By Mortimer Duke

There’s little doubt in the world of Keynesian economics that government spending adds to GDP.  It’s indisputable because we all remember from econ 101 the basic formula C+I+G+NX=GDP.  C is consumption, I is investments, G is government spending and NX is net exports.  So when economists debate whether a government stimulus program adds to GDP, it’s nearly impossible to dispute because government spending is a big part of the formula.  We all know that this is the basic proxy for an overall economy and we use it to gauge growth as well as to determine if and when an economy is in “recession,” which historically has been defined as two consecutive quarters of negative GDP.

If you are only familiar with Keynesian economics, then the mere though of challenging this premise might seem heretical, but in reality the basic GDP formula that every economist and politician weights so highly in their assessment of the economy has become simply a tool to be manipulated and used to obfuscate the real state of the overall economy.  GDP in the present day is simply a tool to gauge consumption and really has NO merit as to the overall state of an economy.  It doesn’t address prosperity or wealth or standard of living or even employment.  It’s simply consumption.  I would liken it to asking your neighbor, who appears to live quite extravagantly, how much he makes.  He replies “I spent 1 million bucks last year! By the way I spent 4% more in 2010 than 2009 — I’m really doing well!”.  Clearly you can see he’s spending a lot of money, but is that really the proxy we should use to gauge his “prosperity”???  When we dig a little deeper we discover that he only makes $500k and has borrowed the balance.  He’s massively in debt, but WOW does he live well!  This game can continue until he’s cut off from credit and the game is over, the house is repossessed and his life is now in shambles.  Some people reading this may say — correctly I might add — that a government isn’t a household.  That true for most spending-type discussions — i.e., the government isn’t constrained by a “budget” or “salary” — but that’s a discussion for a different blog!

When the initial concept of GDP was conceived, it made total sense.  The world was on a gold standard and any excess government spending had to come from savings or out of future expected accumulation of gold.  As the world morphed from a strict gold standard to a gold reserve standard post-World War Two to eventually a completely FIAT money system in 1971, the robustness of GDP as a true proxy for economic well-being and/or growth also morphed into a tool of the political class to manipulate as they please.  Similar to our over-spending neighbor mentioned earlier, our GDP is goosed by borrowed money that has no offset!  It’s assumed that money borrowed in year X needs to be paid back in future years, but in reality the Fed simply creates it from thin air… and off the political class goes a-spending!  I’d suggest that government spending MINUS borrowing might be a more relevant GDP calculation, but in general the whole GDP concept is highly flawed.

Take the current economic situation.  As of this writing, according to our government and most Keynesian economists, we’re again “growing.”  But by any other metric, things are not looking so hot.  Household wealth is WAY off its highs from 2007, the labor market is near collapse, the cost of all the things we need to live like gas, food and clothing are screaming higher.  It really seems difficult to justify the assertion that things are “getting better.”  Do yourself a favor and question the accepted doctrine, and recognize that things are not always as they seem when it comes to GDP.