This Adjusted Buffet Indicator Will Freak You the F#@K Out!

I’ve recently taken on the challenge to work through various indicators that I believe are part of the giant con that America is still enjoying growing economic prosperity.  The basis for doing this is that I have a very difficult time accepting that while real median incomes and real wages are declining that the nations standard of living or economic prosperity is increasing.  The coexistence of such realities simply does not foot.  Pouring over various datasets it becomes obvious that the ‘bridge’ between rising GDP and a declining economy is debt.  Literally every relevant dataset I run over the past 50 years tells exactly the same  story.   That while demand has struggled due to real flat or declining income, economic ‘growth’ has been merely a function of debt principal, both national and consumer.

And as I’ve discussed in depth lately, GDP is supposed to equate to and thus represent total national income, however, it is being overstated because we are adding total additional debt into our change in GDP each period.  The problem with that is for each additional dollar we have taken on since the mid 1970’s we’ve generated less than a dollar of output (i.e. income).  And so we are losing money on each dollar requiring ever more debt to cover the losses and lack of natural growth.  Further, calculating debt as income seems completely contradictory to what we do at the individual level.  Certainly none of us add in the additional debt we take on each year and count that toward our income level.  The reason we don’t is because we understand that at some point that has to be paid back with interest.  And so we don’t identify additional debt as additional prosperity.  It just doesn’t make sense.

In order to get to a GDP figure that more closely represents the nations true economic prosperity I adjust GDP and change in GDP for changes in debt at both the consumer level and at the Federal level.  What we find is that we have not had true growth in economic prosperity since the early 1970’s with the exception of a four year period between 1996 and 2000.  And we have seen a collapse in economic prosperity over the past 6 years.  I find myself debating with people all the time who continue to tout the all time high market valuations are based on an improving economy and it really winds me up.  I throw out facts and figures and get just a lot of conjecture in return, like my recent debate with the CIO of BMO.

One of the metrics people point to all the time is the Buffet indicator.  They tell me things may be slightly overvalued relative to history but that we are still well below the overvaluations we saw in 2000.  I’ve struggled with that one.  I see they are right and I knew something seemed really off about it.  Real median incomes have been declining since 1998, U6 unemployment rate for the past 6 years has remained at least double what the worst one period read was between 1998 and 2007 and the labour participation rate is lower than it has been since 1977 when few women were yet to venture outside the home.  And forget about revenue.  Despite 5% population growth ing the past 6 years real S&P sales are lower than they were 6 years ago.  These should be devastating realities to the economy so then how is it that these all time high stock valuations can be lower than they were in 2000 relative to the economy??  Well thanks to a discussion with a good friend from North Carolina today (h/t Mr. McCabe) we talked right into the answer.  It’s the same as every other economic distortion.  Debt!

When we just think logically about it everyone knows we added $10 trillion of public debt over the past 7 years but no one ever seems to adjust any metrics for the insane amount of debt and the obvious implications and distortions that come along with it.  We just keep on calming calculating with the blinders on.  And so I’ve taken an adjusted GDP figure (excluding growth due only to additional debt principal) and run it against the Wilshire 5000 to get an Adjusted Buffet Indicator.  And what we see is the true overvaluation of today’s markets.  All data is pulled from St. Louis Fed except Wilshire data which I pulled from Wishire.com.

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What we see is that the adjusted Buffet Indicator essentially mirrors the original Buffet Indicator from 1970 through 2000 when it dislocates slightly through 2008 at which point it completely dislocates.  The adjusted indicator is nearing 3.72 standard deviations above the mean.  Comparatively the original indicator had its highest overvaluation in 2000 at around 1.79 standard deviations above the mean.  This suggests today’s true market valuation is more than twice the previous all time high in 2000.

This again makes sense when we start realizing we have to begin adjusting things for the incredible amount of debt we’ve taken on over the past 6 years.  We simply cannot just turn a blind eye to the debt.  And that is exactly what every government agency is doing.  Where are they adjusting for the massive future drag on growth?  Nowhere!  You cannot borrow unlimited amounts of money and simply pretend like it isn’t happening!!  If you could everyone would do it.  Ask yourself where would GDP be if we hadn’t taken on $10 trillion of debt.  And if you think it would be close to the same well then why in the hell did we take it on?  Someone should go to prison because it’s costing us $250 billion per annum.

Hopefully you get the point that we MUST adjust our economic indicators for the enormous amount of debt.  To simply pretend it doesn’t exist or has no material implication on the our prosperity is really beyond my ability of tolerance.  I leave it with you to start thinking about how the additional $10 trillion in debt should start being adjusted out of the infinite ‘positive’ indicators of economic strength being thrown around by all the Krugman wannabes out there.

10 thoughts on “This Adjusted Buffet Indicator Will Freak You the F#@K Out!

  1. A cogent analysis in the vein of countering the MSM meme that America is the best of a bad lot. How dangerous a lie!

    P.S. As a fellow analyst, I admire your charts. Would you mind telling me where I can find this software? Thanks so much!

    1. I pull data from various sources usually into excel where I can manipulate. R is pretty good too and easy to learn (and free).

  2. “And as I’ve discussed in depth lately, GDP is supposed to equate to and thus represent total national income, however, it is being overstated because we are adding total additional debt into our change in GDP each period”.

    Hi Thad, I’m new to your site but enjoyed your article. My understanding is that when BEA computes GDP it does not include any debt increments, though it does include interest payments (income to creditors). I’ve been attempting to understand our national economy using Godley’s sectoral balance equation, which is a ‘flow’ equation and so ought not include and ‘stock’ (asset/liablity) variables which would include debt or debt increments. How did you come to conclude that GDP includes debt or debt increments? Thanks for any details you can supply.

    1. I typically avoid responding because it always leads to unending discussions and I can’t get back to everyone, however, I will give you a starting point to ponder…. ask yourself why we take on debt. I expect you can work it out from there. Thanks very much for your interest. If no other benefit arises from my efforts, interest in the subject will prove a great weapon toward truth.

  3. Thad: Very reasonable and concise analysis….just wonder if we are beyond any ability to correct the debt hole we are in currently? I am so tired of many so-called economists and other charlatans that murmur “we owe it to ourselves” debt, hence, no need to worry about it. Someone downstream will need to pay this debt, without any choice….taxpayers.

  4. I just found your blog today and you are amazing. It’s odd to say but reading your posts is like looking in a mirror that makes me look smarter and more handsome. Keep it up.

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