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You may have heard that the government is going to make some major changes in how our Gross Domestic Product is calculated later this year. Your first thought might be that this is no big deal. However, I will argue today that it is a very big deal, the biggest in a decade, and you need to know why. So I hope you read what follows with more than a passing interest.

Last week, the Commerce Department’s Bureau of Economic Analysis (BEA) announced it will be making some significant revisions to the way it calculates Gross Domestic Product in late July. This change is somewhat controversial in that it is expected to add a whopping 3% to GDP in one fell swoop in the last week of July. That’s about $1,500 worth of extra goods and services for every person in the US!

The reason for the changes is the fact that our economy increasingly depends on the production of intangible goods, and we need to recognize that the production of ideas is an important form of investment. So in the future, the BEA is going to count a company’s research and development as a form ofinvestment just like the purchase of a new office building. And the creation of a lasting work of art – a painting, a movie, a television series, etc. – that can be sold year after year will, likewise, be treated as a capital investment.

Today, I will talk about these sweeping changes and what they will mean for all of us.

Most of the forecasters I subscribe to expect economic growth to average only 1-2% in the first half of 2013. Most believe that 4Q GDP fell sharply from the 3.1% rate in the 3Q of last year, largely due to fears about the fiscal cliff. They also expect growth to improve modestly in the second half of this year to 2% or slightly higher. That’s not too optimistic.

One reason is that the end of the payroll tax holiday on December 31 means that workers’ pay went down by 2% on January 1, thus adding more headwinds to the economy this year. A person earning $50,000 a year before taxes, for example, will pay an additional $1,000 or more to the government this year.

Add to that the fact that we are sure to have another nasty debt ceiling battle next month, which will once again be unsettling to consumers who drive the economy. We all remember the fiasco in the summer of 2011 when the Dow plunged over 2,000 points. For these reasons and others, at least the first half of 2013 could be very dicey.

Actually there are three debt battles – the so called “trifecta” – that lie ahead. In addition to the debt ceiling battle, there is also the sequester/automatic spending cuts on March 1 and the “continuing resolution” to fund the government in the absence of a formal budget passed by Congress. That happens in late March. We will look at all three of these upcoming battles below.

Today we’ll also touch on the pork-laden fiscal cliff bill that passed on New Year’s Day. And we will ponder the question of whether the US has a “spending problem” or a “taxing problem.” Let’s start with this last one first.

I must begin today by thanking you for the overwhelming reader response we received to last week’s E-Letter. It was the largest response we’ve had in several years. Obviously, I struck a nerve with many of my readers last week! I’ll fill you in as we go along.

Following that discussion, we dissect last Friday’s controversial 2Q GDP report, which most found disappointing but some in the mainstream media found encouraging (ie – at least we’re not in a recession). From there, we’ll discuss the Fed’s latest monetary policy meeting that ends tomorrow.

The stock markets rallied strongly last week, partly on perceived good news from Europe, and partly because of renewed expectations that the GDP report would be weak enough to move the Fed to enact QE3. We’ll know one way or the other tomorrow afternoon. If Bernanke fails to announce more QE, stocks could tumble again.

The non-partisan Congressional Budget Office (CBO) has calculated the expected negative effects on the US economy if the Bush tax cuts expire at the end of this year. Their numbers just released last week are eye-opening! To give us some perspective, US Gross Domestic Product rose by 2.2% (annual rate) in the 1Q of this year.

The CBO now forecasts that if the Bush tax cuts expire at the end of this year, GDP in the first half of 2013 will plunge to-1.3%. Think about that. We don't know what the economy will do for the rest of this year, but the consensus expectation is that GDP will probably average around 2.5% for 2012, barring any negative surprises. So a drop from around 2.5% this year to negative 1.3% in the first half of next year – if the Bush tax cuts go away - is HUGE!

For all of 2013, the CBO forecasts GDP growth of only 05.% – if the Bush tax cuts go away, and even that may be too optimistic. I wrote at length on this news from the CBO in my blog last Friday. I will give you a link to that blog posting at the end of today’s E-Letter so you can read it.

What we want to focus on today is why this economic recovery is so weak. We will look at the latest economic reports and ponder why they aren’t stronger. We’ll look at the latest news on the housing market and find that there are some signs of improvement. I will also bring you an independent analysis of why the recovery is so weak (and what caused it) that I think you’ll find very interesting. It’s a lot to cover in one letter, so let’s get started.

Our national debt has now reached a record $15.6 trillion, thus eclipsing our gross domestic product of $15.1 trillion. Of this $15.6 trillion in debt, $10.8 trillion is held by the public (including investors, the Fed, state and local governments and foreigners), and the remaining $4.8 trillion is held by various government agencies and trust funds (including Social Security).

Our national debt consists of Treasury securities ranging from 30-day T-bills to 30-year T-bonds. Surprisingly, the average interest rate on our national debt is now down to only 2.2%. The average maturity on our national debt is only 62.8 months. What this means is that 71% of our privately-held Treasury debt must be rolled over in the next five years. The US now surpasses Greece, Portugal and Spain when it comes to relying on short-term borrowing to finance our national debt.

The question is, will there be ample buyers to roll over all this debt in the next five years? This may shock you but the Federal Reserve bought up 61% of all net Treasury issues in 2011. This makes the Fed the largest buyer of US Treasury securities! What happens when the Fed has to stop this practice? Higher interest rates come to mind, especially when you consider that foreign buyers of our debt have started to scale back their purchases. China, which is the largest foreign holder of our debt, actually decreased its holdings of Treasuries by $156 billion in the second half of 2011. This is scary!

What, you haven't heard all this in the media? Of course you haven't. But I will give you the facts and the dangerous implications in today's E-Letter. Please read it carefully. We need to get this information to as many people as possible. Let's jump right in.

We touch several bases today. We begin by looking at some recent economic reports which are encouraging. We also preview this Friday's very important first report on 4Q GDP. The pre-report consensus is for a number in the 3-4% range (annual rate), following only 1.8% in the 3Q. Following that discussion, I will bring you the latest estimates from the Blue Chip Economic Indicators, a monthly survey of 50 leading economists and forecasters.

From economics, we shift gears and take a look at income tax policies. I will attempt to explain how some wealthy Americans (think Warren Buffet, Mitt Romney, etc.) can legally pay a lower tax rate than rank-and-file Americans who earn "ordinary" (W-2) income. I will also explain the difference between the "marginal" tax rate and the "effective" tax rate. The two rates are significantly different, yet the media often refer both in the same breath without making the distinction.

Next we look at a recent poll of over 500 millionaires. Believe it or not, 71% said they believe the "rich" should pay higher taxes. But in the same survey, 49% said that the higher tax rate should NOT apply to them but only to super-rich types like Warren Buffett. There are several other interesting insights from this poll of millionaires which I will point out.

We touch on several bases in today’s letter. We begin with Fed Chairman Ben Bernanke’s key speech at the Fed symposium in Jackson Hole, Wyoming last Friday, which proved to be a yawner despite all the anticipation beforehand. Next, we look at last Friday’s disappointing GDP report which was revised lower, alonng with other recent economic reports.

Following that, we look at the latest long-term budget forecasts from the Congressional Budget Office. As I will discuss below, the CBO uses so many optimistic assumptions in these forecasts that one wonders if they are even relevant anymore. In any case, I’ll give you the latest numbers.

Next,I make the case that the US economy has now drifted once again into “stagflation” – defined as slow growth and rising inflation. Expect to hear more references to stagflation in the days and weeks just ahead, but you heard it here first. Finally, we look at the latest chaos in the stock markets.

When most people hear the term “Lost Decade,” they immediately think of Japan during the 1990s after it incurred its own financial crisis.Now, however, there are legitimate concerns that the US may be facing its own Lost Decade. In fact, we're already halfway through it. From the 1Q of 2006 to the 1Q of 2011, the US economic growth rate (GDP) averaged less than 1% a year. As I discuss below, we may be looking at a slow economy and continued high unemployment for several more years as consumers continue to pay down debt and curtail spending.

Clients and readers regularly ask me what it's going to take to get this economy moving once again. Normally the economy is growing at 5-6% by this point after a recession. But there are several dynamics that are different this time, most notably the fact that many of the 10 million US jobs that have been lost over the last few years are never coming back. There are numerous reasons for this, and I will point them out as we go along.

We will also revisit the issue of the debt ceiling. While the politicians working on this issue say they're making progress on an agreement, there's no hard evidence that the two sides are remotely close to making a deal before the deadline of August 2. While interest rates have been falling due to the slowdown in the economy, things could get quite wild in the financial markets in the weeks just ahead if the debt ceiling is not raised in time. Stay tuned.