Classical Economics Series: #2 Growth

Actionable ideas to make you a better investor, full portfolio transparency with real-time trade alerts (see exactly when I buy, sell, trim stocks), pre-screened thematic watchlists, data visualizations, macroeconomic insights, microeconomic company-level analysis (including my Stock of the Week), and investor mindsets, strategies, and hacks. Gain investing advantages with OB’s Sunday Investor newsletter here >> Always free.

• • •

This economic series is meant to be educational. It will cover: Economic Growth, The Business Cycle, Supply, Demand, Prices, Inflation, Unemployment, Imports, and Exports. It is mostly academic so it will have a school-vibe, but without the homework or tests! Unlike school though, the tests we face are real-world tests such as pursuing our own financial improvements to reach financial freedom. It will not include much of my own opinion or analysis because that is not the goal for this series. The goal for this series is for you to understand the economics of a nation (macroeconomics), so you can use that understanding to become good investors!

Growth in a national economy is measured in Gross Domestic Product (GDP). If GDP goes up 3%, then the economy grew 3%. When GDP is adjusted for the effects of inflation it is called Real GDP. So, Real GDP is the better measure of whether or not a county’s economy is growing.

In Europe, there was little to no quality of life improvements economically for the general population for hundreds of years between the collapse of the Roman Empire and the formation of capitalist nations in the 1800s. Since capitalism and the Industrial Revolution, a 1-2% Real GDP growth rate has occurred in most countries. But before the formation of capitalist nations institutions of many types were formed, which were essential in developing and sustaining market economies. For instance, printing and the press became an institution after the Gutenberg’s press was invented; this allowed the promotion of ideas further and more consistently than by voice alone.

Generally speaking, Real GDP growth enables increased standards of living for masses of people when they are able to participate.

To determine a country’s standard of living, Real GDP is divided by the number of people in a country to get Real GDP/person. There is an index of goods and services used to calculate Real GDP, and the population of a nation is determined during the census by counting everyone. There are other economic ways to measure standard of living too, but they correlate highly (match closely) with Real GDP/person so economists continue to use Real GDP and make decisions with it. Since Real GDP/person is good and useful, but not perfect, it is important to add in additional measurements to determine the healthiness and desirability of an economy. The number of measurements is really endless. Perhaps I will write more about them in the future. In economics, there are trade-offs like there are in health care. For instance, there are “side effects” that are observed in economics. One example is that with increased GDP comes increased crime rates.

If you want it simple and consistent, write a computer code to run your economy and go live alone on an island. But remember, it is within the complexities and inconsistencies that opportunities live — so if you want investment opportunities you need an environment you can believe in (laws help) but is also dynamic (big capitalist population helps).

Wow, is there no limit to my artistic ability!?

Aside from Real GDP economists also use Nominal GDP, which is a measure of the dollar value of goods (iPhones) and services (Apple Music) sold – perhaps it is up because of more sales, or perhaps it is because of inflation (or both). Nominal GDP does not consider inflation. (If you want inflation considered you use Real GDP.) So what do economists do? They measure GDP in two consecutive years. The first year they consider “a basket of items” (maybe it’s milk, eggs, coffee, rent, sweaters, etc.) and add them up. This is then called the base year. The next year they add up the same basket of items and see if it costs more or less. If it costs more then there is inflation. (If it costs less then there is deflation.) If it costs 2% more then there is 2% inflation present/happening. So when economists measures current prices it is called Nominal GDP, and when they measure versus base year prices it is called Real GDP.

Economists don’t stop there. They don’t just want to know if we had a good year of growth, and therefore an increase in standard of living. They want to compare it against many countries and across time. After all, if you had 2% growth and Mantanistan had 5% growth you should evaluate why. You may have felt good about your 2% until you realized you missed a lot of growth that others were experiencing. This is a major concept to understand as an investor:

It is not just about if you are up or down, but moreso it’s about whether or not you maximized your gains without exceeding your comfort level.

Maybe you want 100% growth, so you participate in illegal activities (don’t do that!)… maybe you don’t want to be a criminal (good!) so you decide to do things legally… in that case, how did everyone doing things legally do? …and how did you compare to them? …but also, maybe you are okay with some factory smoke but don’t want to choke out every living thing around… how did you do compared to countries that limit themselves on factory smoke? Anyway, you get the idea. You can either not look around and compare yourself to how others performed, or you can. Economists look around, and it is important at the national level to do so because the US economy is so dynamic, global, and intertwined that looking around helps you see opportunity or head-off a train wreck.

Measuring GDP across time is done by using Real GDP, as mentioned. Measuring GDP across countries is done by comparing Real GDPs with each other. (You would need to determine if that other country is presenting an accurate Real GDP though… remember, there is a basket of items… Are there items that were not counted in the base year, but then counted in the next year? That would present the world with a Real GDP that is higher than it really is.) For this reason, investors get shy about investing around the world, and if they do they set limits on how much of their money they will invest abroad. Investors want accurate data and if they feel like the data is questionable they invest less in those spaces. Heck, there are investors that only invest in one industry! Maybe they are experts in that industry and only feel comfortable investing there.

Even small differences in Real GDP make a big difference in standards of living because the increases compound! So it turns into gains on top of gains on top of gains. Countries that have even 5% Real GDP growth will double the size of their economy in 14 years! Wow. Now investors start looking abroad again 😉 and play the risk (Is their data accurate?) versus reward (Their economy will be 2x in just 14 years!).

The Penn World Tables are a well respected resource for comparing countries economically.

Historically, there have been shifts in which countries and regions have had the biggest and most powerful economies. After the fall of the Roman Empire, China became the economic leader; during the 1600s Europe transitioned to becoming the economic leader; during the 1800s the UK become the economic leader; and during the 1900s the US became the economic leader. Nowadays, the US, China, and the EU are the 3 biggest economies, but India is set to pass the EU by 2030.

This series uses resources such as Investopedia.com, Wikipedia.com, and my college textbook “Macroeconomics”, 2nd edition, Roger EA Farmer that came with a free CD inside! Now that ages me. But the fact that the textbook is old shows two important things: 1. I have loved all things economics, business, finance, and investing for decades! 2. The study of economics does evolve but what is classic is still powerful and important to understand, and knowing where things have been, and currently are, helps you project where they will be! A priceless skill to hone for investors! I mean, countless people were very sure electric vehicles such as Tesla $TSLA made no sense investment-wise. Maybe they should have opened up their mind to include more economic material! So here’s some classic foundational material for you, and from there we can begin to see changes, directions, and opportunities!

• • •

Enjoy a free investing newsletter delivered directly to your inbox every Sunday morning when you sign up.

Processing…
Success! You're on the list.

Leave a Reply

%d bloggers like this: