consumer confidence

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Weekly Update: GDP and More

Well the economic news seems to have been dwarfed by the ongoing oil spill in the Gulf and the extraordinary events in the Middle East. But there is some news to go over, especially the release last week of the GDP figures for the first quarter.

The good news is that the economy is clearly growing. The government’s news release shows GDP growing at a 3.0% pace for the first three months this year, which is decent, but is also slightly less than the first estimate issued in April. These numbers are notoriously bumpy and are subject to significant revisions as the government sifts through more recently received data. My guess is that this 3.0% will stick though and so we can take a close look at it to see whether it portends well for the rest of the year.

Here’s the broad breakdown:

Personal Consumption [‘PCE’] contributed +2.4%

Private Investment contributed +1.7%

Trade [Exports minus Imports] contributed -0.7%

Government Expenditures [both Federal and State] contributed -0.4%

So what does this say?

First: consumption is obviously picking up. That seems to fit well with all the anecdotal evidence we have received and is in line with rising consumer confidence. This is good news. PCE constitutes about 70% of the total GDP so anything positive in consumption is a huge lift for the economy as a whole. Even better: the growth was fairly well spread across all categories of expenditure, so this was not a case of pent up demand for big ticket items – ‘durable goods’ – but encompassed pretty much everything. Of particular note was the long awaited turn in dining and restaurant expenditures, which posted it first positive contribution since mid 2008. Since dining out is seen as a luxury item the fact that it seems to have turned the corner is a strong supportive factor suggesting that the economy’s growth is now sustainable.

Second: The investment numbers are a little deceiving. The record was very mixed. A steady, but not great, increase in non-residential investment was almost completely offset by a continued decline in residential construction. This is not exactly a surprise given the stupidity and excesses of the bubble, but it demonstrates the continuing drag on the economy of the over-construction of the last decade. As we unwind that lunacy it will tend to press down on the GDP numbers, and I expect this negative effect to be with us for a while.

With these two categories of investment offsetting each other, the big impetus to growth came form inventory investment. This is the third quarter in a row that has been bolstered by this trend, and is something we need to be acutely aware of as we project the rest of the year. Inventories always follow a volatile and exaggerated trajectory during any business cycle. This one is no different. The boost to growth in the first quarter attributable to inventories was about half that of the fourth quarter, so I think it is fair to say we should not expect much more support during the rest of this year. To put this in perspective: about half of all GDP growth in the first quarter came from inventories. take that away, as I think we should, and the next few quarters will see a drop in overall growth unless consumption keeps on rising.

Third: the negative drag from trade is no surprise. Imports were bound to rise once consumption kicked in, and even though exports have also grown, the old pattern of persistent trade deficits as America sucks in oil and consumer goods will be dominant for the foreseeable future. In the medium term this should put pressure on the dollar, but luckily for the US that trend is being swamped by the shorter term chaos that the Euro is stirring up. As long as the European economies muddle around and go through difficult adjustments the dollar will remain stronger than its ‘fundamentals’ justify. I see no way that trade will improve over the near term, so imports will continue to drag down GDP for the rest of the year.

Fourth: government spending exerted a negative impact. This may surprise many you, especially given the hyperbole about the Federal deficit. The really important factor to bear in mind is that the US consists of a bunch of governments and only one has the ability to provide help. That’s at the Federal level. Practically all the rest – predominantly the States – are working to make the economy worse. They are all under immense pressure to balance their budgets which is about the worst thing they could do at the moment. Every cut in expenditure by a State government withdraws purchasing power from the economy. This withdrawal cuts into final demand and slows the economy down. Continued severe contraction at the state level is reducing the impact that the Federal stimulus is having. In fact as these numbers testify, the states are more than offsetting that stimulus. If this trend continues the local contractions could cause us to fall back into recession. This is the basis for my suggestion that we need more, not less, stimulus at the Federal level.

What do we make of all this?

The economy has come out of recession. It is now growing. Too much of that growth is attributable to inventories, but there is plenty of evidence that consumption can allow overall GDP growth to continue even after the boost from inventories subsides.

There are plenty of dangers: the biggest being the drag caused by anti-growth cutbacks at the state level of government. We urgently need more Federal spending to mitigate those anti-growth cuts, otherwise GDP will start to sputter somewhat later this year, and we will not see sufficient activity to generate the jobs we are all looking for.

One last comment before I head back to the mountains of Vermont:

There is a rising swell of demand for conservative fiscal and monetary action. Reports are popping up everywhere calling for government tightening at the budget level, and for a hike in interest rates to ‘head off’ inflation.

Such calls are foolish, and could be disastrous.

The economy is growing, but it is nowhere near robust enough to be taken off life support. Cutting Federal spending would have terrible consequences. We are not yet stable enough to do anything so radical. I agree that the deficit needs attention: especially working out how to overcome the damage done by the Bush tax cuts which are the primary budgetary problem we have, but dabbling around with cuts at the moment would be akin to turning off the medication with the patient not yet cured. It is simply not credible policy to trim the deficit until 2011 or even 2012. Until then we should keep our foot firmly on the gas and allow the cyclical forces that will rein in some of the deficit to do their work before we attack the underlying Bush regime issues.

Remember, even though GDP grew 3.0%, that figure is quite low for this point of a recovery. Typically we expect more than quarter of much higher growth before we settle back down to the long term trend of between 3.0% and 3.5%. The fourth quarter last year saw growth of 5.6%, and already we are slowing down from the peak.

Let me repeat myself: history tells us that economies whose recessions were caused by a financial crisis, as ours just was, take much longer to recover fully and are extremely vulnerable to ‘after shocks’. We seem to be a model case of the historical trend. The after shocks are plentiful – another round of banking write downs caused by the commercial real estate market; the ongoing turmoil in Europe; the impending real estate bubble in China [although they are working hard to prevent too much damage]; and the cost cutting efforts of our states, are the most obvious. What else lurks under the surface is unknown, but the risks are all on the downside. Which means we have no room for error.

In that context I remain on the cautious side and expect growth to slow down as the year progresses. We won’t fall into another recession, but this will not be a very robust recovery. We may well have seen its high point already.

There’s a lot of work to do before we have shrugged off the massive damage we inflicted on ourselves between 2000 and 2007.

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Home Prices Drop; But Confidence Grows

I like being right. Not twenty four hours after I warned that we should expect home prices to drop this year, the Case Shiller index was released for March showing a 0.3% decline. This was a tad better than February’s 0.9% decline, but it continues to demonstrate that the housing market still has a way to go before it settles down.

Home prices rose a ridiculous 155% from 2000 through 2006, and have now fallen about 31% since. The extent of the bubble is still working its way through the economy and I see no let up any time soon. The monthly declines will not be as great as those we saw last year or in 2008, but I expect them to be fairly steady all year.

As I reported yesterday: there is no evidence of enough support from the usual fundamental factors that support home prices for us to predict a definite turnabout. No matter what the realtors say, real estate is still a weak spot in the economy. And will stay that way for some time.

This doesn’t mean that some areas won’t see changes. March’s national decline masks a strong uptick in San Francisco, San Diego, and other parts of California. Oddly Los Angeles continued its way down though, so even within states there are variations.

This ‘spotty’ performance is typical of an economy reaching the bottom of a cycle, and it usually takes a while for enough areas to turn the corner that the national figures change direction. We had a false start last year when the tax credit for first time owners brought sufficient demand onto the market to arrest the decline, but with the credit now gone the cyclical movement down has re-emerged.

It will stay this way all year.

To balance out this relatively poor news I should report that consumer confidence appears to be back on a more positive track. The Conference Board measure of confidence rose to 63.3 in May, up from 57.7 in April. This is the highest that confidence has been since March 2008, and some sub-components of the index are now back to where they were in 2007. By historical standards these readings are still quite weak, but the index has now gained for three straight months, and we seem to be lifting away the gloom that has dominated for the past two years.

Presumably a continued rise in confidence will eventually support a boost in consumer spending, although I suspect that we will see continued debt pay-downs and increased savings dominate the consumer sector over the summer. By Fall, though, I expect consumers to be buying at a more normal rate. That’s what we need for the economy to reach a sustainable, non-stimulus supported, growth phase.

With real estate wobbly, and consumers only now waking back up, I see no need to adjust my GDP forecast for the year: 2.5% growth is still my base outlook.

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Take A Deep Breath: Good Jobs Report

Now that’s much better.

There is nothing in this morning’s report not to like, even the rise in unemployment from 9.7% to 9.9%.

Let me explain:

First let’s all remember that there are two different reports combined here. One is the result of a survey of employers – called the ‘establishment survey’, this is the source of our information about the rise or fall in the number of jobs. The second is the result of a survey of households, which is where the data to determine the unemployment rate comes from.

Because there are two sources of data it is not unusual for them to show what appears to be contradictory trends. Add in the usual disclaimers for statistical error and the chances of contradiction grow even more.

So what did we learn today?

From the establishment survey we learn that the economy added 290,000 jobs last month. That is a very good rate of addition. The total was inflated somewhat by the big surge in hiring for the census, but even if we take those jobs out the revised total – 224,000 – is the strongest we have seen for ages. Even better: practically all these jobs were in the private sector because the non-census level of government employment stayed flat. Couple this news for April with the news that the March figure was revised upward to a gain of 230,000, and that February’s loss was reduced to 14,000, and we see a very clear a decisive shift in the job market.

Businesses are hiring again.

The household survey appears to tell a different story: the unemployment rate grew nearly to 10%. But we should not be too concerned because the jump comes primarily from people re-entering the work force. This is a very good sign indicating that at the grass root level people are seeing more opportunity and are responding by looking for a job. Oddly this piece of information is the best news of all. It implies that the dark cloud hanging over the economy is lifting, and that regular folks, not just the analysts, are seeing the change. This change is probably why the recent uptick in consumer confidence is being maintained. It also helps explain why retail sales are picking up.

More to the point: buried in the data is the nugget that the percentage of the population with a job has increased once again – it has been growing since December – and is now at 58.8%. This tells us that the economy is adding jobs faster than the population is growing. This is another clear and welcome sign of improvement.

So.

We are not used to such good news, which is why I urge you all to take a deep breath.

Now for the big question: are we there yet?

Unfortunately, no.

Let’s put things in perspective. During the Clinton era the economy added jobs at about this rate for eight straight years. We saw nothing like it during the Bush years, and it will take many years of constant 200,000+ months to get the unemployment rate back down to ‘full’ employment which is usually calculated to be around an unemployment rate of 5%.

Still we have to start sometime and it looks very much as if we are firmly on our way.

Hurrah.

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Real Growth, Good Growth

We have been waiting all week for the first quarter GDP numbers to be released, and the general expectation was that they would show growth of between 3.0% and 3.5% at annual rates.

Well, the report cam in exactly as predicted: 3.2%.

So the more important question is whether the growth is sustainable, or whether it came from one time sources. Here’s the breakdown:

  • Consumption contributed 2.6% to GDP
  • Investment, including inventories, added 1.6%
  • Net Exports [Exports minus Imports] reduced GDP by 0.6%
  • Government spending declined and so reduced GDP by 0.4%

So the good news, and it is really good news, is that the core of first quarter growth cam from personal consumption. This is important because it will be consumption that drives the recovery. The jump in consumption was the sharpest for three years and this report came only days after we read that consumer confidence had also risen sharply recently. Couple these two facts together and it is much more easy to predict a sustainable growth rate in the 2.0% to 3.0% range all year.

As for the other aspects of the report:

The pick up in investment comprised mostly a continuation of the inventory adjustment that has been a feature of growth for three quarters now. Given that businesses have been re-stocking for almost nine months now I doubt that inventory adjustments can continue to provide much help to the economy as we get further into the summer months. That leaves business investment and residential investment as the two parts of the overall investment category we need to focus on. In the first quarter business investment picked up quite well and looks set for a decent year. The problem is that the long term issues in residential investment – due to the enormous mess created by the housing bubble – will probably offset and gains elsewhere. So I think that, over the year as a whole, investment will have trouble providing the economy much of a boost.

The trade position always ebbs and flows during a recovery. Usually as the US picks up steam it sucks in oil imports and that hammers GDP . We seem set for a repeat of that cycle this year, so I expect imports to reduce GDP quite a bit as the recovery builds. What could be different this time is on the export side. Our issue continues to be the dollar and its value being too high to enable aggressive pricing by exporters. The turmoil in Europe surrounding the Euro could make the dollar move in the wrong direction – up instead of down – which would then cause our exports to falter. The recent announcement by China that they will allow their currency to float upwards somewhat will mitigate some of this, but, overall, I see net exports being a steady negative all year.

Which brings us to the government spending category.

The really important story here is that total government spending acted as a break on growth. This may appear odd given the enormous efforts being made at the Federal level to provide stimulus. The problem, and it is a huge problem, is that at the state level governments are cutting back furiously to reach more balanced budgets. In the first quarter this state level effort completely wiped out the benefit of the Federal stimulus. In fact it more than offset that stimulus. So we arrived at the bizarre situation where total government spending contracted during the quarter, therefore damaging growth.

While we all can sympathize with states as they struggle to get their budgets sorted out, we should all be very wary of the huge break on growth that this balancing represents. If it is continued at its first quarter pace throughout the entire year – and it may well accelerate – then it will undo much of the good work being done elsewhere.

Frankly many of the states in trouble are getting their comeuppance after years of neglect and voter opposition to sound fiscal management. The aversion to taxes that permeates the nation led many states to resort to trickery, sometimes outright robbery, in order to pay for the services that the electorate still wanted. This obstruction by opponents of fiscal rectitude often came from the more conservative side of local politics where any tax was viewed as a terrible thing. No one, however, wanted to cut services – education, police, firefighting and so on all were allowed to continue at old levels, with the funding increasingly provided by unsustainable accounting tricks. Now the game has ended and voters will have to swallow the consequences of having been coddled all these years. Most of our states are facing huge budget problems that will stretch well into the future. So at the state level, fiscal restraint, will hamper national GDP growth for quite a while.

From an overall perspective, therefore, the GDP report is a mixed bag and contains some pieces that we will need to be concerned about as the year progresses.

Meanwhile, that headline should be the return of consumption as the driver of growth. If that level of activity is maintained throughout the year not only is the economy firmly on a growth path, but it is on a fairly strong growth path.

And that is obviously good news.

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Worse Than It Looks? GDP Versus GDI

With the health care vote pending and dominating the discussion I thought I would spend a little time examining why the economy feels a lot worse than the GDP numbers indicate. Anecdotal evidence and the official statistics seem to be at odds. Then there’s the small matter of an unemployment level apparently immoveable by growth.

Buried in the official reports from the Bureau of Economic Analysis, the economy’s scorekeeper, is a lesser known figure called Gross Domestic Income. This will no doubt sound a bit technical, but the two measures – GDP and GDI – are supposed to be exactly the same. Think of them as accounting terms found on different sides of the ledger, with GDI as the credit and GDP as the debit. As is all accounting the two should balance. In reality, since the source data is very different, there is often a ‘fudge’ factor inserted to force this balance. This fudge factor turns up in the monthly GDP reports at the bottom of the page under the heading Addendum as the mysterious ‘statistical discrepancy’.

GDI consists, as its name implies, of all the various sources of income within the US during any particular year. So it includes wages, salaries, various supplements, an adjustment for taxes on imports [since that is not income], and corporate profits adjusted for depreciation. Anyone familiar with a flow of funds statement will recognize those categories and the need for the adjustments.

To put this in context: for the fourth quarter of 2008 GDI was $14,207.9 billion, down from $14,478.4 billion in the third quarter of 2008. That’s an annualized drop of about 7.5%

But GDP dropped by only 5.4% in that period, and the ‘statistical discrepancy’ needed to account for the difference between the two measures shot up to $139.4 billion.

So while the two numbers are supposed to move in lock step, there are occasions when they slip quite a way out of balance and tell different stories.

Without drifting deeper into the data, I think this discrepancy helps explain why the economy feels very different from the story being told by the GDP data: incomes are moving in a more exaggerated cycle, with stronger shifts up and down. Since incomes is what consumers ‘feel’ most immediately GDI is a better measure of the movement that most people have contact with. It therefore probably reflects the source of consumer sentiment and general mood more accurately.

Even this is only part of the explanation: within GDI two different trends are clearly visible. Since GDI consists of all incomes we can tell the trajectory of profits apart from that of wages. When we get down to this level of analysis I think we reveal an even more accurate gauge to assess the economy’s health, especially with respect to employment.

The crucial point is this: during the latter half of 2009, when GDP rose and the recession was announced as being over, GDI stabilized and flattened out. It did not rise for three straight quarters – unfortunately we do not have the final data for the fourth quarter yet. So the story written by GDP and by GDI diverged strongly as 2009 progressed. One told of recovery, while the other spoke to stagnation.

Worse: within GDI there was a dichotomy. Wages and salaries, which account for over half the total, continued to decline all year long, from a first quarter of $7,833.0 billion, to a third quarter of $7,758.5 billion. The total GDI was level throughout the year only because this drop in wages and salaries was offset by a recovery in corporate profits.

Now, I think, the source of the continued sour mood of consumers is revealed. Incomes have yet to recover.

Further the impact of unemployment is fully revealed. Obviously one major source of the decline in wages and salaries is that there are far fewer people employed and therefore fewer wage earners. Even those who are still employed are facing cutbacks in hours and other forms of lost income. Equally obviously, as sales started to pick up, this drop in wage and salary costs immediately bolstered profits. To the extent that profits grew instead of wages purchasing power was transferred from workers to shareholders and corporations. In other words the benefits of the implied increase in productivity was retained within the corporate world and not passed on. This is not unusual during the beginning of a recovery. What makes this cycle different is the massive level of un- and under- employment which will mean that corporations keep the upper hand in wage negotiations for much longer than normal. So we should not be surprised to see the wage and salary component of GDI track down or sideways for a quarter or two more. As it does the sour mood will continue and will be reflected in a continuation of the low levels of consumption and higher levels of debt reduction we see elsewhere in the data.

The divergence between GDP and GDI has spawned renewed attention on the question of which is a more accurate measure of the economy’s health. The Fed has long looked at both, and there have been a few articles and academic papers written seeking to clarify which is the better indicator.

For our purposes the GDI figures reveal clearly that the crisis was both deeper and more prolonged than that described by GDP. The narrative told by GDI is that the economy was worse than it looked, and that the recovery has favored business not regular people. It is a narrative more in accord with anecdotal evidence. And it helps explain why consumer confidence surveys are still turning up a deep pessimism about the economy.

The people being surveyed, the people on Main Street, are not talking about growth, because there isn’t any at street level.

It’s worse than it looks.

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