Contributions to Gross Domestic Product (GDP)

For an economy to grow it needs to increase consumption, investment, government spending, or exports. It does not need all four to increase but together they must. For twenty-odd years, companies’ lagging investment spending has made economic growth (GDP) increasingly dependent on consumer spending.

Investment

Companies can buy manufacturing plants, equipment, and products; buy another company; pay down debt; or buy back stock. Only spending on plants, equipment, and products directly affects economic growth.

However, over the past decade, stock buybacks have been the preferred spending method. Stock buybacks cut the outstanding stock amount, boosting earnings per share and making companies seem more profitable.

Today, many executive salaries are paid in stock, and stock compensation depends on earnings per share. Buybacks spiked in 2018 to $770 billion. In 2019, however, volume was down 8% to $709 billion. These companies’ capital plowing into buybacks has grown at a compound annual growth rate (CAGR) of 10.4% since 2015. [i]

Plus, if you add the $7 trillion of debt the Federal Reserve owns—which must be replaced with new public and private debt if the Fed ever wants to reduce its balance sheet—the ratio of debt to the size of the economy today is higher than it was before the financial crisis. Do these high levels foreshadow another financial crisis? Not necessarily.

Today we have more government and corporate debt and less mortgage debt. And governments and corporations might be better able to withstand higher interest rates than homeowners with subprime mortgages could do. That test is coming. The Federal Reserve has been hiking short-term rates, and last week long-term interest rates finally spiked. Rising rates put pressure on highly indebted individuals, corporations, and, in some cases, governments.

Government Spending

As a percentage of the American GDP, the national deficit was 15.2% in 2020, the most significant economic share deficit since 1945.[ii] Much of this additional spending was to offset COVID-19’s effects on businesses and individuals.

That spending level might have raised the government’s contribution to the GDP, which has averaged around 17% for almost forty years.

However, with a deficit that significant and total government debt now at \$28 trillion, it is unlikely that government spending will increase as a percentage of the GDP.

Exports/Imports

President Trump came into office in 2016 promising to get tough on China and other countries he felt were using unfair trade tactics. Around this time, the trade deficit took around 2.7% off of the GDP.

A country that buys more goods from foreign countries than it sells runs a trade deficit. Calculating GDP during such a deficit requires a subtraction. If not, you would count the goods and services twice.

In 2019, the trade deficit subtracted 5.8% from the GDP as President Trump’s tariffs and other policies had yet to show much promise. It is not easy to make any conclusions based on 2020 data because of the impact of COVID-19.

Consumption

The U.S. has become dependent on consumer spending for economic growth. Debt has fueled much of that spending. In 1980, the total government, corporate, and personal debt was around $5 trillion. Today, it is around $80 trillion or roughly 7% growth a year.

If we want to rely less on consumption to fuel economic growth from now on, our best bet is for companies to stop using money on stock buybacks and start investing. And let us hope this new investment causes us to produce more goods and services that we can then sell overseas, reducing our trade deficit.

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These are the opinions of Financial Advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice. 

References

[i] T&R Staff, “Corporate Stock Buybacks Hit Record Levels”, Treasury&Risk, June 04, 2020, https://www.treasuryandrisk.com/2020/06/04/corporate-stock-buybacks-hit-record-levels/

[ii] Robb, Greg, “U.S. federal budget deficit soars to record $3.1 trillion in 2020.” MarketWatch, October 16, 2020, https://www.marketwatch.com/story/us-federal-budget-deficit-soars-to-record31-trillion-in-2020-2020-10-16

These are the opinions of Financial Advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

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