The problem with GDP is that government consumption of private capital is positive. And with the government gradually taking over all aspects of the economy, even a small cut in spending can send workers to the unemployment line and shutter businesses.
In this episode, John Flaherty and Keith Weiner discuss why GDP is such a poor measure of economic health, while also suggesting a much better alternative.
John Flaherty: Hello, everyone, and welcome again to the Gold Exchange podcast. I’m John Flaherty and I’m here with Keith Weiner, founder and CEO of Monetary Metals. In our last podcast, we discussed the field of economics and a few reasons why it has often been labeled an inferior science. Today, we hope to drill down a little deeper into one important metric of the health of an economy, namely, GDP
We’ll also see where and how this metric falls short, and if better alternatives exist. So, Keith, gross domestic product is defined in Investopedia as the total monetary and market value of all the finished goods and services produced within a country’s borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health. Thoughts on that definition, Keith?
Keith Weiner: Well, scorecard of a country’s health. You know, there’s a certain analogy to saying that, patient goes to the doctor. Doctor says, get on the scale, and then we take the patient’s weight as a comprehensive scorecard of the patient’s health. Where higher, of course, being treated as better. Is that really what you want to do? Problem with the GDP is that it includes both government consumption, everything the government buys and consumes, and also all of the consumers who don’t produce, who are given handouts by the government, whatever they spend and consume, is also included in GDP.
And both of those are the opposite of healthy. Those things should be subtracted, if anything, and not added. So basically my definition of GDP equals production plus destruction, and they’ve got the sign in front of destruction wrong.
John: So why is it that we pay so much attention to this metric?
Keith: Well, I think the central planners have two reasons for touting these types of macroeconomic numbers. One is as propaganda and the other is as a means of central planning. Of how they target whatever price or rate that they want to manipulate. They purport to be looking at something in order to know what they’re doing. So let’s take the first one first. You know, what the central planners are doing is harmful to us as citizens and particularly productive citizens.
The unproductive ones, the ones that are being given a handout, first of all, don’t have any complaints because they’re getting something for free. And secondly, they don’t really care anyway because they’re not really thinking about it. They’re just happy because as long as the gravy train is is rolling along, they’re fine. But everyone else needs to be sold the way the evil works. And yes, I will use the word evil to describe the central planners.
Evil is always obsessively, incessantly, chronically seeking the support of the good. It’s always trying to sell itself. The lie must always be reinforced and doubled down and propagandized and evangelized over and over and over and over and over again. Because as long as there’s a free market for ideas, then people can discover the truth. So the central planners have to tell you how good they’re doing. And as long as they can get GDP to grow and as long as they can get, most importantly, as long as they can get people to believe that GDP is a measure of the economy, then all they have to do is make the GDP number go up and then they can say, see, look at all this growth we’ve given you and everybody accepts that.
And then secondly, it gives the central planners, it gives them a metric to study and purport to follow it while they do whatever it is they’re doing. Let’s say to the interest rate, which is the price of borrowing money. They know they’re playing at following math or pretending that while we have rules, you see and this is all very objective, this is all very scientific. We’re calculating because Mises said you need prices in order to be able to plan, and has to take individual actors based on prices that they’re seeing in the market.
Well, this is the central planning circuit. Instead of looking at prices as indicators of a zillion and one things going on in the economy, they’re looking at a macro aggregate GDP number. And I think the ultimate way to see this is suppose the government locks the economy down due to COVID. I know that’s crazy. I know that’s a reach. They would never do that, of course. But suppose they did and then GDP takes a huge….falls off a cliff.
So suppose they turn around then, and they start handing out free money to all sorts of different groups, whether you’re big airlines or small businesses or welfare recipients or newly unemployed. They just start writing trillions and trillions and trillions of dollars worth of free checks and doling it out. And suppose people were to go and spend those checks. And the net result is that one dollar more is being spent than was being spent previously when all those people were working and the economy was producing that much more.
According to GDP, you had a dollar of growth. But GDP is not differentiating between growth of what? Of bloat of government, of the parasitic government, which is sapping the lifeblood of fewer and fewer remaining producers. You’re not distinguishing between that, versus increasing production. So according to the propaganda statistic, everything looks good. It grew.
John: So, Keith, we can actually have “growth” in the midst of government just printing and doling out all of that money?
Keith: Well, the question is, that really growth, or is that an artifact of a bad measure of growth? So I’d like to I’d like to point to the fallacy of the broken window, which was proposed by Bastiat with his unique wit, and he likes to make the case in favor of the fallacy and then debunk it. So he’s talking about, isn’t there growth? If somebody throws a rock through the window of the tailor, I think it’s a tailor, breaks a window. Now, the tailor has to go buy a new window so the glazier gets paid.
And isn’t this adding to the economy? Of course, he points out that, well, that means that the tailor doesn’t have as much money….no, it’s the shopkeeper, because he doesn’t have enough money to go to the tailor, as he had planned to do, and go buy a suit. And so the tailor is deprived of whatever goes to the glazier. And so, of course, it doesn’t make any sense. All we’re doing is we’re substituting somebody buying something new and increasing their value attained in this world.
And then all we’re doing is forcing them to replace things that are already thought they had as we break them. Today, of course, with the ability to just add debt, the shopkeeper would go to the glazier AND the tailor, he would just borrow a bit more. And so we just add to the debt in order to fuel this consumption. It is absolutely true today that if you break a window it adds to GDP. And so is that a recommendation in favor of breaking windows?
No. It’s a damning indictment of GDP as an utterly fallacious, not useless measure, but less than useless. Like if you get shot in the heart, putting a Band-Aid on it is less than useless, because not only doesn’t it fix a bullet wound in your heart, but actually it convinces you that nothing needs fixing, that you’ve actually fixed the problem. And so it’s actually worse than useless because of that. So that’s what GDP does.
John: So, we’re actually in a situation where we’re like praying for natural disasters to to juice this metric.
Keith: I think it was Krugman talking about the benefit of a massive war and bombs raining down and destroying our cities. He was talking about economic benefit of that. Oh, no, no, I’m sorry. He was talking about what if we encountered an alien race, UFOs fly to Earth and then are bombing us and we end up with a war with the aliens. So, yes, there are some people that actually believe that.
John: So you’d mentioned interest rates earlier and we all know that the Fed is in the business of suppressing interest rates and have been for decades. How does this interest rates suppression affect GDP?
Keith: Well, it’s always boosting it. Because every time the interest rate drops down, that’s a fresh additional incentive to every business and potentially consumers, too, particularly when manufacturers offer creative financing terms. And you can buy a car and they say zero percent for 72 months or 84 months. And that might be an inducement to buy the car, or particularly to businesses. Suppose you are a manager at a hamburger chain and you’re considering locations for opening a new store. And they always have to go through their numbers. They build a spreadsheet where they estimate how many cars are driving past that intersection to figure out how much business they’re going to get. And then they have to figure out their cost of interest because they borrow money to open the store. So that interest expense is a pretty significant input into their into their spreadsheet.
And then let’s say let’s say there’s ten locations that are marginal. Well, it just doesn’t really work…interest expense is just or they wouldn’t say the interest expense. They would say the overall business case isn’t there to open these restaurants at this time. Now, if the traffic would increase, they would open the restaurant or if the interest rate were to drop. Now you plug in new lower cost of borrowing money and suddenly it makes sense. So then you buy the real estate and you hire a whole bunch of construction guys to build your store.
And then you buy a whole bunch of equipment. You buy the fryers and the grills and the freezer cases and the microwave ovens and all the stuff that you need to operate a burger joint. And then you hire a whole bunch of people that are now drawing salaries and going to staff the burger place, all of which made possible because the interest rate went down. And the other thing that happens when interest rate goes down is the price of all the assets goes up. Because, you know, an asset has a value based on the cash flow that’s going to generate in the future.
That cash flow that you’re going to generate in the future has to be discounted to the present using basically the interest rate. So if you’re going to make a dollar a year from today and the interest rate is 10 percent, then that dollar’s worth 90 cents. But if you cut the interest rate in half, the dollar’s worth ninety five cents. So over long term assets, every halving of the interest rate doubles the value of it. And so every time assets goes up, people feel richer and they they spend more. Economists call this the wealth effect.
John: Which is why we can’t rely on the stock market or price of real estate as other alternative measures of the health of the economy either. That’s a trap we often fall into, right?
Keith: Yeah, they’re just measuring the same thing in a different way. And if you have three or four different numbers that you think are different metrics, but actually they all depend on the same variable, then you’re fooling yourself into thinking that you have multiple metrics. You don’t.
John: So now that we’ve pulled the curtain back a little bit behind this comprehensive scorecard in quotes there for the economic health of a given country, what is it that we should be paying attention to for a realistic picture of the health of an economy?
Keith: So one thing I like to look at, because I think it encompasses…instead of encompassing so much of what the central planners like to tout about their central planning. Instead, this actually encompasses much more of what people should be looking at, and that is marginal productivity of debt. A lot of people, try to look at debt to GDP and say, well, OK, I want to get to this percentage, that’s like a magic line.
And then everything somehow suddenly goes bad at this magic line. Anybody that proposes to you that there’s a magic number, you should immediately be skeptical. Because it doesn’t work that way in the real world. But marginal productivity of debt is simply saying not how much GDP do we have and how much debt do we have and trying to relate those two. There’s not really enough useful information there in order to make that relationship. Marginal productivity of debt is saying that for each new dollar of debt that we add, freshly borrowed in 2020, how much new GDP does that newly borrowed debt create?
So in all the examples I’ve given previously, somebody borrows in order to build a hamburger restaurant. Let’s say they borrow a million dollars. Well, that’s a million dollars added to GDP. Because now you’re building the brick and mortar, hiring all these people, whether you’re buying the bricks or whether you’re buying the laborers of the bricklayers, you are spending what you borrow and adding to GDP.
But a funny thing happens when you borrow for unproductive purposes. That is, borrowing not to build a business, or build an asset that will generate an income, but rather you’re borrowing in order to dole out welfare in welfare state. Or you’re borrowing for other financial engineering purposes. And what happens is you begin to accumulate baggage of debt that isn’t productive debt. It didn’t create a productive asset, but the debt is still there. And so marginal productivity of debt is essentially measuring a ratio of how much debt that’s being created is adding to GDP and how much that is just simply an anchor dragging the whole thing back.
And so what you what you should expect, what you would like to find, if things were going good is marginal productivity of debt should be well above one. That is, each freshly, newly borrowed dollar should add more than a dollar of GDP. I mean, in theory, if you borrow a million dollars to open that hamburger restaurant, that hamburger restaurant is going to generate profits and revenues and add to GDP, for that matter, in perpetuity. That’s a debt was only incurred once and essentially it’s paid off. So the more historical good investments you have, marginal productivity of should be should be positive.
Unfortunately, what we find is going back to at least 1950, which is the oldest data that I’ve been able to find, marginal productivity of debt has been a falling number. That is, we’re tending to get less and less GDP for each freshly, newly borrowed dollar. And that’s a scary, even if you’re not an economist, even if you’re not a Ph.D., you should look at that and say that’s scary. And what happens when it hits zero? What happens when it goes negative? And those are questions that, alas, mainstream economists are not bothering to ask.
John: Yes, probably questions for another episode. Keith, this has been a great discussion. Appreciate your insights today. I’d like to thank you and our audience for joining us on The Gold Exchange.