Markets closed up HUGE on Wall Street: DJI +2.54% SP500 +2.95% Nasdaq +2.97% Gold -0.28%

The markets were up because:

• Manufacturing in China and GDP in Australia beat expectations. Markets opened with a huge gap up and never looked back. So, as of the moment, in the Battle of SP500 1040 the bulls are leading the bears 5-1 >
• US Manufacturing came in much better than expected. The August ISM Manufacturing Index rose to 56.3 versus expectations for 52.5. See why improving fundamentals at Joy Global (JOYG) may mean the stock is worth buying >
• Lehman Brothers executives got flogged on Capital Hill. Former CEO Dick Fuld stopped playing “Where’s Waldo?” and showed his lying grill to the country. Don’t Miss: Lehman Brothers CEO Dick Fuld Blames Us for Bankruptcy. What is Capitalism without Self-Responsibility?

Quantifying all the money being moved around the economy is difficult. It requires understanding the will of households, firms, governments, and foreign markets. To pull off such a trick, we’d need near perfect knowledge.

Such omniscience is impossible. So, our solution is to provide a macroeconomic model for all the money being earned or spent on all final domestic goods and services.

Measuring a Nation’s Income

Gross Domestic Product (GDP) serves as the measurement of the income or expenditures of a nation, the calculation of money transferring hands, and a comparison of national efficiency and wealth. As an economic indicator, it gives us an idea of a nation’s welfare by giving it an income, and comparing it’s earning and spending powers to previous fiscal calendar quarters. Investors and economists looking to interpret the data can find releases from the Bureau of Economic Analysis.

Stocks and Flows

Thinking about GDP means categorizing all things in the national economy as either stocks or flows. Stocks are a quantity we measure at a specific point in time. Flows are that same quantity measured over a specific period of time. These numbers give us two distinct ways of measuring GDP:

1. Looking at the prices of goods with inflation (nominal GDP); and,
2. Looking at the prices of goods without inflation (real GDP).

When nominal GDP is higher than real GDP (it usually is), there is a rate of inflation within the economy. We measure this with the Consumer-Price Index (which finds how prices have changed over a specific quantity or flow variable) and the GDP Deflator (which finds how quantities have changed over a specific price or stock variable). Then we take the best of both worlds and average the two together. This is known as the Fisher Index.

(Note: all numbers are presented with seasonally-adjusted averages.)

The Income Approach and the Expenditure Approach

A nation’s total income is added up in two different forms:

1. the income approach; and,
2. the expenditure approach.

The income approach measures a nation’s income by the amount of money made within the country. The expenditure approach measures by the amount of money spent within the country. Either approach should theoretically yield the same amount.

The Income Approach Breakdown: W+P+R+I+T

The income approach is found through all money earned by firms and households. This includes:

Wages – Monies earned by households through business payrolls.

Profit – Monies earned by firms through businesses. This also includes money earned by the self-employed.

Rent – Monies earned by landlords for use of land and properties by consumer households and firms.

Interest – Monies earned through banking interest.

Taxes – Monies collected by the government.

The income approach is a valid method for collecting GDP data, yet is less popular and not used officially on government economic releases.

The Expenditure Approach Breakdown – C+I+G+(X-M)

The expenditure approach is used more frequently than the income approach, and its components are accessible through Federal Reserve Economic Data.

Consumption – Consumption, which accounts for around two-thirds of GDP, is the expenditure of all households within a nation. It is divided into three subcategories: durable goods, nondurable goods, and services. Durable goods make up items that are held for long-term purposes such as TV’s or cars. Nondurable goods serve short-term purposes and include food and clothing. Services are work done for consumers by individuals and firms.

Investment – Investment is made up of goods bought for future use. Investment is also divided into three subcategories: business fixed investment, residential fixed investment, and inventory investment. Business fixed investment is the purchase of new plant and equipment for firms. Residential fixed investment is the purchase of housing by households and landlords. Inventory investment is the increase in a firm’s inventory. For example, an unsold 2010 Corolla would be added to Toyota’s (TM) investment spending.

Government Spending – Government spending makes up all goods and services bought by federal, state, and local governments. This includes military spending, highways and infrastructure, and funding for government services. However, it is important to note that government spending does not include transfer payments to individuals such as Social Security and welfare. Transfer payments reallocate existing income. Since they are not made in exchange for goods and services, they are not included in GDP.

Net Exports – The last category, net exports, is the total value of the exports a nation provides the rest of the world minus the value of the imports a nation receives from foreign countries. Starting in 1976 our country has experienced a trade deficit because the amount of goods imported were more than the number exported. In 1985 the US began its infamous trading deficit with China.

Is Gross Domestic Product Accurate?

The flaws with GDP data are that some use these numbers to determine the welfare and quality of life in a country. Unfortunately, GDP can only be used to calculate the amount of domestic production. GDP fails to tell us how large the gap is between the rich and the poor, the wealth of the average citizen, and is also underestimated because it does not include money being pumped through underground economies.

Another criticism is that GDP fails to categorize unpaid house work such as that performed by stay-at-home parents. The value of this labor not being included diminishes overall GDP. Similarly, this draws criticism because a sandwich eaten at a restaurant contributes to GDP, where a sandwich prepared at home does not. The sale of used goods is not included either. Anyone who has been to a yard sale or heard of eBay (EBAY) knows this is a major flaw with GDP data.

Lastly, GDP data is backward looking, always revised later, and subject to government manipulation. For this reason, some famous investors such as Jim Rogers don’t even pay attention to GDP numbers.

Want to become a more savvy investor? Don’t Miss:

Your Ultimate Cheat Sheet to Unemployment Numbers

Your Ultimate Cheat Sheet to Consumer Confidence

Premium: Your Cheat Sheet to Investing in Solar

This morning credit rating agency Standard & Poor’s (MHP) said in order for the US to keep its AAA-rating, it is “very important” for Congress to deal with the cascading US Debt. China’s largest credit rating agency Dagong Global Credit Rating Co. was less diplomatic: they simply downgraded the US credit rating to AA.

This, my friends, is only the tip of the iceberg of what will unfold should we choose to kick the proverbial can farther down the road. As you can see in the infographic below, according to the US Treasury we are watching a debt Tsunami come ashore. If we have any pride or patriotism, we’ve got to start dealing with the crisis now before it wipes out generations of wealth:

Click for Larger Image

Are you scared to invest in the current environment? Let us show you how to continue growing your portfolio during these crazy times with our highly acclaimed Wall St. Cheat Sheet Premium newsletter.

Markets closed down on Wall Street: DJI -1.33% SP500 -1.46% Nasdaq -1.66% Gold +0.35%

The markets were down big because:

• US Existing Home Sales in July crashed 27.2% since June. We now have 12.5 months of supply available at current average selling prices. Will we need another tax credit to shift buyer psychology? >
• Japan’s Economy Continues to Ail. The Nikkei is now down 20% from an 18-month high. At least advertising is getting stronger in China >
• Retail Sales dropped week-over-week. So far, no big race to buy stuff for back-to-school. Don’t Miss: 12 Steps to a US Recovery: Step #1 Buy Local >

If you like easy-to-understand research with actionable ideas that can make you money, don’t miss our highly acclaimed Wall St. Cheat Sheet Premium newsletter.

From Yahoo Finance:

It’s the beginning of the end for the U.S. dollar.

China made headlines last week, overtaking Japan as the second-largest economy in the world. However, Damien Hoffman, co-founder of Wallstcheatsheet.com, says it was other news out of China that may prove more vital for the dollar’s standing as the world’s reserve currency.

Not only is China diversifying away from U.S. Treasuries with euros and other currencies, they are buying more gold and opening their debt markets to international companies. Last week, McDonald’s (MCD) became the first nonfinancial foreign company to launch a yuan-backed bond offering. The deal was relatively small, with the fast-food giant raising nearly $30 million to expand in China, but was symbolically huge.

“The number itself isn’t important,” Hoffman tells Aaron in this clip. “What’s important is that now those yuan-backed bonds will change the dynamic of capital that is available in the world and where these companies are going to go to get that capital.”

If this trend continues – which Hoffman believes is inevitable – demand for U.S. dollars will wane, resulting in an even weaker dollar.

Compounding the problem is the seismic shift of industrial jobs to emerging markets in Latin America and Asia. Hoffman worries a disappearing middle class and a compromised currency “doesn’t bode well” for living standards in America. He warns that unless we fundamentally fix our economic imbalances it’ll be wise to teach our children Mandarin — one of the prime reasons famed investor Jimmy Rogers says he moved his family to Singapore more-than three years ago.

Lately, everyone is questioning the consumer and the consumer’s ability to spend at retail. Yet, this earnings season has proved even the smallest uptick in top-line growth is serving better results than consumer confidence. The reality of the numbers has one step up on recent turbulent sentiment surveys. Here’s a look at Gap Inc. latest earnings breakdown (GPS):

Earnings: Q2 profits of $.36 vs. $.35 consensus and a gain of $.33 in Q2 last year, an 9% rise in profits Year-over Year.

Revenue: Increased 2% Year-over-Year from $3.24 Billion last year t0 $3.32 Billion this year, versus $3.31 Billion consensus, slightly passing expectations.

Gap Inc. CEO Glenn Murphy sees potential international growth, “By the end of the month, we’re going to open up our first store in Australia…Everything is on target for China. We’re going to open up at the end of October in Shanghai and we’re going to have four stores by the end of the year in Shanghai and Beijing…And Italy, which was the other big country we announced a few months ago, we’re going to be opening up in late November in Milan with both Banana Republic and Gap stores.”

Comment: Shares of Gap Inc (GPS) are trading down 2.3% following the company’s earnings release on Thursday, August 18th, after-the-bell, trading at $17.30 per share.

In the chart above, Gap Inc. (GPS) shares are trading at 52-week lows well below the 50-day and 200-day moving averages. An upside announcement for shares came from Gap’s board authorizing a new $750 million share repurchase program, on top of the $1 billion already authorized for 2010, bringing the total to $1.75 billion. In general, share buybacks reduce the supply of shares to the public in an effort to preserve share price and potentially increase it down the road if positive earnings can be delivered consistently in the future. Meanwhile, the Old Navy brand accounted for 37% of Gap Inc. revenues in the 2nd quarter. I increasingly hear that Banana Republic has been fashionably out-of-favor and in dire need of a turnaround to kickstart better sales again. As Gap Inc. (GPS) grows its presence abroad, the question remains whether their retail brand will be embraced and accepted. We’ll be waiting to see whether Gap Inc (GPS) performs in new emerging markets, first, before thinking twice about investing in their shares with confidence.

The world’s greatest economies have always competed fiercely to reign supreme. From Egypt to the Iberian Peninsula, to Great Britain and the United States: when a King of the Hill got sloppy-drunk on power, a more hungry rival was ready to pounce.

Over the past decade, China has made huge strides toward the economic throne of the world. They’ve joined the WTO, repurposed their entire country into the greatest manufacturing machine in history, embraced as good a derivative of capitalism as any, and, most importantly, been on the right side of the wealth transfer pipeline.

Now, in recent months, China has pressed their heel into the throat of their debtors. They have sharply pared back purchases of US Treasuries, they have further diversified into Gold, and they are helping foreign companies such as McDonald’s (MCD) offer hordes of yuan-denominated bonds.

What does this mean for the US Dollar? A guaranteed near-death-experience.

While we’re all sitting here using prayer as an economic policy, China is using all the wealth we’ve exported to them. How much wealth is that? Take a look at the Trade Deficit:

That yellow stream is literally the wealth we’ve pissed away. We can cry ourselves a river or wave flags to feel better, but the truth is we need to get our shit together before multinational corporations start looking at yuan-backed bonds as the borrowing instrument of choice. With a virgin $2.1 trillion interbank bond market to tap, it’s a very BIG step toward Chinese capital markets becoming King of the Hill.

If we thought the dotcom bust and the housing/credit crisis were harsh, we ain’t seen nothing yet. And there are two solutions: genuinely fix our economy, or start teaching our kids Mandarin.

Don’t Miss: 23 Occupations That Will Never Recover from the Great Recession >

The US Treasury reported that the budget deficit hit $165 billion in July which is actually less than the near $180 Billion in July of 2009. Month to month activity is volatile so it is best to compare single months to previous years and compare several months of data. I looked at the deficit for the first seven months of 2009 and compared it to the deficit through July of 2010. We are supposed to be in a recovery yet the budget deficit (for the first seven months of 2010) is up 2.36% compared to last year.

The government operates on the fiscal calendar which ends in September. In February they had expected a FY 2011 deficit of 1.267 Trillion. Weeks ago their expectation was revised up to $1.4 Trillion. Meanwhile, the deficit in July marked the 22nd straight month of deficits. In years past some months, such as April were always in the black (as far as receipts and outlays).

We should also note that the often overlooked “interest on the debt” thus far in 2010 is $375 Billion, which is very close to the $383 Billion for all of 2009. That is with five months left in the year! Wikipedia shows an estimated FY 2010 budget of $3.55 Trillion. The interest on the debt already comprises 10.56% of the entire budget!

Hyperinflation is inevitable when the government goes broke. The cause is too much debt and then an inability to grow out of the debt. We are seeing this in slow motion. Even though interest rates are historically low, the interest on the debt is surging.

According to the Treasury, the total current debt is $13.3 Trillion, which means the interest rate on the debt is a little over 3%. What happens two years from today when we add another $2.8 Trillion in debt and interest rates are 4% (which is still historically low)? Per my rough estimates, the interest on the debt would hit $644 Billion. Instead of interest payments  comprising 10.5% of the budget, it would be closer to 20%. This is just in two years accounting for a little bit of economic growth, maintained spending and a small rise in interest rates.

As the interest on the debt consumes more and more of the budget, the government has to devote less and less resources to its citizens and to trying to stimulate the economy. It becomes stuck in a pit of a rising debt burden and an economy that can’t mount any growth.

Hence, bankruptcy and currency reform is inevitable for the west.

Inflation/Deflation, Bernanke, interest rates, Fed policy…it is all secondary to the above, which explains why Gold and to a lesser degree Silver, is rising against every currency and performing relatively well amid short-term changes in the markets and overall sentiment.

This is also why governments of the west hold their reserves in Gold and not in various currencies. Hence, China, India and Russia are buying aggressively. While those in positions of power hate and denounce Gold, they know it will be an integral part of the new currency regime, whenever it comes about.

In the meantime, us little people can be our own central banker and manage our own economy. While Bernanke and fellow US policy makers are shooting blanks, we can hedge ourselves with physical Gold and Silver and devote a portion of our wealth to gold and silver stocks which can rise many times in the ongoing bull market.

Consider a free 14-day trial to our Gold & Silver Premium service. Learn more here.

This is a guest post by Cam Hui CFA at Humble Student of the Markets.

The news flash came across my desk: China’s leading credit agency downgrades the US, Britain and France from AAA. This news is undoubtedly a sign of things to come. The question is, “Can America retain its status as a leading economic power?”

The news is grim. I have written before about the analytical framework of deficit reduction. That kind of macroeconomic adjustment is only effective if Americans retain their underlying competitive advantage. John Hussman wrote this week that the basis of American competitive advantage rests on superior physical capital and human capital [emphasis added]:

The main source of this difference in productivity is that U.S. workers have a substantially larger stock of productive capital per worker, as well as generally higher levels of educational attainment, which is a form of human capital. This relative abundance of physical and educational capital has been a driver of U.S. prosperity for generations. Neither advantage in capital, however, is intrinsic to American workers, and it will be impossible to prevent a long-term convergence of U.S. wages toward those of developing countries unless the U.S. efficiently allocates its resources to productive investment and educational quality. This is where our policy makers are failing us.

The US is squandering its lead on both fronts. Instead of investing on productive physical capital, we have seen excessive malinvestment leading to bubbles in technology, real estate and finance over the past couple of decades. The internet and real estate bubbles were plain to see.

As for finance, what does all of the malinvestment of human talent into Wall Street say to the world? Despite the ineffectual efforts at financial regulation, Americans remain in denial about the role of finance in society. The news of the Alan Greenspan chair at NYU is just another sign of denial.

‘Nuff said.

Trouble in higher education

In addition, there seems to be signs of trouble in higher education, which is a key driver of the productiveness of human capital.

Firstly, the lead in education isn’t what it used to be. A recent study concluded that elite universities are eroding their competitive edge. I had blogged about a Tiananmen Square protester returning to China for the sake of his children because of the lower quality the Canadian education system, which from first hand-experience equivalent or slightly higher quality than the American system.

As well, the cost of a university education is spiraling out of control. Consider Rolfe Winkler’s comments:

The market for college education looks a lot like the market for houses circa 2006 – very bubbly. And the reason is similar: There is too much credit.

Colleges can keep raising prices, despite the recession, because the government keeps lending students more money to pay them.

Rising prices and ample credit to finance purchase – does that sound like anything we saw before, such as the housing market? Carpe Diem shows this chart to illustrate how fast prices have been rising and went on to warn of a bubble in higher education:

Malinvestment in physical capital and failing human capital … there will a time to pay the piper and that day may be coming sooner than anyone expects.

Cam Hui is a CFA Charterholder and currently serves as a portfolio manager at Qwest Investment Management.

Looking for great investing ideas? Wall St. Cheat Sheet Premium subscribers have been crushing the markets with winning stock picks and a professional navigator in the hot gold and silver sectors. Let our team of professionals give you their best investing and trading ideas: click here now for your free trial.

According to the International Energy Agency, China (NYSE: FXI) is now the world’s most voracious consumer of energy. This is a monumental moment in world history because the US has held the top spot for more than a century. Moreover, energy consumption is one of the most powerful indicators of a vibrant economy.

So, where does this new era in energy history lead? First, it takes us into the final act of changing the economic superpower guard. The first act of this ritual started when the US exported industrial production and jobs. That strategic blunder transformed our economy from a Boeing (NYSE: BA) Dreamliner 787 engine into a lightweight hallowed drone. The second act proceeded by turning countries such as Japan and China into our sovereign versions of Capital One (NYSE: COF) credit cards.

Now, in the third act, China will continue to manifest a domestic consumer class modeled after the 20th-21st century American. As we have seen over the past several years, China has scoured the globe to control as many large scale energy reserves as possible. This is not a preemptive move to deal with a nation of rising hippies. It is a move showcasing the long term plans for continued growth and power as both producers and consumers in the world economy.

Of course, the final act of the changing of the guard will be the epic moment when, according to a Deutsche Bank (NYSE: DB) study, China’s GDP surpasses US GDP in the early 2020s. A lot will happen between now and then. However, you can bet the new era of energy history will lead investors and businesses to one of the greatest macro investment trends of our lifetimes.

Looking for great investing ideas? Wall St. Cheat Sheet Premium subscribers have been crushing the markets with winning stock picks and a professional navigator in the hot gold and silver sectors. Let our team of professionals give you their best investing and trading ideas: click here now for your free trial to any of our acclaimed newsletters.