In the summer of 2013, at a time when the topic of soaring US debt was still paramount to the US public (total debt is now a far more ludicrous, and gargantuan, $19.3 trillion but nobody cares since all the central banks are monetizing global debt at an unprecedented pace and investors are happy to frontrun them, thus keeping yields low) the US surprised everyone by “increasing” GDP, and thus reducing the debt/GDP ratio which was at about 100%, in a very simple way: it changed the definition of GDP, in the process boosting GDP by about $500 billion, or 3%, with the flip of an Excel spreadsheet switch.
This is what we reported at the time:
The US economy will officially become 3 per cent bigger in July as part of a shake-up that will see government statistics take into account 21st century components such as film royalties and spending on research and development. Billions of dollars of intangible assets will enter the gross domestic product of the world’s largest economy in a revision aimed at capturing the changing nature of US output. Brent Moulton, who manages the national accounts at the Bureau of Economic Analysis, told the Financial Times that the update was the biggest since computer software was added to the accounts in 1999.
Fast forward three years later, when the biggest fabricator of economic data in the world, China, finally realized that its lowly disciple, the US Bureau of Economic Analysis, has overtaken it. And since China will never rest if it is upstaged in this particular area, China has announced that it too was about to adopt new methodology to assess the economic contribution of the various new sectors of the economy, said Xu Xianchun, a deputy head of the National Bureau of Statistics, cited by China Securities Journal. China’s official GDP growth has been underestimated due to the emergence of this “new economy,” he said.
Specifically, the NBS announced on July 5 that it will adopt the current System of National Accounts (SNA) 2008 standard by treating R&D expenditure as part of capital formation, or in other words, China will do in 2016 what the US did in 2013.
The outcome: billions in “economic output”, retroactively created out of thin air as a result of growth that had previously not been accounted for.
How much growth is China about to add from a mere change in definitions? As it turns out not much (as China’s GDP is measured in terms of Y/Y growth and not in absolute amount), but it will be sufficient to, as Goldman puts it, “eases stimulus pressures on the margin.“
Or, just like in the case of the US, China will have suddenly grown more than it actually grew, even when in reality it may well have been contracting.
Here is the explanation of Goldman’s Yu Song.
Under the new method, the size of the economy is larger than previously estimated; 2015 GDP was revised up by 1.3% to 11tn USD, the Real growth rate was also revised up (rates vary from year to year and averaged 0.06% (6 bps) over the past 5 years). The upward revision is because China’s R&D expenditure growth has been consistently faster than that of overall GDP–though the difference the change makes to the GDP growth rate is small as R&D is a small part of the economy. The NBS announced 1Q real growth was revised up by 0.04% (4bps), but it did not specify whether the growth rate is now 6.8% yoy or remains at 6.7% yoy. We believe the latter case is slightly more likely as an upward revision would have been highlighted. A higher trend level would mean 2Q GDP growth should be higher as well. As a result, we revise our Q2 real GDP growth forecast to 6.7% yoy from 6.6% yoy previously with slight upside risk to our full-year forecast of 6.6% yoy.
Many other economies have already adopted the new method; we note China had been expected to do so as well though the change has come later than expected. As the new method is in accordance to the latest international standard, we do not expect it to have an incremental impact to sentiment around methodology/data credibility. We see this move as beneficial for the economy on the margin as it makes it slightly easier to quantify statistically how to achieve the target of doubling real income by 2020; the method provides added flexibility to pursing potentially necessary reforms. We note that sometimes reform can have a negative impact on short-term growth and the need to meet short-term growth targets can distract policy makers from reform initiatives leading to the potential risk of overstimulating the economy beyond its potential growth rate.
Judging from the rise in inflation since the start of the year, the current level of potential growth is no higher than the recent actual level of around 6.7% yoy. This level is likely to moderate further in the coming years, because of the demographic headwind and modest pace of reform implementation. While the magnitude of the changes to growth rates appear to be small, we believe these seemingly small changes are relatively more important when growth is right around the target level, as opposed to when the economy is overheating or in recession. Furthermore, the move to the new standard opens room for further adjustment as self-owned housing services should now also be captured in GDP according to the SNA 2008 standard, potentially leading to a modestly higher growth rate. Other “new economy” activities such as sharing economy are also being considered according to news reports. In 2018, the government will also conduct the next economic census. As the new sectors in the economy are potentially underestimated by the standard methodology, which is relatively strong with the accounting of the production of tangible goods, previous census typically led to upward revisions to historical data. With further upward revisions, which appear likely, there should be incrementally lower pressures to reach the growth targets in the coming years.
Real GDP growth was revised up marginally because R&D expenditure has been growing consistently faster than overall GDP
Goldman’s conclusion is somewhat troubling for the world’s liquidity addicts as it means that instead of relying on trillions in new credit creation, China may tone it down to just hundreds of billions, and fill the gap with “optics.” This means that as a result of this “non-GAAP” GDP adjustment, China will be able to get away with an even faster true growth slowdown as long as it can fabricate enough numbers to get away with it.
of course, it won’t end there, because in the new normal, where the world may have already hit its debt capacity (as Citi recently speculated), when all else fails, one’s economy will “grow” simply as a result of definition changes, changes which in the case of China, almost certainly make a minus sign into a plus.
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