Gold Forecaster Index: Caution Advised

Be cautious, stay in cash.

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.