Dan’s Blog

Smoke & Mirrors

Dan Calandro - Sunday, August 04, 2013

The big news this week was in regards to Gross Domestic Product (GDP), defined as the value of all goods and services traded in markets for a territory. In its most recent report on economic activity, the U.S. made a couple of changes to GDP calculations. 

First, the U.S. modified the chained period to calculate Real GDP. Prior to the change, Real GDP priced market activity in terms of 2005 dollars; now it prices Real GDP in terms of 2009 dollars. Second, GDP activity was expanded to include items such as research and development, and investments in intangible assets like patents and trademarks; and in addition, a change was made in the method of accounting for employer funded pension plans.

The combination of these modifications added $500 billion to GDP.

Call me a cynic, but this move is so transparenly political it reeks. It is clearly a move made to substantiate government spending and debt levels when the underlying economy simply cannot. And since no other country uses the new U.S. definition of GDP, it is easy to deduce that the changes were made solely to inflate GDP closer to the escalating national debt levels - and I'm sure Washington wants the world to follow.

Doesn't that sound just like Washington DC today?

While one-half trillion dollars is a significant adjustment indeed, it doesn’t change the economic picture to any great extent. New GDP figures also slightly changed the action zone, the high point (a.k.a. irrational exuberance) now stands at 15,068. Below is a ten year chart comparing the Dow Jones Industrial Average to Real and Nominal GDP.  


In Real terms, stocks haven’t traded this high in the last twenty years – not even at the peaks of the housing and tech booms!

So why does "the market" continue to trade at multiples like these?

Inflation, plain and simple.

Many TV pundits often defend Ben Bernanke’s and the Fed’s easy money policy by citing that no inflationary problem exists – that the general rise in prices for goods and services is "tepid." But these people overlook the asset bubble (a.k.a. inflation) being created in the stock market, courtesy of the Fed’s addiction to QE.

More new money always creates inflation somewhere. The spread between Real and Nominal GDP is inflation. Inflation, as shown in the chart above, is anything but tepid with approximately 3,000 points of inflation, or 19% of its value, currently in stock prices today.      

The reason the economy is barely growing in Real terms is because QE isn’t doing anything to expand the economic base. It’s being used to artificially inflate the stock market – to put on the façade that economic conditions are better than they actually are. 

This is political smoke and mirrors.

The last two economic booms had legitimate catalysts: housing and technological advances. The internet opened local markets to the world, juiced employment, created wealth and circulated money to all four corners of the Market. The housing boom did much of the same. But there is no economic boom going on right now. Economic growth, even under the new calculation, stinks at best.

As such, this is a smoke and mirrors stock market run, built and sustained solely on the Fed’s addiction to poor monetary policy and QE. 

And like all pyramid schemes, this bubble too will burst.

Stay tuned…

ShieldThe road to financial independence.

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