It does appear that the Chinese will opt for inflation rather than revaluation.

(1) I am not sure that your example does represent a criticism of the GDP calculations. If an American product declined in quality but had an unchanged price in dollars, its quality-adjusted price would have risen, so deflated US output would be appropriately lower.

(2) I do not think your scenario is analagous to what is currently happening. The key development is that import prices have simply gone up, because, as far as the US is concerned, the supply of commodities has contracted – essentially because other parts of the world are now consuming more (your model might be better with China and commodity producers split). It’s not that American products (and those of the rest of the developed world) have got worse; it’s just that the competition has got tougher. If we want to maintain the same standard of living, we must produce more or better than before, because the terms of world trade have moved against us. What worries me is that people in the developed world find it hard to accept that things can get worse without anyone having done anything wrong, and are liable to vote for politicians who at best deny the need for adjustment and at worst offer damaging populist solutions like protectionism.

This is a variation of the problem of the person with a hammer, for whom every problem looks like a nail.

Imports are simply not part of GDP, and therefore import inflation is not part of the GDP deflator.

The GDP deflator simply translates nominal GDP to real GDP by subtracting or deflating it by the appropriate inflation measure, which excludes import inflation, because GDP excludes imports.

And the deflator is not necessarily an indicator that either nominal or real GDP is contracting. My sense is that this may be a point of confusion for you.

Import inflation may be associated with many different types of GDP changes, including reduced domestic margins, increased domestic prices, changes in domestic demand, or sympathetic changes in export pricing and activity. The possibilities are endless. Recent import inflation has been accompanied by an increase in exports and real GDP growth via exports, partly due to the lower dollar.

The point I think is that the idea of the GDP deflator is simply a measurement of GDP inflation, which excludes import inflation, notwithstanding the many indirect consequences or associations import inflation may have for domestic pricing changes and the deflator.

You are not the first. And if we export tax subsidized cotton and crappy Coca-Cola made by illegal aliens, it’s even worse.

But here are what some economists don’t like about it.

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* Austrian economist critique – Criticisms of GDP figures were expressed by Austrian economist Frank Shostak[1]. Among other criticisms, he stated the following:

The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.

He goes on:

For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

Austrian economists are critical of the basic idea of attempting to quantify national output. Shostak quotes eminent Austrian economist Ludwig von Mises:

The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.

Simon Kuznets the inventor of the GDP, in his very first report to the US Congress in 1934 said[2]:

…the welfare of a nation [can] scarcely be inferred from a measure of national income…

In 1962, Kuznets stated[3]:

Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.
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http://en.wikipedia.org/wiki/Gross_domestic_product

To be a little more clear, let me take “financial product” out of the equation. Instead considering the following scenario:

Imagine toy economic system where America sells the country of Chirabia cotton and Coca-Cola, while Chirabia sells America oil and electronics.

Chirabian consumers wake up one day and realize that Coca-Cola is not a magic substance that makes you happy, rather, it is just flavored sugar water. Incompetent American management had taken all the coca out of Coca-Cola, making it far less valuable to the Chinese. As such, the demand curve changes, and the Chinese refuse to pay any more than $1 for Coca-Cola.

Since exchange rates must balance, the price of cotton and Coca Cola as sold to the Chirabians would go down. The quantities of cotton sold would increase, and the quantities of Coca-Cola sold would decrease or stay the same (depending on the exact structure of the supply and demand curve). The price of oil and electronics to Americans would go up, and the amount purchased would go down.

Americans would experience this as “import inflation” and a “falling dollar”. However, what really has happened is that a certain American produced product has substantially decreased in value. The new Coca-Cola no longer makes people happy and foreign demand for it has slackened. This means it is harder for Americans to buy Chirabian products.

Thus, overall, this example shows how “import inflation” can result from a decline in domestic production. Perhaps, then import inflation should be included in GDP deflator calculations.

My questions would be:
1) Is this scenario a fair criticism of the GDP calculations?
2) Is this scenario analogous to what is currently happening?

Italy is a completely different story. They have a huge public debt load. There politicians are probably the most corrupt in the EU and the Mafia has incredible power. I wouldn’t bet my life on Italy’s credit worthyness.

Italy and Spain will default tomorrow, or perhaps they will wait a while. I would personally consider an Italian default vindication, but I am sure it will not happen in our lifetime.

Devin Finbarr,

Not sure I understand your question, but a few points:

a) “American financial products” per se aren’t part of anybody’s GDP. They’re a flow of funds rather than GDP output (but this example is beside the point).

b) Most US domestic production isn’t valued according to the external value of the dollar. The dollar only affects the foreign value of exports and the domestic cost of imports.

c) The dollar is down which tends to make imports more expensive. And oil is up as well. The combination affects import inflation mightily.

I think in the end however you may be confusing the GDP deflator, which is a measurement of inflation, with the idea that GDP has contracted or been deflated, at least at the margin, as a result of import inflation. In fact, quite the opposite has happened. Import inflation tends to correlate with export competitiveness when looking just at the dollar. And exports have been growing and were the big contributor to recent reported GDP strength.

Sorry if I misunderstood your point.

On the other hand, if foreigners decide that they no longer value American goods – say they decide they do not want to buy American financial products – and that drives up the exchange rates, making foreign goods more expensive, then that does represent a decline in the U.S. GDP. That means that U.S. domestic production was much less valuable than it was in previous years.

Since the rising price of imports has been due to the second scenario, it makes sense that imports should be counted as part of the GDP deflator.