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Magic Money Tree


National Income and Product Accounts

This is an Earnings Statement for the U.S. productive (ie., production-and-consumption) economy. It is compiled by the U.S. Bureau of Economic Analysis. (The table is copied from page 9 of BEA's GDP Primer, Measuring the Economy).

table

The right side of this statement is a compilation of all spending for final goods and services produced within the nation's borders during the year, the total of which is defined as Gross Domestic Product (GDP).  The left side of the statement is a compilation of all income from that spending, which also totals to GDP because of the logical tautology that all spending is someone else's income.

BEA uses spending data to compile GDP because that data is the most accessible and accurate, available from the multitude of monthly and annual financial reports businesses and government agencies are required by law to submit.

BEA uses the (less-accessible) income data from the submitted financial reports in a double-entry accounting system (as shown in the table) to confirm that they're accurately compiling the spending data.  Any difference between the two compilations is accounted to a Statistical Discrepency account on the income side, which is monitored and held to a tiny fraction of GDP.

Note that what is being measured is the flow of currency through the economy, ie., the income and spending — not the stock of currency, ie., the assets and liabilities (or net worth or wealth).  Note also that it's the flow of currency through a business (as compiled in their earnings statement) that most businesses use to manage their operations.  This is equally applicable to managing the economy.

Gross Domestic Product

Gross Domestic Product (GDP) is the most objective and accurate measure available of the income and spending through the economy — as it's compiled from real data reported by those who are actually receiving that spending.  The table below shows GDP spending for 2018.  Each column shows the previous 12-months' spending.  The Q4 column shows GDP for the year 2018.

table

Personal consumption expenditures shows the spending by households — which accounts for about 2/3 of GDP.
Gross private domestic investment shows the spending by businesses — which accounts for about 1/6 of GDP.
Government consumption expenditures and gross investment shows the spending by government (Federal, state and local) — which accounts for about 1/6 of GDP.
Net exports of goods and services shows rest-of-world spending for domestic goods and services — which accounts for a small, single-digit percent of GDP.  Note that Net Exports is exports minus imports.  The imports are subtracted because they're already included in the other spending accounts (largely households).  During 2018, if all imports were included in household spending they would have accounted for about 17% of that spending.

The latest GDP spending data is available online as BEA Table 1.1.5 and the income data as BEA Table 1.10  Brief descriptions of the table Line-items are given in the GDP Primer cited above.  More complete definitions of these items, as well as the sources and methodologies used in compiling them, is provided in the GDP Handbook

Note that GDP as used here is nominal GDP (NGDP).  In order to allow comparisons of GDP over time, BEA also reports a real GDP (RGDP), which is NGDP (the actual measurement) adjusted by an estimate of inflation over time. 

The U.S. Economy

Given the above, and recognizing that the U.S. dollar is a fiat currency (ie., backed only by government decree), we can describe the U.S. productive (ie., production-and-consumption) economy both very accurately and very simply.

GDP is the measure of our productive economy.  GDP is the sum of household, business and government spending (and likewise the income of those sectors equals that spending, because all spending is another's income).  Our economy depends on household spending (2/3 of GDP).  That spending is limited by household income (which comes only from those three sectors).  Business provides that income to the extent demand (ie., business opportunity) exists, and government provides the rest.  All that's important to the economy is maintaining this flow, and with a fiat currency (whose value, by definition, depends only on currency-users perception), there are no limits other than that perception.

Thus the dollars we pass back and forth are tokens that have value (ie., purchasing power) only because we believe they have.  They're accepted by our landlord, grocer, auto dealer, ... only because the owners of those businesses believe that their employees and the businesses they patronize will accept them.  (That's something to keep in mind when we're considering wealth,
ie., accumulating those tokens.)

Note that the household spending in GDP includes everything that the public buys to consume — food, clothing, housing, transportation, healthcare, entertainment, etc. However, looking at the income side of GDP, we find that neither Federal borrowing nor personal or corporate income taxes are part of that income — so they do not (and never have) paid for (or funded) that spending. [1]  So there really is a Magic Money Tree!

The existence of a Magic Money Tree triggers many questions:

Why do we pay taxes?  Taxes serve two main purposes:  (1) To give credibility to the dollar.  (Since dollars are required by law, to pay taxes, they're convenient to pay for other things.)  (2) To redistribute wealth.

Why does the Federal government borrow?  It doesn't borrow.  It sells payables denominated in dollars that others can invest in as a "safe harbor".  What you know as the Federal debt is simply a bookeeping record of what government spends minus what it receives in tax revenue, that has no relevance to the production-and-consumption economy.

Why doesn't government make everyone rich?  Because that would change users' perception of the dollar. If too abundant, it would be perceived to have no value. But note that government could freely spend to pay for the public's livlihood needs, and likely many of its wants, if it took care to ensure that there was adequate (and competitive) supply before spending. That this is not currently happening is a political problem — not financial.

Why isn't government paying for the public's livelihood needs?  Because it needs a method to ensure that most of the dollars paid out get spent, not saved.  Additional dollars spent flow through the economy, creating more business activity (increasing GDP).  Additional dollars saved have no benefit to the production-and-consumption economy.

Why would people work if government gives them free pay?  Two reasons: (1) They wish to earn more.  Peoples' wants exceed their livlihood needs.  (2) The human need to be involved and contributing.  People work, if able, for a feeling of self-worth.  Politics will determine whether pay is given freely (eg., a UBI) or in return for guaranteed work (eg., a JG).

The Other Economy

The production-and-consumption economy described above is the ESSENTIAL U.S. economy,  It's what feeds, clothes, houses, ..., us.  But recognize that there's another economy at work here — the income taxes collected must be going somewhere (actually they're just destroyed), you can buy and sell stocks and bonds, you can insure most anything you want to insure, banks encourage you to run up debt to buy more (while simultaneously lobbying politicians to keep your income in check) — and none of this activity in included in GDP.  This other economy is known as the FIRE (Financial, Insurance, Real Estate) economy.  Since it's not part of the essential economy, it can be fairly called the NON-ESSENTIAL economy.

What's importamt here is recognition that these are two different economies.  The essential economy is measured by GDP and depends only on dollar flow, ie., spending and its resulting income.  The non-essential economy deals in assets and liabilities (or wealth). and is unmeasurable in any sensible or meaningful way.  Don't confuse the two.  I'll be describing the non-essential economy in a subsequent article.

References

[1] GDP Handbook, Glossary, Account 1.6, Taxes on production and imports. "Does not include personal and corporate income taxes and personal property taxes".)


Addenda


  1. Is GDP a compilation of real data?
    Yes. Every business in the nation is required by law to submit their financials to agencies of the Federal government (for taxation and other purposes).  If, for example, each month, every restaurant in the country reports its sales and costs for that month, we know what the restaurant industry’s sales and costs were for that month — and we know what households spent in restaurants that month — and that is one sub-account in GDP’s Personal consumption expenditure account.  That’s real data – nothing fuzzy about it.
  2. Is it useful?
    Yes. Using the example above, due to the quantity and geographical disbursement of restaurants throughout the country, composite restaurant financials hold quite steady.  If there’s a significant change, it’s important to those trying to manage the economy to explore what caused the change and whether and how to correct it.  Even looking at the data over time can tell us something, not just in questionable attempts to view long-term trends using statistically-derived inflation-indices, but in realistic relative spending patterns, eg, restaurant consumption increasing or decreasing relative to grocery consumption, imports increasing or decreasing relative to total domestic consumption, etc.
  3. Is it accurate?
    Reasonably so given the complexity of the data.  BEA's classification of income and spending follows the well-established NAICS (North American Industry Classification System).  The methodology used in compiling the data is described in detail in their 500-page Handbook and detailed definitions of their composite accounts are included in the Handbook's extensive glossary.  But probably the best argument for its accuracy is its wide use throughout the business community (including the acedemic).  If there were any serious failings — or better alternatives — they'd be well known by now.
  4. Why are some productive activities excluded?
    Some obviously-productive activities, like unpaid housework, are not included in GDP because GDP does not measure (and is not intended to measure) all productive activity.  GDP simply measures the flow of currency through the production-and-consumption economy to see where that currency is being spent and where the resulting income is coming back from.

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