GDP Output Gap Vs. Inflation

The GDP Output Gap is a very nice indicator for inflation. It is a leading indicator for inflation and is based on the potential real GDP.

Potential gross domestic product (GDP) is defined in the OECD’s Economic Outlook publication as the level of output that an economy can produce at a constant inflation rate. Although an economy can temporarily produce more than its potential level of output, that comes at the cost of rising inflation.

Potential GDP = (natural rate of employment) ÷ (actual rate of employment) * (actual GDP)

So if you see that the output gap (potential GDP – current GDP) is narrowing, you should begin to see inflation. On the chart below we see that the output gap is narrowing and I expect inflation to start showing up in 2017.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=4ks8

Let’s take a look at the 1980’s. You can clearly see that inflation appears when the red line goes above the blue line.

Default Rate Vs. Debt to GDP

The debt to GDP is a leading indicator for default rates.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=4xji

Business Inventory to Sales Ratio Vs. GDP

Inventories can be considered a part of a group of leading indicators of business cycles. Whenever inventories surge, a possible reason could be a decrease in consumer demand. The result is that producers will cut output and sales. This will translate in a lower GDP growth.

It is worthy to plot the business inventory to sales ratio against GDP growth.

Following chart shows that the blue line is leading the red line. As inventories build up and sales go down (blue chart goes down), GDP growth will follow the trend (red chart goes down).

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=YXu

Since 2012, the inventories have continued to build up against lower sales, so I expect GDP growth to slow down.

China Power Consumption Forecasts Slow Growth

The latest China power consumption numbers forecast slow growth, but it is improving a bit. With 5% yoy power consumption growth, I believe 7% GDP growth will be the norm.

Commodities Will Be Hit By China Slowdown

I have bad news for commodity fans. China is indeed slowing down as power consumption has reached sub-zero year over year growth in August 2014. This means that China GDP growth will be sub 6% as the correlation suggests on chart 2.

Chart 1: China power consumption growth

Chart 2: Power output growth Vs. GDP growth

Waiting for the Plunge in Stock Markets

This is not going to end well I tell you. We are significantly overvalued at 123%. The question is: “When will it happen?”

I think it happens soon, because when we look at Japan, the GDP estimates there are now in negative territory. Japan second quarter GDP is forecasted to drop 10% year over year. That means the Nikkei will surely plummet and don’t even think this won’t affect the U.S. markets.

Japan GDP

China’s GDP Stabilizing

Latest numbers indicate that China’s GDP growth is stabilizing at 5% as power consumption shows steady yoy growth.

Stock market overextended

When GDP growth gets consistently revised downwards while the stock market goes up every day, we get an overextended TMC/GDP ratio at 121.3%. Yes, we are in a stock market bubble. The question is, when will it pop? Keep your finger on the sell button.

First it was 0.1% GDP growth, then it was -0.1%, then it was -1% and suddenly today they reported -2.9% GDP growth. Incompetent people…

GDP Vs. Trade Balance

The trade balance numbers are given monthly, so they can be a good indication on how the GDP numbers will pan out as they are quarterly numbers.

We can predict the GDP numbers by looking at the trade balance numbers. Whenever the trade balance goes into surplus, the GDP growth actually accelerates. This is because people will import more to consume more. A big part of GDP is mostly based on consumption.

For more info on this, go here.

Predicting GDP with the Trade Deficit

We recently got the trade deficit numbers and it widened the last month. Peter Schiff notices that GDP is influenced by the trade surplus/deficit. He says that GDP will drop when the trade deficit widens. This is very useful because trade deficit numbers are monthly, while GDP numbers are quarterly measures. But I think this theory is faulty, because there are other things to consider.

So I looked up the definition of GDP:

GDP (Y) is the sum of consumption (C), investment (I), government spending (G) and net exports (X – M).

Y = C + I + G + (X − M)

Here is a description of each GDP component:

• C (consumption) is normally the largest GDP component in the economy, consisting of private (household final consumption expenditure) in the economy. These personal expenditures fall under one of the following categories: durable goods, non-durable goods, and services. Examples include food, rent, jewelry, gasoline, and medical expenses but does not include the purchase of new housing. 
• I (investment) includes, for instance, business investment in equipment, but does not include exchanges of existing assets. Examples include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in investment. In contrast to its colloquial meaning, “investment” in GDP does not mean purchases of financial products. Buying financial products is classed as ‘saving‘, as opposed to investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds or stocks is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products. 
• G (government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchases of weapons for the military and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits. 
• X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations’ consumption, therefore exports are added. 
• M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreignsupply as domestic.

So this basically means that if we have a bigger trade deficit (or X-M becomes smaller), then the GDP will drop. Correct.

The question is, by how much? Looks like the X-M part isn’t that big (only 3%). But it does give an indication…

So I don’t expect the trade deficit to be an accurate measure to predict GDP. What is more important are the durable goods and we know about the durable goods orders metric. Let’s look at the durable goods orders.

Something amazing can be found between durable goods and the trade deficit.
Whenever the trade deficit widens (red chart goes down), then the durable goods orders go up (blue chart goes up). This means that GDP could increase, if the trade deficit widens. Very weird right, but it’s reality. Because Americans buy things via imports and thereby the trade deficit gets worse.

Conclusion, if the trade deficit widens, GDP growth will probably accelerate and the stock market will go up (not down). So you can predict the GDP with the trade deficit.