Peter Radford / Economics / consumption, deficits, exports, Federal Reserve Board, fiscal policy, GDP, imports, inventories, jobs, monetary policy, non-residential investment, stimulus /

More GDP Muddle

October 29, 2010

We have been waiting for a while for today’s first look at third quarter GDP. We should have known better. At an annualized rate of 2.0% it was neither good nor bad. Frankly this concerns me more than either of those results would have. Muddling through is fast becoming the American way. That cannot be good for our ong term health or wealth.

First let’s look at the numbers:

Consumption added +1.79% to the total
Private investment added +1.54%
Trade deducted -2.01%
Government Spending added +0.68%

As usual it’s more interesting to get behind some of these numbers.

The consumption figure is encouraging. It is the fastest rate of personal spending since the end of 2006, and is the third straight steady improvement. Households appear to be coming out of the depths of their funk. But they are nowhere near back to sufficient activity to drive the economy forward without help from other sectors. Within consumption the big pick up over the last few quarters has come from services. The recovery in sales of services has been both stronger and more sustained than the recovery in the sales of goods. This suggests to me that people are out and about more frequently than they were back in the depths of the recession, but that they are also still postponing commitment to the purchase of expensive durable goods. That does not auger well for manufacturing, and may show up as a slow down in our factory activity early next year.

In fact the private sector investment figure includes hints that manufacturers are already scaling back a little. While investment grew quite well it is well down from the pace earlier in the year, and, more worrying, the majority of investment came in the form of inventory build up. I have been saying that the shift in inventories during the end of last year and the beginning of this was a temporary phenomenon and would dissipate as the economy recovered. That is the normal trajectory we should expect. And that was the pattern we saw during the first six months of the year. So to have that normal path reverse itself is a a concern. We don’t know exactly what the cause of the shift is – was it voluntary in advance of expected higher sales; or was it involuntary because sales fell short of projection? Plus inventory numbers are one of the least reliable of all the statistics in the GDP calculation, so it could change as the numbers are refined. Nonetheless, that inventories figured so prominently in the investment data is pause for thought.

As for trade: after the huge hit that imports dealt to GDP in the second quarter the trade number was bound to improve. Even so, at -2.01 it is still a big drag on the economy. The good news is that imports did indeed fall back from the awful record of the second quarter. The bad news is that exports also fell back. We need the dollar to fall quite a bit further is we want to get trade under control. Unfortunately it is not easy to have the dollar fall without other nations trying to make offsetting adjustments. Obviously a decline in the dollar implies an increase in the value of other currencies, which, in turn, implies rising prices and so on elsewhere. As the world struggles to rebalance the very unbalanced nature of trade and capital flows we should expect a very bumpy trade number in our own GDP calculation. This is not the place to opine on trade wars, but they remain a distinct possibility, especially if the Fed’s QE2 efforts flood the world with cash rather than inflating the US economy alone.

Lastly, government spending. The key here is that while spending at the Fed level remains a strong positive for the economy, state level spending went into reverse last quarter and undid some of that good work. This is a constant problem in the US, and one we quickly overlook. State level cutbacks offset and undo some of the stimulus effect of the Federal deficit, which means that the expansionary impact of the stimulus is reduced. This is why I have always advocated that the states maintain deficits and have the Federal government underwrite them. That way services are not reduced and the stimulus is not muted. That would be too easy for us however and some states, especially those run by Republican governors have steadfastly cut back and added to the malaise by so doing.

So what do we make of GDP?

It simply is too slow growing.

For an economy ostensibly recovering from a very deep slump, GDP growth is very disappointing. As I have said repeatedly, however, this is entirely normal for a recovery caused by a banking crisis. Both the depth and length of the problem was underestimated by our leadership. That meant the response was inadequate. As a result we are headed for a very weak and potentially long lasting period of poor performance. There is nothing in today’s data to change my opinion: the economy is growing far too slowly for unemployment to come down at an acceptable pace. We are likely stuck with high unemployment, disinflation, and high risks for a long time. The Fed will no doubt use today’s figures to justify the launch of QE2 next week. I have my doubts as to the value of monetary policy at the moment. We need more Federal level fiscal stimulus. We won’t get it. So the malaise will linger. Get used to it.