| May 29, 2010

The Bureau of Economic Analysis (BEA) released its initial revision to first quarter GDP data this week, reporting a relatively small downward change from 3.24% to 3.04%. If you strip out the effect of inventory adjustments and focus on sales growth alone, the figure dropped from 1.67% to 1.39%. The economic growth spurt from last year, fueled by massive government stimulus programs, appears to be moderating as we have been expecting, and the inventory build is effectively complete. We anticipate additional deterioration in the economic data as we move into the second half of the year.

The mainstream financial media generally focus on the GDP growth rate. However, there are two other measures reported by the BEA that are useful to monitor. Gross Domestic Income (GDI) measures the total amount of income received across all sectors of the economy, and Gross National Product (GNP) is a superset of GDP that includes interest earned from and paid to the rest of the world. Let’s take a closer look at both beginning with the GDI.

In theory, GDP should always be equal to GDI; while the former measures how much has been spent, the latter measures what was consequently earned. However, they are calculated in different ways, and their rates oftentimes diverge. Whenever this happens, the BEA calls it a “statistical discrepancy” and the difference is generally ignored. Upon closer inspection, though, divergences between the two often have useful stories to tell. For example, during this last economic contraction a wide gap developed between the two, and the GDI has now exhibited nine quarter-to-quarter contractions since the beginning of 2007, while the GDP has only done so four times. In other words, according to the GDI, this last recession has been much worse than the GDP suggests. So which measure provides a more accurate representation of economic growth or contraction when they disagree? As you might expect, that depends on whom you ask. The BEA itself claims that the GDP is the more accurate measure, but others, including John Williams over at Shadow Government Statistics, see things differently.

“Where the standalone GDI does not receive the media and Wall Street focus of the GDP, and its reporting lags GDP reporting by a quarter or two, it is not subject to the same political pressures and financial market needs that impact GDP reporting. Accordingly, I view the GDI series as better-quality indicator than GDP of broad business activity.”

As always, the government and big business are interested in painting the rosiest picture possible, so they do everything in their power to improve the consumption side of the equation as reported by GDP. Since relatively few track the GDI closely, there is very little perceived need to massage the data that it is based upon, suggesting that it may indeed provide a more objective measure of overall economic health. The current GDI reading for the first quarter is 2.89%, which is below the 3.04% GDP growth rate.

As for GNP, it was once the headline number here in the US many years ago. Why was it replaced by GDP as the most important gauge of economic activity? Keeping in mind that the folks in charge are perpetually focused on delivering the most optimistic appraisal of the current situation, the reason for the shift from one to the other is obvious. Since the GNP includes interest payments to and from other countries, it will suffer when the country in question owes the rest of the world more than it is owed. If you are paying more interest than you are earning, the GDP will look better than the GNP. Therefore, as a net debtor nation, the US has a vested interest in promoting the use of GDP over GNP.

The promotion of GDP as the most accurate measure of broad economic activity is yet another attempt to shape your views as a market participant. Economic and financial market realities oftentimes lie somewhere beneath the headlines, so it is always important to analyze the data yourself and draw your own conclusions. We have said it before and we will say it again: self-reliance is the key to long-term success.

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Category: Commentary, Market Update

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