The Third Quarter Bump

By Jeff Harding

It isn’t as if taking your money and giving it to other people to buy new cars doesn’t create sales, it obviously did and I would expect that we’ll see an upward tick in GDP for Q3 as a result.

Almost every investment house is revising upward their predictions on Q3 results. The Wall Street Journal’s survey of economists now collectively predict GDP to be +2.4% in Q3. Corporate profits are one of indications that they point to: a 5.7% increase in Q2 over Q1. Also they point to increasing new home sales, rising durable goods sales-4.9% in July, and declining inventories. They also point to consumer spending increasing for the third straight month in July, up 0.2% almost all of which is attributable to Cash for Clunkers.

John Maynard Keynes

John Maynard Keynes

What the bulls tend to discount is that consumer spending is basically weak, household debt is still high, and home prices, the basis of most people’s wealth, continue to decline. Deflationary forces are still at work in the economy and inhibit credit expansion through bank lending. Banks still are burdened with a high amount of overvalued assets on their books, and, as the previous article, Anatomy of a Deflation, pointed out, banks remain cautious, if not nervous, and they are reluctant to lend.

Banks are concerned about commercial real estate loans, rising mortgage defaults, and, because of falling asset values, the value of loans and asset backed securities on their books. While mark-to-market rules have been relaxed, thus allowing them to avoid being adequately capitalized, the banks all know that stated asset values of many loans and asset backed securities are a fiction. Since much of banking involves being able to rely on the solvency of other banks, this has restricted lending as well.

The point to all this being that there are still powerful forces at work that point to continued deleveraging, deflation, and tight credit that will put pressure on employment, and thus spending.

While declining housing inventories is a good sign, we are going through the next phase of the bust: the deleveraging of overvalued commercial real estate and personal debt such as auto and student loans. I believe we will still experience declining home prices for some months before it stabilizes.

The “bump” in GDP seems to be primarily due to Cash for Clunkers. This is a transitory effect that will not last. As I pointed out in Cash for Clunkers = Cash for Unions, these sales come at the expense of future sales. You can’t create growth by taking money from one person and giving it to another to spend. You lose the economic benefit that the original person would have achieved with the money, and, when the second person runs out of money, the effect is gone. Thus the GDP numbers when they come out will be fake, a false indicator of economic activity.

I just saw where GM and Ford are ramping up production to meet expected higher demand in 2010. This is sad to see and a serious error on their part.

What a mess. You can thank John Maynard Keynes and almost all the economists in America who are his disciples.

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5 comments to The Third Quarter Bump

  • Lloyd G.

    Cash 4 Clunkers, First Time Homebuyers credit, stimulus and other bailout money all had an effect to be sure. All the TV pundits are saying “Yay!” Bernanke and Krugman have both credited their ideas with saving the world. Well…

    To put it in terms that the average layman can understand, what’s happened in the US economy in the last 12 months is analogous to a guy who had a very good paying job.

    Our friend spent every penny he made. He borrowed as much as he could — for a house, cars, vacations, etc. Banks loaned him the money because he had a good paying job, and he’d always paid his debts on time. His credit was good. He had a good life.

    One day the boss announced that their business was not doing very well. Everybody’s hours and pay would be cut. All of the sudden there was less money. Our friend went home and discussed the situation with his family. What to do? Make cuts in the household budget? Give up one of the leased cars? One of his kids who did a book report on the John Maynard Keynes and the Great Depression in high school pointed out the obvious solution: Max out the family credit cards! Our friend did this and life was better than ever.

    The end.

  • Good observation, Lloyd.

    Also, I enjoyed your comment on the teachers’ response to the No Child Left Behind act. I’ll bet they could solve all the education problems if we just gave them more money.;-)

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