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The Daily Reckoning Monday, November 2, 2009 Bill Bonner is still wandering around the Pampas, The Mogombo Guru is still on hiatus, But "Aussie Joel" is on the job in his native Australia with a few words about the GDP "growth" that isn't... And over to Joel Bowman, checking in briefly from Australia's Gold Coast... An interesting thing happened last week. On Thursday, the government announced its "all important" GDP figures for the September quarter. The results bettered the Street's expectations and promptly sent investors into a buying frenzy. The S&P 500 finished the day up 2.3%. But by Friday, investors were scratching their heads with one hand...and hitting the "sell" button with the other. Apparently the "man on the street" is not doing so well...despite news that the economy around him is improving. Consumer spending was down 0.5% for the month of September, according to the Commerce Department, and the housing market is still floundering. "[N]ew home construction is 74% below the peak it reached in January 2006," reports Forbes. "The drop is far more dramatic than the 46% decline in 1981 and well ahead of the 60% fall between 1986 and 1991." There are now almost 20 million vacant homes in the United States. That's a lot of inventory to move. By close of trading Friday, investors had given back all of Thursday's gains...and then some. How could this be? "Don't believe the GDP hype," Dan Denning cautions from his post here in Melbourne. "The big problems in the economy - too much debt, too much leverage, too much government - are still there. They didn't go anywhere overnight. We'd suggest that getting sucked back into stocks now because of the US GDP figure is a very bad idea. "Of course, we could be wrong," Dan continues. "Maybe stocks will go up another 20% from here. Or 30%. Or 50%. But it's not likely. It's more likely that the recession is over, but that the Depression has just begun. "It's begun because what the US GDP numbers actually show is a private sector in full retreat as its income shrinks, its assets fall in value and the cost of servicing debt rises. Into that terrible breach the public sector has stepped, armed with an arsenal of inefficient and stupid programs that give the illusion of economic activity, but actually prevent the economy from liquidating excess capacity and bad debt (the two conditions required for a real recovery)." Your editor will be down in Melbourne this weekend...partly to lose all his money at the Spring Carnival horse races, and partly to catch up with Dan, who heads up the Australian version of The Daily Reckoning. We'll keep you posted on that but, in the meantime, here are a few more thoughts on GDP... --- Outstanding Investments Metals Research Report --- From Hulbert's #1 Ranked Advisory Letter Over a Five-Year Period... 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To the first point, the stock market may be right or wrong about what's coming next. The stock market has been both right and wrong before and we are certain that it will be either right or wrong this time. To the second point, the US GDP calculation is just plain wrong, and therefore, deceptive... The "GDP Fraud" by Joel Bowman Gold Coast, Australia If GDP is telling us that the US economy is steadily improving, how come so many folks on Main Street feel so bad? Don't they read the papers? Don't they know the GDP is improving? The short answer to these questions is that the GDP calculation is a fraud...or perhaps it's a fraud wrapped in a deception. To understand why the GDP numbers could be so good when the economy all around looks so bad, it is necessary to understand a few pertinent details of the GDP calculation. It is necessary to see just what meat and meat by-products go into this economic sausage. For one thing, GDP includes government spending...but does not SUBTRACT any of the borrowing the government does to fund its spending. And obviously, government spending is in no way a reflection of private sector economic activity. Therefore, as Frank Shostak, an adjunct scholar of the Mises Institute, observes, "The GDP framework gives the impression that it is not the activities of individuals that produce goods and services, but something else outside these activities called the 'economy.' However, at no stage does the so-called 'economy' have a life of its own, independent of individuals. The so-called economy is a metaphor - it doesn't exist." Convention tells us that the GDP framework is, more or less, a tool used to measure the size and health of this "metaphor"...ahem, the "economy." Most often, we hear it expressed as a rate of growth - either positive or negative. And it is this widely followed number that determines when economic expansions end and recessions begin (two consecutive quarters of "negative growth."). But GDP as a measurement is really just hogwash. It can no more calculate the health of an economy than it can tell you the time or give you a back massage. Let us consider briefly the computation of the GDP measure. There are three main ways to calculate GDP: 1) The expenditure method 2) The income method and 3) The value-added method. Theoretically, all three methods should produce the same result although, in practice, this almost never happens. For instance, when there is a large surge in public spending, as we have seen recently with the torrent of stimulus packages from governments around the world, the GDP "growth" registers most prominently in the expenditure method. Roughly speaking, this method calculates the "size" of an economy by totaling its expenditures, minus imports. It is also the most common method employed to determine GDP. The equation looks like this: GDP = private consumption + gross investment + government spending + (exports - imports). To understand just how misleading the expenditure method can be, let us consider briefly the case of the Australian economy. It is widely accepted that the Aussies, under the deft stewardship of Prime Minister Kevin Rudd, had avoided entering a technical recession during the crisis from which we are now said to be "recovering." It's a nice story...except that it is a lie or, at best, a "one-third truth." Australia DID unquestionably fall into recession. It's just a matter of definitions. Like their American counterparts, Australian politicians pushed through a series of emergency stimulus packages, now credited with having helped the country avoid recession. Dr. Steven Kates, who lectures on economics at RMIT University in Melbourne, provided a rare dose of clarity in a recent article, published in The Australian. Dr. Kates concludes that by both the income and value-added measures, Australia comfortably satisfied the criteria for a technical recession. "The income series... indicates a pretty minimal year all round," Dr. Kates explains. "Both the September and December 2008 quarters showed an actual fall in the level of output, the very definition of a technical recession. Over the year, the level of GDP has fallen 0.4 per cent, by no means as bad as elsewhere, but more in keeping with the general experience across the economy. "The third measure shows the changes in GDP according to the production-based data," Kates continues. "Here, too, [in the value added, or, production series] we have the ingredients for a technical recession, with an actual reduction in the level of output in both December 2008 and March 2009. Across the year, GDP has fallen by 0.7 per cent. "While the stimulus package appears to have been able to distort one of the three sets of national accounting measures we use," Dr. Kates concluded, "beneath it all the Australian economy, in keeping with the rest of the developed world, has gone through a recessionary phase from which it is only now beginning to emerge." Therefore, the only way the Australian government could claim that it had "avoided" a recession was by utilizing the expenditure method, or by averaging all three measures of GDP together. Here we see that unprecedented government stimulus spending propped up the expenditure metric, much like a steroid injection might help prop up a cheating athlete. Not only is stimulus spending an unsustainable and deceptive scam, measuring it as a "+" under the expenditure GDP calculation separates further the reality individuals experience from the fantasy their governments serve up to them. As the Australian example shows, this methodology simply ignores the fact that government spending is not true production at all because it is debt financed. Government spending, therefore, should really only be government spending, LESS government borrowing. You see how misleading this measurement can be, especially when huge sums of debt-financed stimulus must be taken into account. Sound familiar? Murray Rothbard, the legendary Austrian economist, elaborated further when he proposed his alternative measures: Gross Private Product (GPP) and Private Product Remaining (PPR). Rothbard defines the former as "gross national product less income originating in government and government enterprises." PPR is GPP less the higher of government expenditures and tax revenues plus interest received. Rothbard argues that because government output is "financed coercively" (i.e., by taxation), it is unclear what - if any - market value may be ascribed to the end product. Simply put, both measures place government "production" where it belongs: in the "opportunity cost" pile. If free market participants did not deem it worth their while to buy something in the first place, why should it be considered a net positive when the government uses their money (or China's) to buy it on their behalf? This case may be brought against the "cash for clunkers" program, the $8,000 credit for homebuyers and impending "cash for anything" programs currently finding their way through the special- interest-greased halls of Congress as we write. Indeed, the entire bailout and stimulus programs fall squarely into the opportunity cost pile. But that's not how those trillions are calculated using conventional GDP metrics. Measure it how you will, dear reader; true economic progress is forged not in the crucibles of debt or coercion, but from the honest toil of individuals seeking to better their own lot, unhindered from the government's long, strangulating reach. No nation can spend its way out of recession...no matter what the official GDP numbers may imply. Regards, Joel Bowman, for The Daily Reckoning P.S. What are the implications of such blatant, government-sponsored manipulation for us individual investors? Glad you asked. The "recovery" can only last as long as the delusion that propagates it. Once enough investors realize the game is up, the house of cards will collapse again. When it does, we want you to be in a position both to protect yourself from the fallout...and even to make a tidy sum along the way. To that end, we've arranged with our publishers for a special risk-free, one-month trial of our premium short-selling service, The Strategic Short Report. The editor, Dan Amoss, reckons the coming weeks and months may present some of the "greatest short selling opportunities of our lifetimes." 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