government statisticians have made significant progress in this direction. Independent analysis in the US by both Shadowstats.com and the Chapwood index suggests that prices are rising by approximately ten per cent per annum, not the 2% claimed by the government. It should be noted that in common with many other governments, the US Government faces some of its costs being indexed, so already has good reason to suppress evidence of rising prices, which they have been doing progressively since the 1980s.[i]

The fact of the matter is that changes in the general level of prices cannot be measured, and no one religiously buys the components of the consumer price index in the proportions allocated. Nor does anyone pay a hedonically adjusted price. This gives government statisticians with all their tools of statistical manipulation the ability to calculate whatever goal-sought result they want. The cumulative effect of this deception should not be underestimated, as Chart 2 illustrates.


Chart 2 shows end-year GDP between 2010 and 2018 deflated by the consumer price index for all items (US, city average, all urban consumers - the blue line). The end value of GDP adjusts from $20,898bn down to $18,231 in 2010 dollars, giving an average annual real growth rate of 1.71%. The red line is the end-year GDP adjusted by the Chapwood Index.[ii] The values taken are average annual inflation rates for all fifty cities included in the index, which are in turn comprised of the top 500 items on which Americans spend their after tax dollars. The average inflation rate of all these cities between 2010 and 2018 is exactly 10% and gives a final value for adjusted GDP in end-2010 dollars of $8,996bn. This is a drop in GDP values of 41%.

Besides showing that you can prove anything with statistics, the serious point is that by undermining the purchasing power of the dollar, monetary inflation has surreptitiously impoverished the American nation, something we also know from the wealth transfer effect of currency debasement. Clearly, the monetary authorities have pulled off an extraordinary trick: they have managed to transfer wealth from ordinary people and still be able to claim everyone is better off. Doubtless, they will not only continue with this monetary policy, but are about to accelerate it. Consequently, financial markets, being divorced from economic reality, will continue to believe everything is hunky-dory while the productive capacity of the economy continues to crumble – until they don’t.

It is a situation that one day will surely be corrected by a big adjustment; a sudden realisation of what’s actually happening. It can only lead to a crunch involving financial assets and fiat currencies, the apportionment between the two yet to be revealed. It is the stuff of the next credit crisis, which is bound to be crippling for the banks, a recurrence meant to be prevented following Lehman.

The authorities set up the G20 to coordinate plans to stop another banking crisis, but all they came up with was bail-ins to replace bailouts, and stress testing to identify banks in need of more capital. Both will not prevent another crisis, because they fail to address the cause. The forces behind a new financial calamity, driven by markets adjusting from extreme wishful thinking to reality, will only be appeased by a tsunami of new money.

The surprise is likely to be all the greater because adherents to the false science of macroeconomics, which includes the central bank establishment almost to a man, will find they have been misled by their maths, their statistics, and their charts. Instead of basing their approach on a proper understanding of the theory of money and credit, central banks and the economists in government treasury departments continue to worship their false gods. Because a banking crisis was averted in 2008/09 by nationalising or rescuing banks and other financial providers, it is believed the expansion of money and credit involved will work next time. The quantity required is whatever it takes to return order to the financial system.

All this extra money will ensure GDP will appear to grow, so long as evidence of price inflation remains suppressed. For believers in macroeconomics it will be proof the state theory of money works. It is pure deception.

Unfortunately, what is unseen is an acceleration in the rate of impoverishment faced by the wider population, that can only end in a collapse of the system. If you don’t believe it, talk to an Argentinian, a Venezuelan, or brush up your Shona and talk to a Zimbabwean.

- Source, Goldmoney