Tuesday, October 14, 2008

TMS, CPI, S&P 500, nominal GDP

I have been looking at this chart for some time trying to understand the interplay between the variables.

Generally, the correlation between CPI & nGDP is moderate at .25. TMS is not closely correlated with GDP or CPI, however basic understanding of economics would lead me to believe that somehow it is. An analysis of variance shows only a small contribution by TMS to CPI. There are obviously more variables at play here. Consumption, Investment, and Government spending are the traditional components of the Production equation in macro economics. Somehow these variables have to be affected by TMS.

The TMS does have a correlation with the S&P and appears to be a leading indicator in some periods. However, rapid expansion of the TMS leads to bust periods such as the one we have experienced in the last year. The S&P appears to move mostly in lockstep with the TMS and suggests that no real wealth is created in the US. If the S&P is an indicator of value created by US companies, it shows that money-adjusted, there is no addition of value. When the S&P is below the TMS it tends to correct towards the TMS and when it is above the TMS it tends to correct down towards the TMS. This takes a period of several years, but it is inevitable.

For investors, this provides valuable information. It shows that the US monetary and fiscal policy of credit expansion during economic downturns does not necessarily lead to absolute new wealth being created. In fact no net wealth has been created since the 1980s. Our system is dependent on inflation of the money supply. Without it, credit losses can wipe out our capital base because the leverage in the system is very high. Wealth creation is not dependent on the supply of money. In fact exports manufactured in the US or services provided by the US to other countries are necessary to add value to the wealth of a country. Unfortunately, while we are great service providers, we are also even greater importers. Thus our net debt increases. Economists argue that this is fine since the debt is then bought by foreign holders of our debt. However, debt can be a crushing problem for countries and individuals if it is not eventually paid down. The debt service coverage for the US as a whole is probably around 2:1. This includes federal, state, local, and individual debt. I have seen figures of total debt to GDP between 3-4:1. This is not a healthy statistic. The Great Depression occurred when debt to GDP peaked at around 3:1. We are living in dangerous territory and I hope we have future leadership that understands the problems we face and how to fix them.

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