US Growth Picks Up – A Bit

Be careful with today’s report on US GDP. It looks better than it is. The headlines all read that the US economic activity accelerated in the fourth quarter of 2011. It did. At 2.8% the last three months of the year represent a significant improvement, and suggest that the recovery, however strong it is, is persisting. That much is good news.

But.

Beneath the surface there are a few problems we should all be aware of before we trumpet success. This is particularly true in our current fraught election mode. No doubt Obama fans will be crowing, continued improvements like this will create a nice following wind for him as we approach election time. Can we expect that? In a word: no.

First here are the numbers.

• Personal consumption contributed + 1.45%
• Private Fixed Investment contributed + 2.35%
• Net Trade contributed – 0.11%
• Government Spending contributed – 0.93%

This all adds up to an increase in GDP of 2.76%, which the media rounds to 2.8%.

The consumption number is stronger than the third quarter, with the most significant increase coming in durable goods, especially auto sales. We had been tracking this shift in spending as the year wound down and so there is no surprise: consumers took advantage of discounts as the industry tried to reduce last year’s inventory; lower borrowing costs encouraged some activity; and, possibly most important, people were forced to replace older vehicles that could no longer be fixed up. There always comes a time in each business cycle when pent up demand creates a little surge in sales. It looks as if the fourth quarter saw such a surge. Whether we see it continue is questionable, and is one of the bigger causes for caution in interpreting these numbers.

But the biggest issue is embedded in the investment figures.

Most of the gain in private sector investment came from a run up in inventories. I have said many times that we need to be very careful in our analysis of inventory accumulations. There are both positive and negative interpretations for a build up. The positive spin is that businesses are preparing for a better sales environment or that they have experienced unusually strong sales and need to replenish stocks. The negative spin is that anticipated sales failed to materialize and that businesses are stuck with rising, and unwanted, inventories. Judging by the improved pace of sales in the fourth quarter I think we can err towards a more positive spin: demand is picking up, hence the need to re-stock. Naturally there is a downside: once business is satisfied it has the right stock on hand it will slow additional inventory accumulation. This will imply less of an impact in the first half of 2012. Because of the significance of the impact of re-stocking in the current numbers, this inevitably means that the headline GDP growth figure will be much lower.

That following wind will abate and growth will appear to slow back down.

The impact of trade is not very significant, so we don’t need to dwell on it, except to note that it is a small part of the economy. This is important to remember when we discuss the impact of Chinese imports on jobs and so on. The vast majority of American jobs are in the service sector and are not at all subject to the impact of trade. While manufacturing is obviously affected by trade, and some parts of the service sector – IT, banking, and consulting for instance – are as well, the largest source of employment here is in locally generated and locally consumed activity. Boosting trade is a great idea to help manufacturing. It is not a panacea for our overall employment problems.

Lastly, government spending is now a major negative for the economy. We are on the downward side of the Federal stimulus of 2009, as this programs end and abate they reduce the amount of money being injected into the economy and thus show up as a decline in spending. This acts as a brake on GDP. Likewise the ongoing slash and burn tactics at the state and local government level, as the effort to balance budgets continues, is having a dampening impact. State level retrenchment slashed 0.3% off GDP at the end of last year. As state’s approach balance this austerity impact will be reduced, but it is likely to be replaced by a ramped up Federal austerity effort. Consequently it looks as if government spending will restrict GDP growth for a while, putting more pressure on the private sector to recover more fully.

Adding all this together suggests that sustainable growth is much lower than the headline implies. The first and second quarters this year are likely to see growth around 2.0% – simply reducing that inventory figure to something more normal achieves this slow down. Further: once the bulge in durable goods sales fades there is nothing in the base data to suggest that other consumption will be sufficient to replace it. This, too, supports the argument for a modest 2012.

Lastly, even though the fourth quarter was much better than the earlier part of 2011, it didn’t quite match up to expectations. As the basic information trickled out during November and December, many analysts – although not me – started talking about fourth quarter growth of well in excess of 3.0%. Some even began to talk of 3.0%+ for 2012 as a whole. I just don’t see it. This is a post debt binge grind it out kind of recovery. There will be periodic spurts of faster growth – that inventory build up for instance – but by and large this is more akin to trench warfare than blitzkrieg.

The forecast for a long, slow recovery still stands. This year will come in around 2.0% as a whole. Next year may be a little better. Unemployment will edge down very slowly.

Things are better?

Yes.

Are they great?

Not at all.