The economics behind the bull and bear case

[Timmy]

The issue arises with capital goods, and how they are costed and imputed into final GDP. An example:

Iron ore is mined, and sold to a steelworks that turns it to steel, which is sold to a manufacturer of steel metal tools, which manufactures a machine tool, which is sold to a manufacturer [using the tool] to manufacture a component of an automobile, which sells the component to Ford.

In GDP, the calculation is as follows:

Selling price of iron ore - mining costs.
Selling price of Ford - purchase costs of iron ore.

All the intermediate transactions [with associated profits/losses] are lost to the final GDP calculation. Thus we can see immediately that the assertion of consumer purchases constitute 70%+ of the economy, is a fallacy.

duc - thanks for the detailed post with plenty of info to think through.

One thing I don't get is what you have said here, that the intermediate steps not being captured. If we take the final step in the chain (Selling price of Ford in this example) and subtract the first step in the chain (cost of iron ore), wont that capture all the intermediate steps anyway, the value added at each step will be built into price, which is passed on up the line etc.?
(Hope I explained this clearly enough?)

ps. On deflators not working under certain circumstances, bit of homework for me there to grasp this - tks again.

 

[Whiskers]

For what it's worth the World Bank, IMF and CIA all do GDP estimates which don't exactly agree, but the general picture tends to be about the same.

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)


Probably what's more important is the differance in accounting standards for bad debt which some argue caused paper/potential losses to be recorded more quickly than in Aus for example... which axcelerates the rate and chain of defaults, margin calls etc... or conversly in Aus delaying the reporting of bad debts.

I'm only generally aware... maybe an accountant can eloberate.

 

[Beej]

For what it's worth the World Bank, IMF and CIA all do GDP estimates which don't exactly agree, but the general picture tends to be about the same.

[snip]

Probably what's more important is the differance in accounting standards for bad debt which some argue caused paper/potential losses to be recorded more quickly than in Aus for example... which axcelerates the rate and chain of defaults, margin calls etc... or conversly in Aus delaying the reporting of bad debts.

I'm only generally aware... maybe an accountant can eloberate.

Not sure about the bad debt accounting question (or how this would effect GDP calcs?), but as far as the different figures from CIA/IMF etc etc, I think that has purely to do with the way exchange rates are used to get a number that can be used to compare countries, rather than any difference in the calc methodology itself. In fact I'm pretty sure all sources would have to start with the GDP figures published by the various countries government agencies, as there isn't really any other source for the data you would need to work GDP out otherwise.

Cheers,

Beej

 

[professor_frink]

Theory (maybe at your peril) by all means but now its time to look at backed up facts

Well from my studies and reading proper economists, (not ex Bank Clerks) there are really no good facts.

US GDP is 75% consumption, this is unproductive GDP (only one third of adults in the US work productively)

Still waiting for those backed up facts explod

 

[GumbyLearner]

Couldn't find any CIA links. How about the Hoover Institute at Stanford University?

http://www.hoover.org/research/factsonpolicy/facts/4931661.html

Personal consumption accounts for 70 percent of gross domestic product.
The gross domestic product (GDP) is the generally accepted measure of the size of the national economy. It is the sum of investment, personal consumption, government spending, and net exports. Personal consumption, at 70 percent, is the largest component of GDP. Other components of GDP include
–Investment: 17 percent
–Government spending: 19 percent
–Net exports: –6 percent

You were 5% off explod. But hey nobody's perfect.

Also check out this take on economics junkie.

http://www.economicsjunkie.com/true-consumption-as-percentage-of-gdp/

 

[ducati916]

Couldn't find any CIA links. How about the Hoover Institute at Stanford University?

http://www.hoover.org/research/factsonpolicy/facts/4931661.html

Personal consumption accounts for 70 percent of gross domestic product.
The gross domestic product (GDP) is the generally accepted measure of the size of the national economy.

It is the sum of investment, personal consumption, government spending, and net exports.

Personal consumption, at 70 percent, is the largest component of GDP. Other components of GDP include

–Investment: 17 percent
–Government spending: 19 percent
–Net exports: –6 percent

One thing I don't get is what you have said here, that the intermediate steps not being captured. If we take the final step in the chain (Selling price of Ford in this example) and subtract the first step in the chain (cost of iron ore), wont that capture all the intermediate steps anyway, the value added at each step will be built into price, which is passed on up the line etc.?

The fallacy of Personal Consumption is wideranging and pervasive. I have highlighted the question, which is actually the crux of the problem. To answer the question, and demonstrate the fallacy, I shall stay with the original example. I have simplified the numbers for ease.


...........................................................Costs..........Profit.........Gross
Consumer demand: Ford Falcon.................$80.............$20...........$100
Ford demand for parts/components............$60.............$20...........$80
Component Maker supply parts..................$45.............$15...........$60
Toolmaker demand for Steel.....................$30..............$15...........$45
Steelmaker demand for Iron Ore................$20..............$10...........$30
Mining operation demand for Iron Ore...........................$20...........$20
Total...................................................$235...........$100..........$335

Thus the ultimate arbiter of prices and demand are the consumers. It is their final end demand that determines prices, and thus profits [or losses] higher up the productive structure.

You also see that starting from the first producer, viz. the [land] mining operation that provides the iron ore, that the purchaser of the higher order producer, pays the total of that producers costs + profit.

Thus the mining operation, who own the land [and I know I haven't worked the costs all the way back] produce from the [land] $20 in profits, thus, land as a productive factor, earns RENT [or a mortgage payment] Again, ignore for the moment Depreciation/Depletion.

The Steelmaker, purchases for $20 the mines output, and sells the produced steel for $30 and this continues down to the final consumption product, the Ford Falcon, purchased by the consumer.

Looking at the totals:
Costs..............................$235
Profits.............................$100
Gross..............................$335

Now to the question of Consumer Spending equalling 70% of GDP.

Consumer spending = $100 [the cost of the Ford Falcon]
Total Spending = $335 [the cost of all stages involved in production]

Consumer spending = $100/$335 = 29.8%

Herein lies the failing of Keynesian economic theory. Keynesianism postulates that consumer spending is vital to the health of the economy, the 70% of GDP fallacy, and as such, falling prices, or deflation, are highly detrimental to an economy.

Nothing could be further from the truth.

jog on
duc

 

[Timmy]

Thanks for the detailed reply Duc.

 

[GumbyLearner]

The fallacy of Personal Consumption is wideranging and pervasive. I have highlighted the question, which is actually the crux of the problem. To answer the question, and demonstrate the fallacy, I shall stay with the original example. I have simplified the numbers for ease.


...........................................................Costs..........Profit.........Gross
Consumer demand: Ford Falcon.................$80.............$20...........$100
Ford demand for parts/components............$60.............$20...........$80
Component Maker supply parts..................$45.............$15...........$60
Toolmaker demand for Steel.....................$30..............$15...........$45
Steelmaker demand for Iron Ore................$20..............$10...........$30
Mining operation demand for Iron Ore...........................$20...........$20
Total...................................................$235...........$100..........$335

Thus the ultimate arbiter of prices and demand are the consumers. It is their final end demand that determines prices, and thus profits [or losses] higher up the productive structure.

You also see that starting from the first producer, viz. the [land] mining operation that provides the iron ore, that the purchaser of the higher order producer, pays the total of that producers costs + profit.

Thus the mining operation, who own the land [and I know I haven't worked the costs all the way back] produce from the [land] $20 in profits, thus, land as a productive factor, earns RENT [or a mortgage payment] Again, ignore for the moment Depreciation/Depletion.

The Steelmaker, purchases for $20 the mines output, and sells the produced steel for $30 and this continues down to the final consumption product, the Ford Falcon, purchased by the consumer.

Looking at the totals:
Costs..............................$235
Profits.............................$100
Gross..............................$335

Now to the question of Consumer Spending equalling 70% of GDP.

Consumer spending = $100 [the cost of the Ford Falcon]
Total Spending = $335 [the cost of all stages involved in production]

Consumer spending = $100/$335 = 29.8%

Herein lies the failing of Keynesian economic theory. Keynesianism postulates that consumer spending is vital to the health of the economy, the 70% of GDP fallacy, and as such, falling prices, or deflation, are highly detrimental to an economy.

Nothing could be further from the truth.

jog on
duc

Thanks for clearing that up Ducati.

It is great to have a poster like yourself who can challenge some of the fallacies about GDP produced by the Ivy league institutions like Stanford University in the USA.

 

[ducati916]

Thanks for the detailed reply Duc.

Hope it helped.

Of course the example I offered is only one possible permutation of a structure of production. Some structures, in a highly technological product might have 30+ stages, some simple products might have only a few.

Either way, you can now see that the fallacy of consumer demand standing at 70%+ leads to some very serious misperceptions from our political masters who seek, for the good of the economy, to stimulate consumer spending.

Certainly by increasing consumption, GDP, as it is measured will increase. This however will not [increased GDP] actually help the economy in any real sense. The answer of course is to increase the stages of production. This has the effect of growing total economic activity.

To create a longer, narrower productive structure, capital, in the form of savings must be made available for capital investment, or an increase in capital goods. No scream the Keynesian's - that will only reduce consumer demand [true] and shrink the economy [GDP] as measured by our econometricians.

When consumer [final] demand contracts, the axioms of supply and demand come into effect: viz. falling demand mandates that to clear the market, price must be reduced [law of marginal utility]

By creating a longer, narrower productive structure, lower prices that conform to marginal utility can become profitable, under marginal productivity. Thus consistency in theory and reality.

jog on
duc

 

[ducati916]

Thanks for clearing that up Ducati.

It is great to have a poster like yourself who can challenge some of the fallacies about GDP produced by the Ivy league institutions like Stanford University in the USA.

I had a look at the two links that you provided. This one contains another fallacy. http://www.economicsjunkie.com/true-consumption-as-percentage-of-gdp/

To follow up on Consumer Goods vs. Factors of Production:

In that post I illustrated consumer goods production vs. investment goods production in the US. I noticed that the composition of the GDP at bea.gov has one flaw: It includes so called “Residential Investment” under Investment. But what mostly falls under this category are purchases of new homes.

A home clearly does not qualify as a factor of production and it is thus a mistake to include the production of it under investment goods (factors of production). It makes a lot more sense to include it under consumption.

This assertion is simply incorrect on the following basis.

As in the case of any other good, the capital value of land is equal to the sum of its discounted future rents. The value of the land increases as the capitalization rate falls with interest rates. Thus when the Fed lowered rates, the present value of the implied future rents on land became more valuable.

Ground land, then, is ‘capitalized’ just as are capital goods, shares in capital-owning firms, and durable consumers’ goods. Rothbard

Why is land classified as a capital good? Essentially the answer is durability. Land, is for all intents and purposes, eternal and unchanging, as such, it is capitalised, because otherwise it’s value becomes infinite, and it could never be bought or sold for money.

The raw land cost is generally 10 to 25 percent of a home. In 2001, the Bureau of Land Management (BLM) sold government-owned land to developers for $26,672 per acre in Las Vegas, Nevada. Four years later, BLM acreage was going for $270,000 per acre. So while land prices were increasing tenfold, the medium new-home price shot from $130,000 in December 2000 to $350,615 in early 2006.

Land, quite clearly is an original factor of production. As are Labour and Capital. Thus, we can refute his assertion.

jog on
duc

 

[ducati916]

Re: XAO Analysis

Not one of those examples is a fact, they are opinions. I pointed out to you that there are facts to support improving economies so i'm not sure the relevance of those examples unless your point was that there are no facts so opinions based on little are being substituted.

facts are China GDP, Recent US GDP, 6 straight months of growth in the ISM report with January PMI at 58.4 percent, its highest reading since August 2004 and the job market, (but that one is a lot more subjective) as a few examples.

Just to add a little fuel to the fire. The above data series [GDP etc] are not facts, they are obviously simply historical data. Said data is subject to many revisions that can in the case of GDP, stretch to years.

Additionally, data, that is subjected to analysis on a faulty premise, does not yield a factual conclusion.

jog on
duc

 

[ducati916]

From Trembling Hand,

Some of these replies are so far removed from reality I think I must live in a parrell universe.

There is plenty of wealth created "by consuming imported products." As an ex importer who use to bring in products and add to them, even if it was sometimes just distribution, and then sell them for 3 times their import cost I have seen plenty of families (employees and customer & their customer) benefit locally from that.

This is an example of a stage of production. The cost of purchasing stock [inventory] was the investment in capital goods. The selling price, returned the original investment + profit, which is the reward to entrepreneurs for correctly supplying a consumer demand.

Then of course there is just the whole premise that consumption is a negative. If the farmer makes milk, that the truck driver takes to the factory, that the factory sells to the retailer, that then makes a latte' from it, who sells it to the customer who consumes it????

Again, we have the original factors of production, land + cows, that produce the milk - which is then sold to the factory, investment in capital goods [which includes the requirement to transport], who add further capital goods to the onselling price, to be recouped, if they have correctly gauged their market - until it reaches final consumer demand, and is consumed.

Where is the negative in that?? production comes from consumption. Just because its not a Ford falcon sold to an export market you dudes think its the end of the financial world coming.

The highlighted sentence is a correct premise. Production, that has no end use: viz. consumption, are simply wasted resources. That they result in an economic loss, will immediately tell the entrepreneur that this product is not required, and will therefore end it's production, reallocating scarce resources to more profitable [consumption] uses.

jog on
duc

 

[ducati916]

From explod,

Well from my studies and reading proper economists, (not ex Bank Clerks) there are really no good facts.

A fact is something that is supported by real evidence. If you read the business pages you will note that the good feeling statements are not supported by verfiable facts.

Interestingly we are regressing to the origin of economics that evolved out of philosophy. The philosophical argument that developed, essentially finds expression within explod's assertion [highlighted]

The two conflicting area's, and actually there are substantially more, are: Empiricism & Rationalism

In epistemology and in its modern sense, rationalism is "any view appealing to reason as a source of knowledge or justification" (Lacey 286). In more technical terms it is a method or a theory "in which the criterion of the truth is not sensory but intellectual and deductive" (Bourke 263). Different degrees of emphasis on this method or theory lead to a range of rationalist standpoints, from the moderate position "that reason has precedence over other ways of acquiring knowledge" to the radical position that reason is "the unique path to knowledge" (Audi 771). Given a pre-modern understanding of reason, "rationalism" is identical to philosophy, the Socratic life of inquiry, or the zetetic interpretation of authority (open to the underlying or essential cause of things as they appear to our sense of certainty).

In philosophy, "empiricism" is a theory of knowledge that asserts that knowledge arises from sense experience. Empiricism is one of several competing views about how we know "things", part of the branch of philosophy called epistemology, or "the Theory of Knowledge". Empiricism emphasizes the role of experience and evidence, especially sensory perception, in the formation of ideas, while discounting the notion of innate ideas (except in so far as these might be inferred from empirical reasoning, as in the case of genetic predisposition).[1]

In the philosophy of science, empiricism emphasizes those aspects of scientific knowledge that are closely related to evidence, especially as discovered in experiments. It is a fundamental part of the scientific method that all hypotheses and theories must be tested against observations of the natural world, rather than resting solely on a priori reasoning, intuition, or revelation. Hence, science is considered to be methodologically empirical in nature.

The term "empiricism" has a dual etymology. It comes from the Greek word ἐμπειρία, which translates to the Latin experientia, from which we derive the word experience. It also derives from a more specific classical Greek and Roman usage of empiric, referring to a physician whose skill derives from practical experience as opposed to instruction in theory.[2]

Just in case you find yourself at a loose end this Sunday!

jog on
duc

 

[explod]

Still waiting for those backed up facts explod

And still working on it. A problem one has is that established facts in ones mind are built up over a period of time and includes many snippets from many sources. So in order to address this issue I am working back through the various texts to which I subscibe so as to substantiate with exact sources of my assertions

And there is an old saying to which we can be caught "a little bit of knowledge can be dangerous". and "One should not speak with forked tounge" Well its Sunday and time to cleans the soul

ducati916, I like you posts and is great to have you in the discussion. Have a close friend,, a Sociologist, who sums it up just like you can.

This is going to be a great thread, and Professor, will get to your answers in a day or so.

cheers explod

 

[ducati916]

From Whiskers,

GDP is just a measure of the productivity of a nation. Just because 70% of the GDP comes from 'Consumption' doesn't necessairly make a weak or fragile economy.

Productivity actually has it's own definition, separate from the definition of GDP, although it is related.

Productivity is the econometric measurement of the output for 1 unit of labour or capital. As such, it measures the volume of output produced with given amounts of factor inputs [land, labour, capital] Land, is not used very often, thus, most measures are recorded as data in the following format.

*Output per worker
*Output per man hour

Labour productivity is heavily influenced by capital investment, which accounts for [amongst other variables] the differences in wage scales.

Productivity as in GDP and real wealth (or debt) are two different things.

Well, actually four different things.

I agree that the US has a lot of unfunded liabilities... BUT, this quote distorts/skews the picture. Again, GDP is about productivity and arguably not the perfect measure of productivity at that, because it doesn't account for underground financial activity not reported to the Gov and we know that the US has a large underground economy in the agricultural and textile industries to mention a couple... not to mention the secret activities of the CIA and other government agencies.

I have included the data detailing the unfunded liabilities estimated in various economies. Ugly data series.

Other measures of wealth are probably more important in determining the health of a country, such as tangible v intangible assets, the savings rate and debt to equity ratio's of it's citizins and corporations.

I would agree, simply looking at GDP growth/contraction, in isolation, is an almost pointless exercise in of itself.

Say for example the US is actually holding considerably more gold reserves than we are led to believe and/or they decide to open up those large areas of currently protected coastline for oil exploration and development. If the US changes policy, his would substantially change the equation.

Well if they were holding substantially higher gold reserves, yes, the Fiscal and Monetary pictures would need to be adjusted. With regard to resources held, or believed to be held, it depends on how they decided to access said resources. Therefore far more information would be required prior to any projected figures.

I say don't get too obsessed with 'current' reports assuming the status quo will never change... keep an eye on what other unrealised/unreported assets and income sources may be available.

The old value investor approach.

For me fixing issues in order of priority such as improved accountability, regulation and oversight of the financial industry is what the world needs and wants now for a better degree of trust and confidence in the short term. Once that happens a lot of the other issues will work themselves out in a much more orderly manner.

I would disagree. The primary problem is the volume of government regulation and intervention: viz. the increasing socialisation. The answer is shrinking government, and returning to an unhampered market, or laissez-faire. A good start would be winding up all the Central Banks, and returning the money supply to a commodity based money - gold.

jog on
duc

 

[CanOz]

Nice chart Duc, have you got something similar for Asian countries or just BRIC?

CanOz

 

[ducati916]

Nice chart Duc, have you got something similar for Asian countries or just BRIC?

CanOz

Nothing for Asia, their data is notoriously difficult to access. Neither do I have anything for the BRIC's.

jog on
duc

 

[Whiskers]

I would disagree. The primary problem is the volume of government regulation and intervention: viz. the increasing socialisation.

I agree to some extent there duc... but, by "improved accountability, regulation and oversight of the financial industry" I don't mean more, I mean more efficient as in substantially updated and overhauled laws, many of which were written decades ago and don't capatilise on modern technology for efficiency and effectiveness and mainly in the areas to protect shareholders and consumers from the 'enron' and 'ponzi' type operators.

The answer is shrinking government, and returning to an unhampered market, or laissez-faire.

I've not thought too much about that, because it seems like a way far off and remote possibility atm, although some headway is argubly being made in free trade agreements. BUT, with state owned companies from China for example, permiating the international business scene a state of 'laissez-faire' is surely way off the radar atm, isn't it?

A good start would be winding up all the Central Banks, and returning the money supply to a commodity based money - gold.
jog on
duc

I will not dissagree with your sentiment here, but we seem stuck with it for a long time yet... but assuming it was agreed to do this, what would be some of the main macro economic consequences in converting back, given the situation the world finds itself in now?

 

[ducati916]

Whiskers

I agree to some extent there duc... but, by "improved accountability, regulation and oversight of the financial industry" I don't mean more, I mean more efficient as in substantially updated and overhauled laws, many of which were written decades ago and don't capatilise on modern technology for efficiency and effectiveness and mainly in the areas to protect shareholders and consumers from the 'enron' and 'ponzi' type operators.

The financial industry has been aided and abetted by government, as government is a direct recipient of bank exemptions to the law.

100% demand deposit reserving, would eliminate at a stroke the fractional reserve money creation responsible for the massive credit expansion. This unfortunate development, regrettably, was created again by the British in 1844 and paved the way for todays Central Banks.

Central Banks are essential to provide liquidity, viz. print money for insolvent banks subject to a depositer bank run. Thus, by eliminating the Central Bank, removing the legal ability for banks to use demand deposits in fractional reserve lending, the problem is solved.

I've not thought too much about that, because it seems like a way far off and remote possibility atm, although some headway is argubly being made in free trade agreements. BUT, with state owned companies from China for example, permiating the international business scene a state of 'laissez-faire' is surely way off the radar atm, isn't it?

Unfortunately that is true. In fact, governments are actively engaged in a power grab currently.

I will not dissagree with your sentiment here, but we seem stuck with it for a long time yet... but assuming it was agreed to do this, what would be some of the main macro economic consequences in converting back, given the situation the world finds itself in now?

Consequences:
*Significant curtailment of Welfare State and related spending
*Significant curtailment of all government spending, viz. military etc
*Deficit nations would see interest rates rise in proportion to deficits
*Debtors would suffer, creditors would prosper
*Certain industries may become uneconomic, with resulting unemployment
*Confusion in the financially illiterate, until they adjusted
*World trade would [need] to increase, thus tariffs/subsidies would cease


There are probably many, many more, but these are some of the major ones that immediately come to mind.

jog on
duc

 

[explod]

Still waiting for those backed up facts explod

Have not been able to locate the source of 75% US GDP being consumption, but will keep at it. However the finanical news continues to deteriorate IMHO.

The following quote from Chuck Butler "EverBank" in the US on GDP, employment numbers bears some relevance:-

On 29/01

Watch the major dumbed down media drool all over themselves today, when they announce that the U.S. 4th QTR, annualized GDP was the strongest growth in 4 years, at +4.7%... These dolts will conveniently forget to mention that the growth was mainly Government stimulus, but don't let that get in the way of a "feel good story"... Someone with a little intestinal fortitude should stand up and ask the question... "How can we have 4.7% growth when 2/3rds of our economy is consumer spending, and we have 20% unemployment?"

and 1/02

OK... Let's take a step back for a moment... Remember the 3rd QTR GDP that was supposedly showing strong economic growth? Well... A funny thing happened on the way to the forum... Growth in the third quarter was originally estimated at an annualized rate of 3.5%, but was revised down to 2.2% after more information was received. And... Most of the 4th QTR growth came from increased manufacturing to rebuild inventories. Consumer spending - the biggest component of the U.S. economy - was down...