This is a Capital Market Story, Not a Recession Story

This is a Capital Market Story, Not a Recession Story

January 22, 2008 0 Comments

(January 22, 2008) Forget the GDP accounts that you learned about in macroeconomics class. The big economic and financial earthquakes always take place in the asset markets. Policy actions that target spending, like the stimulus measures being discussed today by President Bush and Congressional leaders, are not going to solve the problem.

When most people talk about the economy they mean gross domestic product (GDP), which measures the market value of the goods and services produced during a given year or quarter. This is a rough estimate of the value of the work produced by the economy over that period. Macro textbooks illustrate this concept with an island economy, as depicted in the figure below where some islanders catch fish and others pick coconuts and GDP is the total value of fish and coconuts produced during the year.


To get a handle on the size of GDP, the most recent report indicates that GDP in the third quarter of last year (Q3/07) U.S. nominal GDP, using current market prices, was $14.0 trillion at an annual rate. Real GDP, calculated by adjusting nominal GDP to remove price changes since 2000, was $11.7 trillion in 2000 dollars. We will get our first estimate of Q4/GDP from the Commerce Department on January 30.

Changes in GDP, which we use to measure growth, are much smaller. In Q3/07 real GDP increased $138.8 billion at an annual rate, a 4.9% annual rate compared with the previous quarter.

Within the Q3/07 GDP accounts, residential construction accounted for $463.3 billion or 4.0% of real GDP, but fell by $27.4 billion compared with the previous quarter.

It is important to remember that all of these numbers are measured at annual rates, which means that they tell us what GDP would be over a year if all four quarters of the year looked exactly like this one. That means real production of goods and services actually only increased by about $35 billion (one quarter of the $138.8 billion annual rate number and that residential investment actually fell by about $7 billion (one quarter of $27.4 billion) during the quarter.

I am not writing this to make light of the housing crisis but to illustrate that it is a story measured in the billions of dollars–not trillions.

Compare these numbers with measures of privately-owned assets. According to the most recent Flow of Funds Report from the Federal Reserve Board, the market value of U.S. assets at the end of Q3/07 is roughly $195 trillion, or about 14 times the size of GDP. (This estimate does not include the value of the vast government land holdings.) Because the numbers are so large, even a small disturbance in the asset markets–a change in people’s relative desires to hold assets–can send shock waves through the economy that will dwarf anything going on in the GDP accounts.

What is happening in today’s asset markets is not a GDP event; it is not the result of late mortgage payments. It is a profound reduction in the willingness of wealth-holders to own the existing stock of assets. It will not be fixed by giving checks for $12.50 to every man, woman and child. The fix must restore confidence in the underlying assets. More on this to come.


John Rutledge


  1. mark

    January 23, 2008

    Dr J
    confidence in holding the assets? So do you subscribe to the view held by the like of that the derivative markets are in danger and it will be necessary for the mortgage insurance industry to be nationalised.
    Do you see Gold Bullion as the store of value relative to paper currencies
    Good health

  2. finance ninja

    January 29, 2008

    Wow. Your blog is pretty confusing for the non-economist educated, but enlightening. I've been reading many of your posts on the stimulus package and I think you are right that the market will go where it wants to. What would Alan Greenspan say about this? No rate cuts and tuffen up?

    I think the market is ready to move much further down, but my economists friends think different and say much of the worst is over. Like they say "I dunno", neither do I.

    What I do know being a real estate investor is that if mortgage rates do drop lower again more opportunies with cut homes prices to be bought up and current homes going back up in price will be sold for a fat profit (which that money goes back into the economy).


  3. Fabian Tavernier

    January 30, 2008

    Dr. Rutledge my question is simply this. Money is never lost it simply changes hands and if this is the case then where is the wealth being transferred to? My comparison of the economy is that of a casino, when the individual player looses then the house wins and vice versa. With this said who are the individual players and who represents the house?

Would you like to share your thoughts?

Your email address will not be published. Required fields are marked *

Leave a Reply

Copyright © 2014 Rutledge Capital · All Rights Reserved