Introduction
The peace at which the national GDP increases is, naturally, of great interest to the FED and to all traders and investors.
The capability to offer insights into the exchange of products and services across markets makes the GDP Growth Rate an excellent indicator of the condition of the Country’s economy.
In this article, we’ll find out what the GDP is and why its growth is so important.
What is GDP and what does it include?
The simplest way to explain the GDP is to describe it as the way we measure the monetary value of all products and services produced within a country and sold to the final consumer in a given time period.
GDP is universally recognized as the most representative indicator of the size of a Country’s economy while the GDP Growth Rate is best suited to offer an insight into its economy’s health.
In the US, GDP figures are calculated and released quarterly by the Bureau of Economic Analysis. Generally, a GDP Growth Rate of 2%-3% is considered ideal but any rate above zero would show an economy is growing whilst a negative rate would indicate a contracting economy.
The FED pays a great deal of attention to the GDP Growth Rate figures as it is inversely correlated to the unemployment rate; a growing economy is more likely to require a greater workforce.
As a trader, you too should pay the same level of attention to every GDP figure released keeping in mind that any surprise result can easily and drastically move virtually all markets.
What exactly is included in GDP calculations?
There are four distinct elements within an economy that need to be considered when calculating national GDP and GDP Growth Rate. These are Consumption, Government Spending, Investments, and Net Exports.
GDP = C + G + I + NX
C: Consumption.
“Consumption” is consumer spending and it includes all general day-to-day personal and business expenses.
Let’s take for example a person going to the ice cream parlor to treat himself after a hard day at work.
The price he pays for the ice cream will be included in the GDP figure as well as the parlor’s staff’s wage, energy bills, and rent. Of course, also part of GDP calculations is the value of the ice cream’s ingredients, the cost of the fuel necessary to drive to the shop, the wage this person has earned, and the services he or she has provided during the hard day at work and… well, you get the idea.
G: Government Spending
The Government spending figure includes all its expenses at the federal, State, and local agencies levels. Health care and defense spending are part of the national GDP as well as the cost of constantly improving and maintaining infrastructure and those related to the legislative, judicial, and executive branches of the Government.
It is important to note that national Debt, national debt repayment, and transfer payments such as Social Security are NOT included in the GDP calculation.
I: Investments
When it comes to GDP calculation, the term “investment” refers to the value of all business investments in new capital goods such as land, buildings, and equipment. It does also include large personal investments such as home buying but NOT investments made in stock, bonds, or any other financial market.
NX: Net Exports
Simply put, Net Export is the difference between the Nation’s imports and exports value.
A Country that exports more than it imports (in value terms) would have a positive Net Export (called a “trade surplus”). In the opposite scenario, a Country would have a negative Net Export (called a “trade deficit”).
The two economies
The fact that investments in the financial market are not included in GDP calculation can often give the impression of the existence of two economies within a Country.
The GDP figures reflect what is generally referred to as “the real economy” whilst financial investments can be seen as one of its byproducts; one with such a great amount of capital involvement to be able to create a “second economy.
The “two economies” are strictly correlated and, usually, when one flourishes, the other often follows. However, it is important to remember that while GDP calculations only take into consideration the current state of the economy, markets trading and investment are made based on future expectations. This means that the real economy and the markets don’t always move in parallel lines; the two can differ enormously in performance, results, and degrees of success. During the Covid pandemic, for example, the US saw a drastic reduction in GDP (caused primarily by work and movement limitations) whist the Stock market reaches its all-time high with companies such as Apple, Amazon, Microsoft, and Alphabet breaking the $1 trillion market-cap level (and then some).
Always keep an eye out for every GDP release and, of course, for our next article too.
Hope this helps.
Read and learn more about the fundamentals on our blog
Join Trade The Pool now to trade the next GDP data
If you liked this post make sure to share it!
