Zimbabwe’s Output Gap

If you missed yesterday’s Money Morning on ‘Born Again Keynesians’ (BAKs) love-affair with the Output Gap, then take a quick read now. You can click here for it.

You’ll need to read it as a primer for the following item. And don’t forget, you can now leave comments on the Money Morning website, as ‘Nick99′ already has for yesterday’s story.

Now you’ve read the primer I won’t need to give any further background.

But I will mention this, yesterday was a torrid day for your editor. We just couldn’t get our pea-sized brain around the idea of Actual GDP and Potential GDP. We’re still none the wiser. Sure, we understand that ‘potentially’ an economy can produce more if it’s at full capacity, but the problem is where do you draw the line?

Is the ultimate potential GDP where you have 100% employment and every business and consumer is using every form of new technology to improve their productivity?

If not, then the concept of Potential GDP must be a subjective number. It is therefore subject to manipulation and inaccuracies as various BAKs feed in their own economic modeling to extract the result they’re after.

But after that torrid day, your editor’s brain was finally relieved of its torment as we belatedly confirmed to ourself that the Output Gap is an irrelevant and fraudulent method of predicting inflation and prices.

Referring to the diagram above lifted from the Reserve Bank of New Zealand website, if the red line is below the blue line then price inflation is not possible. That’s because GDP is running below its potential and therefore there is no pricing pressure.

We wonder then how the Born Again Keynesians factor in Zimbabwe.

Let’s look at some numbers from the economic basket case of a nation that has set the trend for Western economies:

• Unemployment is 94% (that’s unemployment, people not working!)
• 80% of the population live below the poverty line
• Gold Production in 1998 was 27,114kg; in 2007 it was 7,017kg
• Agriculture production has been decimated
• Yet, inflation is 231,000,000%

Surely even the BAKs would agree there is a lot of ‘potential’ in an economy that has only 6% of its population in the workforce, and where production of gold is only 25% of the level it was nine years previously.

And where successful farmers were driven from their land to be replaced by ineffective Mugabe drones.

Zimbabwe’s ‘red line’ would be firmly planted below the ‘blue line.’ There should be no inflation in Zimbabwe…

Only there is. And at the last count it was 231 million per cent.

We’ve had a crack at Rory Robertson from Macquarie over the last couple of days, but the sad truth is he’s not alone. We remember NABs Alan Oster at the ASX presentation a few months back telling everyone that inflation is not important.

Unfortunately, any of the economic ramblings you read from the economists at the major banks trot out the same dangerous message. It’s a message principally designed to save their own bacon and that of their banking bosses – and of course the politicians that do them favours (banking bail-outs anyone?).

The Output Gap is a sham, yet it’s a sham that 99% of the mainstream economists worldwide are using to argue that printing money and propping up prices is not inflationary.

We’ll keep our eyes open for the creeping reliance by mainstream economists on this deeply flawed theory.

Other Stuff on the Markets

The S&P/ASX200 fell 0.43% yesterday, while there was better news overnight on Wall Street with the Dow Jones Industrial Average adding 90 points. In Europe the FTSE100 gained 1.25% and the CAC40 added 2%.

The price of gold in Australian dollars is trading at $1,161.61, while in US Dollars it trading at $938.00.

The Aussie dollar remained steady versus the US dollar and Japanese Yen, trading at USD$0.8072, and JPY77.57.

Further strength for Crude oil overnight, closing at USD$71.49.

For the biggest movers on the market yesterday click here…

And today on the economic calendar we have Private Sector Credit and HIA New Home Sales. In the US the S&P/CS Home Price Index is released.