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Measuring our Financial Well-Being

by on May 15, 2011 6:00 AM

One of the benefits from the current economic situation is that we are all learning more about the dismal science, i.e. economics. I’m pretty sure we, as group, haven’t yet arrived at being competent about macroeconomic policy. If those in Washington don’t watch out, however, we might just take over economic policymaking and let them do something else.

To that end, I would like to add one more piece to the puzzle to help make understanding economic policy a little easier.

We measure our economic well-being by the growth of our economy. This growth is measured by the percentage increase in our GDP or Gross Domestic Product. Real GDP grew by 3.1 percent in the fourth quarter of 2010 and by a slower 1.8 percent in the first quarter of 2011.

Of course, this first-quarter data is actually only an advance estimate. Government bureaucrats collect lots of data and distill an estimate for the number, which they correct at least twice after issuing the initial headline number. The headline number, when first issued, usually garners all the spotlights, while the corrections, which are supposedly more accurate, can only be found on the back pages of the paper.

For those of my readers with a penchant for equations, the GDP is equal to the sum of consumer spending, business investments, government spending and the net of exports less imports. In equation form:

GDP = C + I + G + (e-i)

So GDP really measures spending, and makes no distinction between spending that is sustainable (supported by income) and spending from borrowing.

Somehow, we have come to believe that the growth of spending means prosperity. It does not. The GDP equation fails to account for borrowed spending. Growth of the GDP that comes from borrowing is not real growth at all. It is a dose of steroids that artificially enhances the growth of the GDP in the short term and has long-term deleterious effects. Sooner or later we have to pay off those borrowings or devalue the currency to make the debt more manageable. Right now, we are in the process of devaluing the currency.

If the GDP isn’t a good measure of our prosperity as a nation, then what might we look at to measure our economic progress? If we do a little tinkering with the equation, I believe we can come up with a better measure of our economic health.

First of all, let’s deduct from the above equation any consumption that is a result of borrowing. We then come up with a GDP that occurs without help from deficit spending. Further, if we adjust for population growth, we can calculate how the average person is doing by calculating real GDP per capita (per person). Since the private sector generates all the money for the economy, then if we measure the private sector real GDP per capita, we finally come to a better measure of our wealth or prosperity. 

So, if we look at private real GDP per capita since the late 1990s, what do we discover? Since the crash in 2007, we have had literally no improvement in the private economy and, indeed, we are running at pre- 1998 levels of real prosperity. In other words, we have had no progress in the past 13 years.

To put it more bluntly, the housing bubble made no contribution to personal wealth; the tech bubble made no contribution to personal wealth. No government program has contributed to average personal wealth and, although the stock market has been jerked around by expansive monetary policies and lax lending practices among other issues, there has been precious little progress in real growth (after inflation) in the stock market since the late 1990s. Clearly, we need more effective macroeconomic policies from our leaders in Washington.

Translating this notion into good portfolio strategies is the job of the investment industry. But this is the fodder for another column.



Dan Nestlerode is the Director of Research and Portfolio Management at Nestlerode & Loy Investment Advisors in State College. A graduate of Penn State University, Nestlerode has been an investment advisor since 1965. He can be reached at danielj@nestlerode.com.
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