Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Extending our research on the use of the Big Mac Index, as created by The Economist, we wanted to apply the rise in the price of a Big Mac and relate it to the overall economy. While prices continue to rise, the burger, as a representation of GDP, may be stealing more than calories from consumers.
Yesterday the Bureau of Economic Analysis (BEA) reported that the economy grew 1.7%. This was above the 1% expected, and increased from 1.1% in the first quarter of 2013. However, the first quarter was lowered originally from 2.5% to 1.8% and now to 1.1%. Curiously, the rise this quarter in GDP was completely offset by the lower revision from the previous quarter. But this was not the only unusual finding.
Odds and Ends
The BEA defines gross domestic product, the measure of economic growth as:
GDP = private consumption + gross private investment + government spending + (exports – imports)
Taking it one step further, we can break this down to by private consumption into service and actual goods and investment into fixed investment (machinery) and inventories.
When looking at GDP with all its components, we can see that companies have not invested in inventory, but rather have let that dwindle, while government spending has declined more than it has risen in the last 13 quarters. Doug Short graphically represents the components of GDP.
Inflation boosts the growth rate of each of the components of GDP. When the price of food or gasoline increases, GDP increases. This is more accurately called "real" GDP.
Thanks to The Economist, we have come to look at the price of the Big Mac as a good indication of inflation. The Big Mac includes beef, dairy (cheese), wheat (bun), cost of labor, and the cost of real estate. As a result, I believe it is a good representation of inflation.
However, our analysis of the Big Mac indicates that the escalation of the price of a Big Mac has grown much faster than the official government rate of inflation (CPI-U). Consequently, here is a view of GDP in light of our analysis of prices using the Big Mac Index.
As you can see, when including the price of the Big Mac, GDP growth has been exaggerated. We can see that GDP without the benefit of lower inflation has actually declined by more and for longer lengths of time than the official GDP numbers suggest.
Wednesday's first estimate of GDP growth for the second quarter of 2013 came in at 1.7%. However, adjusting for inflation using the Big Mac Index, GDP was a much more meager 0.5%.
In fact, when you compile GDP by using the government's provided consumer price index (CPI), you get divergences both above and below the official figure on GDP.
Richard Davis, the founder of Consumer Indexes, has graphed the differences between the official stated GDP index and GDP compiled with CPI (above). In the last four years, the divergences using the CPI for inflation have caused the GDP to be higher (Quarter 2 2010; Quarter 2, 2012) and lower than GDP (Quarter 3, 2009; Quarter 1 2011; and Quarter 3, 2012).
For another view of how GDP is compiled using different "official" rates of inflation, go to Doug Short's analysis. In his work, Short concludes that using an alternate CPI compiled by Shadowstats was too negative and may significantly understate growth in the economy.
The Real Truth
My conclusion is twofold. First, many, many people in the US and around the world rely on Big Macs as sustenance. If this is what they are experiencing in escalating food prices, it should be incorporated into the measure of inflation and GDP growth. Second, financial advisors should be aware of the differences in inflation. When running projections and creating financial plans, they should consider what individuals actually experience for inflation and what the government puts out in the form of CPI-U and in the GDP numbers may not reflect what the consumer experiences. Therefore, financial advisors should understand the differences so that they can help a person plan for one's retirement rather than have the hamburglar steal a portion of one's retirement.
Study the differences in GDP and learn how to advise your clients in a manner that best prepares them for the changes in the real consumer experience. Stay tuned for updates from AUM in a Box about GDP, inflation and more.
Quarterly GDP dates from 1947; Big Mac Index from The Economist began in 1986, but did not become consistent until Q2 1990. The Economist update Big Mac prices once or twice a year.
Real GDP is quarterly annualized to compare against the annual change in Big Mac prices.