States are not participating in a systemic, orchestrated conspiracy to fudge the economic data they collect. Getting a large number of individuals to agree to manipulate data would be far too difficult. Instead, it is much easier for a small group of government officials to simply change the method of calculating various metrics they want to manipulate so that these leading indicators look better.
For example, since the abolition of the gold standard in 1971, countries have repeatedly tinkered with the CPI formula to convince the public that prices are much more stable than is actually the case. And with developed countries now suffering from weak economic growth rates – which are due to the huge debt overhang – countries have now started to change the way GDP is calculated.
Starting this year, the Italian government will also take into account the economic performance of the mafia and include its goods and services in GDP. And the UK has also chosen to include illegal activities such as smuggling, prostitution and drug trafficking in its growth figures. Analysts believe that these changes in the GDP calculation method will ensure that Italian GDP will increase by a few percentage points every year.
Another study found that the U.S. underground economy is worth USD 2 trillion per year – that's over 10% of legal U.S. GDP. Therefore, you can bet that the U.S. will soon adopt Europe's new GDP calculation method.
The U.S. already tinkered with GDP last July. The U.S. government made significant changes to gross capital formation. Gross capital expenditures have since included research and development costs; art, music, film and book royalties; and other entertainment industry revenues.
U.S. GDP numbers have underperformed since the supposed end of the Great Recession. Economic growth was just 1.9% in 2013, and it was as low as -1% in the first quarter of this year. There is practically nothing else that can be said about GDP in Europe; Europe is also suffering from below-average and/or negative economic growth.
Another indication of the worsening economic conditions are the latest figures from the World Bank: the World Bank reduced its global growth forecast and lowered the growth forecast for the U.S. for the current calendar year from 2.8% to just 2.1%.
So our political leaders are out to fudge the GDP calculation method, and to do so until the desired image they want to convey to the public is achieved. So you'd better expect both nominal and real GDP figures to be inflated even more in the future. Thinking logically, this means that investors can also expect leading indicators such as the percentage debt/GDP ratio to look significantly tamer in the future than is actually the case.
However, the most important leading indicator, which provides information about the health of a nation, cannot be changed by the states without further ado. Although it is easy for politicians to fudge the data on economic activity and growth, they can only expand tax revenues if they use taxation to siphon off additional private wealth and redistribute it.
And that means that the existing tax revenues that governments have to service their national debt will be unaffected by all the changes, no matter what formula they now come up with to calculate their GDP numbers. The consequences will be devastating, as an unprepared public is lulled to sleep with rosy leading indicators, and later, abruptly, comes the big bang when the bond bubble bursts as tax revenues plummet relative to government borrowing costs.
Officials might as well factor illegal activity into their GDP equation by a factor of 3. Since it is illegal activity, by definition alone, it cannot generate additional tax revenue.
The sad truth is that economic growth will continue to be disappointing and is likely to deteriorate further as the year progresses, after perhaps a small recovery in the second quarter of this year. There can be no sustained economic recovery, as the economic stimulus effects attributable to a decline in interest rates have already had their effect.
Corporations have already generated increasingly larger profits and individuals have already reduced their debt burdens through refinancing measures. Mortgage closings are down 17% year-over-year in the U.S. This goes back to the fact that the flow of people who have the borrowing power to refinance their mortgage, or are eligible for a home purchase, has already declined massively. And as the refinancing market, like the homeownership market, is depleted, the economy-supporting effects from this sector also continue to decline.
Now that interest rates have hit rock bottom after a 30-year slide, the effects of continually declining borrowing costs have also been steadily weakening.
And meanwhile, as economic fundamentals continue to deteriorate, expect official statistics on inflation and economic growth to become increasingly fictitious in the future. Below is a little reality check for investors:
- Debt has exploded in recent years and has now reached stubbornly high levels in industrialized countries.
- Central bankers – the supposed defenders of our purchasing power – have resorted to pushing nominal interest rates to 0% or into negative territory, as it is their expressed desire to drive real interest rates even further into negative territory.
- The speculative bubbles now extend not only to the real estate market, but have now also hit the stock market and the bond market.
- The middle class will continue to be eroded by inflation, falling real incomes and debt levels.
Normally we have been used to a world where asset prices are determined by the free market. But today's markets have been completely distorted by a handful of central bankers – who provide low interest rates and enormous amounts of money.
However, free markets always prevail in the end, which is why the upcoming adjustments, in which the current musings of central bankers and states will be corrected again, will be extremely brutal and devastating. There is a high probability that these adjustments will start as early as the next two months, as the Federal Reserve's asset purchases, i.e. quantitative easing, will be lowered to 50% by the end of July and completely over a few months later.
I assume that during this phase the forces of the free market will begin to exert their cleansing effect. And then all hell will break loose in the major financial markets, which is why it's important for investors to prepare their portfolios for the chaos ahead.