Six indicators—okay, nine

A reader asked me what I thought were the most important indicators of the nation’s economic and financial health.  I quickly rattled off six of them, sent the email—then contemplated that list for a few days, spotted a weakness, and added three more. 

Here are what I consider the six most important indicators of the USA’s financial health—the ones I rattled off at the beginning of this three-day exercise—with some brief remarks on each.  These are not prioritized; in my head, they are all tied for first place.

1.  Interest rate on the 10-year Treasury note.
An indicator of the world’s investors’ opinion of the dollar and the safety of US Treasury securities. 

2.  Inflation rate.
An indicator of the value and stability of the US dollar, and therefore of our economy’s ability to support the value of the dollar.  (If only there were a single reliable reading on current inflation, let alone a predictor of future inflation . . . but there isn’t, so I track several inflation indicators.) 

3.  Foreign exchange rates.
An indicator of our trading  partners’ opinion of the dollar’s current and future value, and therefore of the strength of our economy now and in the future.   

4.  Size and growth rate of real GDP, and real GDP per capita.
Indicators of the wealth-creation performance of the US economy.  (If only we were a little better at isolating quality improvements from true price inflation, we’d be better at deriving “real” GDP from nominal GDP.)

5.  Net interest as a percent of federal tax receipts.
An indicator of the federal government’s creditworthiness.  The inverse of “times interest earned.”  (A purer indicator than #6, I think, but not as well known.)

6.  The ratio of nominal federal debt to nominal GDP.  A proxy for #5.  Some say “publicly-held debt” is the important numerator—but I prefer to track that ratio and the “total debt” ratio, because demographics are likely to begin transforming intragovernmental debt into “publicly-held” debt rapidly within the next two decades.  See the debt clock at the upper right of this page.

[Each one of those six deserves at least a full article; this is just a quick summary.]

I thought about that list for three days, and noted that, for the most part, they are snapshots of the bottom-line results of years, even decades, of momentum driven by the marketplace and tweaked by policy decisions.  That snapshot was a little weak on indicators of the underlying causes.  Trends are easy to calculate for GDP, tax receipts, spending, etc., but mechanical extrapolation always gets more dangerous the farther out one extrapolates, unless one has a thorough grasp of the underlying drivers.  (I keep my fingers crossed when I extrapolate out eighteen months; any guess what I think about CBO projections looking thirty years out?)  Anyway, I decided I should add three or four more indicators to provide a few sanity checks regarding the underlying strength of the economy—the fundamental driver of every one of those six indicators.  Here are the sanity checks I decided to add:

•  Productivity (real output per labor hour).
This will be a key factor in how well we pull through the coming demographic changes.  (Again, if only we were better at measuring inflation, we’d have a better handle on this one.)  Capital productivity might deserve a place on the list, too.

•  Employment levels and trends.
Indicates how well our creative destruction process is working; i.e., how much faster we create new, better jobs than we destroy or export old, obsolete jobs. 

•  Unemployment levels and trends.
Those who are in the job market but don’t have jobs aren’t producing much GDP (…duh), or consuming as much; as a result, the measurable economy isn’t as strong as it could be. 

Again, those three extras will help shore up any tentative conclusions I draw from the first six. 

Notice anything that’s absent?  If so, feel free to add a comment below—although I must point out that I rejected several headline-grabbing stats, intentionally, right off the bat.  Examples:

• dollars of debt outstanding;
• dollars of interest payments;
• debt held by foreigners;
• the size of the fiscal deficit;
• the size of the trade deficit; and
• the value of trust fund “IOUs.” 

Reason: those headline-grabbers are large numbers with no context; they are emotional diversions resulting from single-entry accounting, which—notwithstanding its vitality in the world of propaganda and political rhetoric to this day—died a well-deserved death in the objective accounting world nearly five hundred years ago.  Good riddance. The key to our future is economic growth, not misleading emotional rhetoric.   

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[Thanks to Loire Marteney for asking the question.]

Comments

[marmico]

The gini-coefficient...http://en.wikipedia.org/wiki/Gini_coefficient

[Bob]

Steve,

GDP is fine as a broad measure. But whhat about the components of GDP? Yes, there are long and short cycles in there though I would think that private non-residential investment is a key indicator of how businesses view the future (with optimism, right?).

I suppose one could take the position that employment is a form of investment though I am interested in hard assets as well. I don't want them all going to India and China.

[Olivier]

Well that is an interesting question. But the list of good indicators can go on and on and I would suggest instead to look for an 'overall' indicator of an economy. This is necessarily restrictive, of course. But this quest for the uber indicator should really make us think about what is really important to us, citizens.
I think that, overall, what's important is the quality of life. Now this is subjective and should be pinned down more to an economic concept. In the list Steve provided, the most important is #4 -- GDP per capita, IOW purchasing power.
This is more important than just one partial figure of, say, inflation or debt. In addition, "purchasing power" drives productivity up and unemployment down.
But then again this is the problem of the chicken and the egg, because "purchasing power" needs good economic policy beforehand.

[Stephen Reed]

On a related topic, the treasury budget numbers just released for this month were not good. Tax recepits increased by only 1.17% March of '07 compared to March of '06, much less than the rate of inflation.

[woodchuck64]

How about the ratio of household debt growth to income growth?

http://www.levy.org/pubs/ppb_88.pdf

If debt is growing and income is not keeping pace, how healthy can an economy be?

Hypothetical: let's assume everyone is letting their debt run up uncontrollably because they own tulip bulbs that have appreciated so much over the years that the average tulip-bulb owner is, on paper at least, worth quite a lot. Is this a healthy economy?

[Tim Shell]

Energy consumption per capita is a good indicator, too. It is probably the best way to measure and compare living standards.

[Kevin]

Steve, sure there's an indicator of "future inflation", now that the Treasury has TIPS bonds. Just take the yield differential between the 5 or 10 year Inflation-indexed bond vs. the comparable regular T-note or bond. Which now happens to be 2.5% ... which is just about what I'd expect of inflation.

The Bloomberg Rates & Bonds page gives an easy one-look comparison:
http://www.bloomberg.com/markets/rates/index.html

[Kevin]

I grapple with what productivity number makes the most sense. I've had misgivings about labor productivity numbers ever since I did a thought experiment and imagined a country in which only one person had a job. Maybe he's the most productive SOB ever to punch a time clock, but that would be one very impoverished country. I figure that's pretty much France.

[Bob]

The problem with labor productivity numbers is that they are manufacturing based. That's why GDP per capita is better. I liken it to revenue per employee.

[Steve]

Kevin:
Right, the TIPS spread is one popular indicator, although like others, it hasn't been a flawless indicator of actual inflation. In any case, I like to keep an eye on it; latest chart was posted in this article:
http://www.optimist123.com/optimist/2007/03/mar_2007_inflat.html

[Olivier]

Kevin,
You are totally right: the perfect example for high productivity and high unemployment is France. And this is Frenchman writing. So long those who tell you that productivity -alone- is the key to prosperity. Think Japan, too, until recently.