GDP Formula

GDP = C + I + G + (Net Exports)
Which is to say, that Gross Domestic Product in a country is equal to total Consumption (personal and business) plus Investments plus Government Spending plus next exports. This equation is known as an identity equation. It is true for all countries and times.Now, gentle reader, I am going to spare you a few pages of algebra and cut to the chase.
Let's divide a country's economy into three sections, private, government and exports. If you play with the variables a little bit you find that you get the following equation.Domestic Private Sector Financial Balance + Governmental Fiscal Balance - the Current Account Balance (or Trade Deficit/Surplus) = 0This equation was introduced to you a few months ago in an Outside the Box written by Rob Parenteau.

We are going to review this briefly, as it is VERY important. Paragraphs in quotes will be from that letter. As Rob noted, "...keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong."By Domestic Private Sector Financial Balance we mean the net balance of business and consumers.

Are they borrowing money or paying down debt? Government Fiscal Balance is the same: is the government borrowing or paying down debt? And the Current Account Balance is the trade deficit or surplus.The implications are simple. The three items have to add up to zero. That means you cannot have both surpluses in the private and government sectors and run a trade deficit. You have to have a trade surplus.Let's make this simple.

Let's say that the private sector runs a $100 surplus (they pay down debt) as does the government. Now, we subtract the trade balance. To make the equation come to zero it means that there must be a $200 trade surplus.$100 (private debt reduction) + $100 (government debt reduction) - $200 (trade surplus) = 0.But what if the country wanted to run a $100 trade deficit? Then that means that either private or public debt would have to increase by $100. The numbers have to add up to zero. One way for that to happen would be:$50 (private debt reduction) + (-$150) (government deficit) - (-$100) (trade deficit) = 0. Remember that we are adding a negative number and subtracting a negative number.Bottom line.

You can run a trade deficit, reduce government debt and reduce private debt but not all three at the same time. Choose two. Choose carefully. And before we get into the implications, let's look at yet another equation, although this is somewhat simpler.Delta ForceThere are two and only two, ways that you can grow your economy. You can either increase your population or increase your productivity. That's it.The Greek letter "Delta" is the symbol for change.

So if you want to change your GDP you write that as:Δ GDP = Δ Population + Δ Productivity

If you are a country facing a population decline (like Japan) that means to keep your GDP growing you have to increase your productivity even more. That is why I have written so much about demographics over the years. Population growth (or the lack thereof) is very important. Russia is facing a very serious problem over the next 20 years that will require either a significant increase in productivity or large immigration to stave off a collapsing economy.

Russia's population has declined by almost 7 million in the last 19 years to 142 million. UN estimates are that it may shrink by about a third in the next 40 years. But that's another story for another letter.One last economic insight.

You cannot grow your debt faster than nominal GDP forever. At some point, the market begins to think you will not be able to pay your debts back. This is no different than the fact that a family cannot grow its debt faster than its income ability to pay the debt back. At some point, you run out of the ability to borrow more money as lenders "just say no."As a family's or country's debts grow, the carrying cost or interest expenses rise.

At some point, the interest expense consumes an ever larger portion of the budget. Increasing the debt increases the interest expense eventually to the breaking point. There are limits.

Six Impossible Things | John Mauldin | Safehaven.com

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