Every year the U.S. Bureau of Economic Analysis releases data on U.S. GDP and real GDP growth. It’s widely accepted as the leading metric to determine the growth or deterioration of the U.S. economy, and cited by publications and media to evaluate a president’s ability to create prosperity.
It’s interesting how most sources fail to reveal a second critical component of analyzing the U.S. economy– and it stems from the relationship of real GDP growth to this second component.
This article will describe that second critical component while also showing how each president fared over the last 40 years. The numbers may surprise you, and may help you shed some political biases and realize that oftentimes there’s more going on beyond what is commonly reported and shared. I don’t have a political agenda here, I just love looking at the numbers.
Here’s what everyone is missing regarding those numbers. While it’s true that GDP estimates the flow of goods and services pretty well, by itself it’s not looking at the entire picture.
What we all need to understand is how the fluctuations of the credit cycle relate to economic growth, as this is a more accurate representation of real economic prosperity.
What’s the Credit Cycle?
I won’t cover this too extensively as anyone could easily write a doctorate thesis on the topic. Like the economy and the markets, the impact of credit (particularly interest rates) is so widespread in its reach that it’s impossible to estimate with any certain accuracy.
Think about how the economy works for a second.
It behaves like a living, breathing organism. All parts have a butterfly effect on each other.
When customers flood into a business and buy a bunch of their products, this creates profits for the business. The business has a financial incentive to expand and grow, and must hire more workers to make that happen. As more workers get hired, more disposable income reaches the hands of the common man to allow for more spending at businesses and increased profits.
It’s a beautiful compounding cycle, when it is working well. Of course on the flip side, the opposite is true. When unemployment is high, disposable incomes shrink and businesses see less inflow to their bottom line. This makes them less likely to hire more with the possibility of needing to downsize their workforce.
The Benefits of a Low Interest Rate Environment
Now, the credit cycle has a major influence on these moving parts of the economy. The two ways for companies to have enough money to hire employees is through either profits or debt.
Most companies in the stock market have some level of debt. The amount of debt they are willing to carry oftentimes depends on current interest rates.
When rates are low, companies tend to borrow more because the interest they’ll have to pay isn’t as high.
When rates are high, companies tend to be more conservative in their leveraging because it becomes very expensive.
You see the effect of various levels of interest rates in the consumer world as well. [click to continue…]