According to an article in the Wall Street Journal, the Dow Jones Industrial Average has tracked GDP pretty closely over its 115-year history. The most interesting part of the article is what Dow level is implied by the current GDP level:
Depending on growth of the U.S. economy, in 2011 nominal GDP will likely be reported somewhere above $15 trillion, suggesting a Dow trading above 15,000 can also be expected.
This is interesting because the level of the Dow Jones Industrial Average is right now only about 12,400, about 17% below that level. The article has some caveats and mentions that perhaps stagflation will hold the price back, but it is interesting nonetheless. My guess is that investor sentiment is the main thing holding price back. The world economy is actually pretty good, but US investors are still feeling lousy from a poor domestic economy and the 2008 bear market hangover.
Source: Yahoo! Finance (click to enlarge)
GDP is consumer spending, plus government outlays, plus gross investments, plus exports minus imports. With the exception of exports, GDP measures spending. The problem is GDP makes no distinction between debt-financed spending and spending that we can cover out of current income.
Consumption is not prosperity. The credit-addicted family measures its success by how much it is able to spend, applauding any new source of credit, regardless of the family income or ability to repay. The credit-addicted family enjoys a rising “family GDP”—consumption—as long as they can find new lenders, and suffers a family “recession” when they prudently cut up their credit cards.
In much the same way, the current definition of GDP causes us to ignore the fact that we are mortgaging our future to feed current consumption. Worse, like the credit-addicted family, we can consciously game our GDP and GDP growth rates—our consumption and consumption growth—at any levels our creditors will permit!
Consider a simple thought experiment. Let’s suppose the government wants to dazzle us with 5% growth next quarter (equivalent to 20% annualized growth!). If they borrow an additional 5% of GDP in new additional debt and spend it immediately, this magnificent GDP growth is achieved! We would all see it as phony growth, sabotaging our national balance sheet—right? Maybe not. We are alreadyborrowing and spending 2% to 3% each quarter, equivalent to 10% to 12% of GDP, and yet few observers have decried this as artificial GDP growth because we’re not accustomed to looking at the underlying GDP before deficit spending!
From this perspective, real GDP seems unreal, at best. GDP that stems from new debt—mainly deficit spending—is phony: it is debt-financed consumption, not prosperity.
I agree with you that debt-financed consumption is not prosperity. There is little doubt that GDP growth has been artificially enhanced with debt. But it does create additional consumption, and that drives GDP.
On the other hand, deleveraging may create Hangover III at some point because debt-financed consumption can continue only as long as the debt can be serviced.