The Bureau of Economic Analysis (BEA, a part of the Commerce Department) came out with its long awaited report on GDP for the second quarter and the results show a sagging economy. GDP weighed in at a positive 2.4% growth for Q2, but that is against a backdrop of an upwardly revised Q1 of +3.7%. This is something I have been expecting and it appears that more recent data is declining even more.
It has been my premise that (1) fiscal stimulus would only give a temporary boost to GDP without leaving any permanent economic growth, and that (2) the business cycle is stalling out because the government has thwarted the underlying factors necessary for a recovery.
The headline from the mainstream media has been for the most part that the reason GDP declined from Q1 is that exports have dropped and that imports have risen. In calculating the “national account” the BEA nets out imports and exports: imports result in payments to foreign sellers and exports result in payments from foreign buyers. Rising exports have been largely due to the surging value of the dollar in Q4-09 and Q1-10 as troubles in the eurozone caused institutions to dump euros for dollars. Europe’s troubles caused the euro to decline relative to the dollar and this made U.S. exports more expensive U.S. exports fell off. Further, Europe’s problems caused them to cut back on their imports that hurt not only U.S. exporters but also large exporters like China. As you can see, the euro is starting to turn around as the foreign exchange markets believe Europe is solving its problems. This may help exports if European companies recover.
But the decline in exports is not the real story behind GDP. The real story is the fact that the production cycle is stalling out because of a lack of consumer demand.
In the intial phases of the economic crisis, consumers cut way back on spending:
This caused retailers to liquidate inventory, which caused manufacturers to slow production and reduce their inventory. As you can see that cycle bottomed out one year ago. At some point in a cycle retailers understand they need to have some inventory, albeit substantially less than during the boom, and they start re-stocking their shelves. This causes manufacturers to deplete their inventories and start production. Consumers, at least those with jobs, may feel more comfortable about their future and begin spending, but it has been limited spending due to their negative view of the future.
This cycle is now slowing. As reported earlier this week, new durable goods orders, an indicator of future production, were down 0.3%. But, more importantly, shipments of such goods declined and inventories grew by 0.9%. As noted in the BEA report:
The change in real private inventories added 1.05 percentage points to the second-quarter change in real GDP after adding 2.64 percentage points to the first-quarter change. Private businesses increased inventories $75.7 billion in the second quarter, following an increase of $44.1 billion in the first quarter and a decrease of $36.7 billion in the fourth.
The big story in the second quarter as has been the case for much of the past year was the contribution from inventories – there was a “build” of $75.7 billion and this added over a percentage point to headline GDP growth. This follows a “build” of $44 billion in the first quarter so this is no longer the case that companies are merely reducing the pace of inventory withdrawal. Businesses actually added to their stockpiles at the fastest rate in five years. And with sales lagging behind, this inventory contribution is likely to fade fast in coming quarters. Real final sales – representing the rest of GDP (excluding inventories) – came in at a paltry 1.3% annual rate last quarter and has averaged 1.2% since the economy hit rock bottom a year ago in what is clearly the weakest revival in recorded history.
Here are the positives and negatives from the BEA report:
Final sales of computers added 0.04 percentage point to the second-quarter change in real GDP after adding 0.10 percentage point to the first-quarter change.
Motor vehicle output subtracted 0.01 percentage point from the second-quarter change in real GDP after adding 0.74 percentage point to the first-quarter change.
Real personal consumption expenditures increased 1.6 percent in the second quarter, compared with an increase of 1.9 percent in the first.
Durable goods increased 7.5 percent, compared with an increase of 8.8 percent.
Nondurable goods increased 1.6 percent, compared with an increase of 4.2 percent.
Services increased 0.8 percent, compared with an increase of 0.1 percent.
Real federal government consumption expenditures and gross investment increased 9.2 percent in the second quarter, compared with an increase of 1.8 percent in the first.
Real state and local government consumption expenditures and gross investment increased 1.3 percent, in contrast to a decrease of 3.8 percent.
The personal saving rate — saving as a percentage of disposable personal income — was 6.2 percent in the second quarter, compared with 5.5 percent in the first.
Almost everything except government spending was softer. I see nothing on the horizon that would change my negative outlook.
The BEA announced a major revision of their methodology for calculating GDP and they revised all of their data since 2007. Here is a summary of their revisions of GDP:
You can read into this what you will, and people do. I don’t get excited by this. I think it is important to view GDP numbers as nothing more than a rule of thumb as to what the economy is doing. You can do many things with the data to adjust it to your liking, for example, I would strip out government spending and view imports as a positive (but since GDP measures the ‘national account” it’s how the books work). I think the data is useful but not exact. The revisions are a good example of this: their views of how to measure economic activity change over time and will in the future. Trends are more important.
1. Businesses eventually will slow spending on technology efficiencies unless consumer spending increases. Remember, all production eventually leads to the consumer.
2. Money supply is declining and that is a pretty good indicator of deflation.
3. Government fiscal stimulus is running down and leaves us with an empty cup. There is little political will for more useless Keynesian spending.
4. Attempts to “fix” the economy through legislation and regulations will have no positive impact, but rather will continue to distort the economy and inhibit recovery: see, housing tax credits, Cash for [Your Industry Here]; TARP bailouts, mark-to-make-believe, extend and pretend, and many other programs that have backfired.
5. Increased taxes will harm the economy; if the Republicans get a foothold in November it is likely that the Bush tax rates will stay. On the other hand …
6. The Fed will invent some way to expand money supply. Perhaps they will use Open Market Operations to flood the economy with cash. One possible program is to allow banks to securitize their bad commercial real estate loans and then have the Fed buy them. If the Fed can buy toxic residential mortgage backed securities, why not toxic CRE debt? Perhaps they will charge interest on excess reserves. We don’t know exactly what they’ll do, but nothing is not a political alternative.