inventories

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The Economy Trips Up – Or Does It?

Oh dear. Two days ago I suggested things were looking up. Today we hear about fourth quarter economic growth. GDP – the measure we use, rightly or wrongly, as a yardstick for economic growth – fell very slightly, by 0.1% at annual rates, in the fourth quarter last year. The brouhaha Monday, if you recall, was because durable goods orders rose sharply last month suggesting a stronger economy.

How do we reconcile these things? And what is actually going on?

It isn’t as difficult as it appears.

Let’s look at GDP:

The fourth quarter was disappointing because it followed what appeared to be a strong third quarter – remember that GDP grew at a 3.1% clip in the third quarter last year. The truth, as is often the case, sits somewhere between these two poles. So here’s the way in which each sector of the economy added or subtracted to the total:

  1. Personal consumption added at an annual rate of + 1.5%
  2. Business investment added + 0.8%
  3. Residential investment added + 0.4%
  4. Inventory changes subtracted – 1.3%
  5. Net exports subtracted – 0.2%
  6. Government spending subtracted -1.3%

Under normal circumstances I would report the three investment categories – business, residential and inventories – as one item, but this time we need to break them apart to get at the underlying story.

Personal consumption, which still amounts to about seventy percent of the total economy, grew well. That 1.5% rate of growth adds to a string of decent quarters and is a sign of good, but not great, economic activity.

The puzzle lies in investment. Both business and residential investment are going at a decent pace. Again neither is very strong, but neither is weak. The recovery in housing has been consistent throughout the past few months and shows no signs of diminishing. Business investment tends to be more erratic, and there were concerns in the third quarter that it was weakening as businesses waited for the fiscal cliff mess to be sorted out. Looking deeper into the data though we can detect that some of the quirkiness of the third quarter was due to the same trends that boosted that durable goods report we all got excited – sort of – over on Monday. Transportation equipment is the key. In particular aircraft orders. As I noted on Monday aircraft orders are sufficiently large in dollar terms, that when an airline announces a big order, it can shift the data about considerably. The same thing goes for production and sales of the aircraft later on. Much of the odd movement in investment over the past six to nine months stems from this volatility. So a more considered view is that the third quarter was not quite as strong as the 3.1% seems to indicate, and the fourth quarter was not was weak as the – 0.1% shows.

This same factor shows up in the wild swings in inventories. The last five quarters have seen the following inventory changes: +2.53%; -0.39%; -.046%; + 0.73%; and now – 1.27%. That’s a wild ride and one that can shift the total GDP numbers about quite a bit if the other sectors of the economy are only mediocre, which is our current case. So this is another instance of where we need to look beyond this volatility and focus on the trend, which is still showing modest growth.

The other two major categories of GDP, trade and government spending, detracted from growth also.

Trade, reported as exports net of imports, was a modest drag on the economy mainly because exports slipped for the first time since the economic crisis was at its peak. A slight hesitation in worldwide growth slowed both service and goods exports and a smaller decrease in imports was not large enough to offset that slowdown. Trade is not a huge factor in the US economy and is rarely enough to alter total growth. In order to get our economy moving we need to focus on domestic spending and regard better exports as icing on the cake not a substitute for good local growth.

Government spending continues its recent restricting action on the total economy. After a quirky increase in the third quarter last year when a surge in defense spending stopped a string of quarters of contraction, government spending returned to its steady decline. This may come as a shock to some of you so it’s worth repeating: government spending has been declining steadily since late 2010. This is because the Federal stimulus has gone away and spending on social programs to do with the recession have ebbed as the crisis itself waned. This was entirely predictable and was one reason why I, amongst many, never worried about the budget or the level of debt. Government spending is designed to rise when there is a crisis and fall when that crisis goes away. So the surge we saw in 2009 and 2010 was not the beginning of some nefarious socialist take over – as was represented in right wing media – but was a sensible response to a crisis. It happens every time. It ebbs every time. That this last surge was so large is simply a reflection of the size of the crisis, not of some shift in philosophy.

So what do we take away from all this?

The economy is not as weak as the headline numbers suggest. It wasn’t as strong as those headlines suggested in the third quarter either. The truth sits in the middle as usual. We seem to be growing at a rate hovering between 1.5% and 2.0%, which is what I have been saying is what to expect for the best part of two years now. Absent any attempts in Washington to kick us into a higher gear I can see no cause for predicting faster growth. All the risks remain on the downside. Especially if the Republicans get their way and cut government spending this year. Such a cut in spending could send us into recession, increase unemployment, and set us back a couple of years.

Which is why spending cuts are such a bad idea.

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Update On The Economy

It’s been a long break occasioned by a string of visitors. What happened in the interim? Not a whole lot. Washington is now deeply immersed in the three ring circus known as the fiscal cliff, an event, we are told, so horrendous that we all ought to be prepared to sacrifice our preconceived notions of fairness in order to rush helter-skelter into a fudged ‘grand bargain’.

No thanks.

Meanwhile the economy muddles along.

It would be nice to see some of the energy being directed towards the entirely pointless fiscal cliff activities being diverted and put to better use. Like getting the economy onto a secure, sustainable growth path. In my dreams.

Still the economy is hobbling along by itself. Today we read the latest GDP numbers. This is the second estimate and represents quite a jump up from the first. According to the report GDP grew 2.7% during the third quarter, up from 1.3% in the second and 2.0% in the first. So on the face of things the economy appears to have picked up the pace.

The problem with this is that the first estimate of the third quarter had consumption considerably higher than the 1.4% in the current version. Likewise business investment, excluding inventories, actually declined rather than increasing as was reported before. These are signs of weakness not accelerating strength, so the top line numbers are somewhat deceiving.

Looking more deeply into the data it becomes obvious that much of the apparent strength during the third quarter came from inventory accumulation. This is an ambiguous source of growth. The question we need to ask is what caused businesses to build up their stocks. If it was anticipation of demand, then it might signal continued good growth. If it was an error created by a miscalculation of demand it may signal a retrenchment ahead and weakening growth. Nothing is ever simple. Looking through the lens of subsequent activity, especially reports of strong sales during the early part of this holiday season we can – for the moment – speculate that it is the former reason, not the latter. It looks as if businesses built stocks ahead of stronger sales, got the call right, and that activity will continue at a more rapid pace.

When we deconstruct the 2.7% overall growth we find it has the following components:

Personal consumption contributed +1.0%

Private investment contributed +0.1%

Inventory change contributed +0.8%

Net trade contributed +0.1%

Government spending contributed +0.7%

You can see clearly from this list the significance of inventories. Everything else looks a little weak.

Elsewhere today we heard about new claims for unemployment assistance. They fell dramatically, by 23,000, to 393,000 last week, and down from the 451,000 of a couple of weeks ago. Once again I urge caution. These numbers are highly skewed by the effects of hurricane Sandy and are not a reliable barometer of the economy. It will take a while for things to settle down, by which time we will be into the funny numbers of seasonal employment. Of course the data is seasonally adjusted, but there are always blips that obscure trends. So don’t go celebrating today’s report, it is simply part of a return to normality, rather than an indicator of a new, stronger, normality.

Looking further afield we also heard about pending home sales which rose 5.2% in October, the eighteenth straight month of gain. Pending sales are now 13.2% higher than a year ago and continue their long road to recovery. As a comparison: this level of activity is roughly the same as that in late 2001, which is decent, not great, and not frenzied. We can safely say that real estate is back on its feet, albeit at much lower levels of activity than those reached during the insanity of the bubble years. Let’s hope it stays that way.

Finally, let me return to the fiscal cliff.

It is a contrived problem designed to scare us. Of course we don’t want a dramatic tightening of fiscal policy next year. That would be awful. But we must not forget that we do not have a Federal debt problem. At least not now. The annual deficit as a percentage of GDP shot up exactly as we would expect during a deep recession. It went from an order of magnitude of about 1.2% to around 9.0% of GDP. This explosion was predictable and temporary. Once growth is re-established it will decline back to its former levels of its own accord. No significant policy changes are needed. Remember: non-health care transfer payments have been a fairly constant proportion of GDP for decades. They rise during recessions and then fall back subsequently. Absent health care, transfer payments are not a cause of our supposed debt problem. By the way: defense spending has been a reasonably steady proportion of GDP as well. This irks me and others who would like to build a case to cut it, but that case has to rest on non-budgetary reasoning, not on false debt crises.

So, if the fiscal cliff is a made up problem, who made it up? and, why?

The fiscal cliff is an artifact of class war. It arises from the longstanding attempt of the political right wing to defund and shrink government, deregulate, and boost business profits. Hacking away at the safety net is simply part of that long term plan. Likewise the horror stories on the left are all designed to fight a rearguard sufficient to protect the safety net from the predation of our plutocracy. We happen to be living through a moment when the right came close to winning. They were perilously close to ramming through more tax cuts for the wealthy to be paid for by stripping funding from social programs. The result of this would be the long term impoverishment of the middle class and the continued enrichment of the top tier of income earners. So these are tense times when compromise is dangerous and thus difficult.

In this sense the fiscal cliff is also the first battle in a war designed to tackle inequality. Hence the obsessive focus on raising taxes on the wealthy, even though such an increase is insufficient to make much of a dent in the long term deficit.

In other words, the fiscal cliff is a political construct that results from our deeply divided views on social policy. It has less economic significance other than the near term negative shock it would deliver were all its aspects to come to pass.

Ironically, as I have pointed out before, anyone who is alarmed at such a negative shock is, by definition, making the statement that they see benefit in stimulus. For if sudden contraction in fiscal policy is capable of sending the economy into recession, as they argue, then sudden expansion of fiscal policy will drive the economy out of recession. The fiscal cliff rhetoric thus hides a stunning level of agreement. Apparently, and perhaps unwittingly, our right wingers are now ardent Keynesians.

Similarly, anyone who has made a fuss of the damage to inflationary potential of large deficits and government spending should now be applauding the imminent slashing of spending incorporated within the fiscal cliff packages. Think of the rating agencies. They are an example of the confusion on the right. On the one hand they warn us that failure to resolve the fiscal cliff issues will force them to downgrade US bond ratings. On the other they claim that reduced spending is a criterion for getting a higher rating. But the fiscal cliff would produce exactly such reduced spending. Clearly they don’t mean reduced spending. They mean reduced social spending. They have declared their ideological colors.

So we hear no applause, nor do we see consistency.

Which is why I make my claim about class war. The fiscal cliff is artificial. It exists as a ploy by the right to hack away at social spending. The rational response is thus to drive off the cliff, and then to negotiate backwards. This would make the right the fall guy for a hike in taxes on the middle class and consequently provide a major incentive for them to bargain quickly to undo the damage.

All this is my way of saying: tune the fiscal cliff blather out and enjoy the upcoming holiday season!

But wouldn’t it be nice were Washington to tackle some of our real problems instead of the mad up ones? Oh well. Dream on.

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Economic Drift

We are at sea. Adrift. Going nowhere. Wallowing about with little direction. Not sinking. Not soaring. Just floating. Just.

Today’s GDP numbers validate the view that our economy is all of the above. The economy grew at a 1.9% rate rather than the previously announced 2.2% rate. The next few quarters look set to follow the same pattern. There is precious little drive to pull us forward, yet not much to torpedo us either. It is exactly what we would expect from an economy still deep in private debt and without any coherent political leadership. Insipid policies have real consequences. You don’t deal with the demons of an underperforming, overly indebted, and decaying private economy by introducing a series of tweaks. You hit it with a hammer. But that implies having the courage and conviction to deliver such a blow. Obama didn’t in 2009. He still doesn’t. And, worse, Romney doesn’t see the need to do anything positive at all. So this year’s election will not be a palliative for our economic woes. It may be significant for other reasons, but the economy looks set to flounder whoever wins in November.

The data speaks enormously to our malaise:

Private consumption, which makes up about two thirds of the total, contributed +1.9% to growth.

Private investment, which has slowed since last year, contributed +0.8%.

Trade – exports minus imports – contributed nothing.

Government spending was negative and thus reduced growth by -0.8%.

Personal consumption was actually up quite a bit over the levels we were plodding along at last year. It grew 2.7% in the first quarter, which is the best showing since back in the first half of 2010. Most of the strength came in the purchasing of goods, with durable goods growing at a 6.1% rate, and non-durable goods at 14.3%. Unfortunately spending on services, which is a very large and diverse category, was only up at a 1.0% rate, and thus pulled the overall spending pattern down.

Private investment grew at a 6.3% rate, which looks good until you compare it with the 22.1% rate of the fourth quarter last year. Investment is always a volatile category so such a violent shift is not unusual, but the slow down is unwelcome as it indicates, potentially, a weakening of business confidence. The goods news within the investment figures was in home construction which jumped 19.4% after languishing for so many of the previous quarters. This was, naturally, from a low base and so had little overall impact, but at least it is no longer a drag on GDP.

The trade figures netted out to a zero impact on overall growth despite both exports and imports growing at significant rates. Exports rose a little more quickly, at a 7.2% rate compared with the 6.1% increase in imports, but because exports started from a smaller base that faster growth could not contribute to GDP as a whole.

The real warning sign in the data is that government spending contribution. We are deep in austerity. Not to the degree that Europe is, but significantly enough for it to act a substantial brake on the economy. With the effects of the stimulus package of 2009 well behind us Federal spending is now declining – this is the sixth straight quarter of reduced Federal spending – with both defense and non-defense spending head downwards. While our attention seems always to be on the budget fights in Washington, we should all remember that state and local government is playing a large role in pulling the economy down. Spending at those local levels declined 2.5% last quarter and has been negative in 14 of the past 16 quarters. Indeed much of the Federal level stimulus was offset by the by the efforts of states and local governments to balance their books. For instance in 2010, when the Federal stimulus was at its peak, Federal spending grew 4.5%. But state spending contracted by 1.8%, meaning that the stimulus, too small to begin with, was mush weaker than the headline numbers suggested.

It is this government austerity program that most threatens our growth rate at the moment. We have imposed a lower growth rate on ourselves through our government budget cutting, and are thus prolonging the period of convalescence beyond what it could, or ought to, have been. And this austerity is producing no discernible benefits.

Those economists – I am not one of them – who argue that cutting government spending will somehow spur business confidence and thus produce a magical burst of investment growth have a lot of explaining to do. The data contradicts their thesis. Yet they persist. Indeed they still dominate the airwaves, media debates, and policy decision making. History will be unkind to them. But unfortunately for millions of unemployed Americans, history’s verdict will be scant repayment for the unnecessary impoverishment being forced on them by the combination of incompetence and ideological blockheadedness that currently passes for Washington elite thinking.

One last thing.

As Europe continues to self-destruct moony is flowing out of the Euro into “safe harbor” currencies like the Pound Sterling and the US Dollar. This is driving down interest rates on government debt. The rate on long term UK bonds is now at an all time low. All time being since 1702, when records were first kept. Here in the US rates are now down to levels not seen since 1948. So. Why are we not borrowing as much as we can? At those rates we could borrow enormous amounts and rebuild our rotten infrastructure thus bequeathing our children and grand children a modern economy replete with world class infrastructure. And the cost burden on them would be small compared with the benefits. The rate of growth in GDP would be higher thus allowing them a higher standard of living even after the debt repayments they would need to make. Instead we are being foolish and passing by this historic opportunity in the name of false economy. We are going to bequeath a diminished economy riven through with second class infrastructure and unnecessarily inefficient costs. Clear thinking and a commitment to our kids would produce a very different policy response than that we have in place.

Then again, we lack vision, courage and a sense of generational morality. No news there. It’s been that way for at least three decades. Why change now?

Oh. And the result of our efforts?

Economic drift for ourselves, and a rotten future for our kids.

Sad. No?

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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.

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GDP Revised Downwards

I don’t think there was too much surprise, except, of course, amongst the Wall Street stock market shills, in today’s announcement that third quarter GDP was lower than first reported. Growth was trimmed from 2.5% to 2.0%. The biggest shift down came in the form of a much reduced business inventory number. Apparently businesses had a hard time restocking shelves. Or they chose not to. Which one of these two explanations you prefer will depend on your overall view of the economy’s health. The first reflects the view that business is having a hard time keeping up with demand, or, perhaps is facing decent demand but had supply chain problems. The second explanation is more pessimistic and reflects the view that business is still being cautious in its expectation for sales growth, and so is content to allow inventories dwindle in order to avoid their carrying cost.

This being economics, there is a middle ground also: it is quite possible that business is both cautious and facing supply chain issues. This is the position I am still taking. We should not forget the variety of natural calamities that afflicted the world earlier in the year: from the Japanese tsunami to the flooding in Thailand, they all have crimped the delicate flow of materials upwards through the supply chain. The Thai floods in particular are still recent enough to be causing some disruption, and provide a good explanation for the involuntary component of the inventory decline.

Having said that I still think that businesses are generally being careful about avoiding a build up in inventories. The ongoing lack of strong demand is the dominant theme in business planning for year end and the start of 2012, and so inventory levels are being watched with more care than usual.

If we adjust GDP to eliminate the effects of inventories we arrive at a statistic called real final sales, and this tells a slightly more robust story. Real final sales grew at a 3.6% pace in the third quarter suggesting that consumption and investment were relatively healthy after all. This pace was a considerable improvement over the second quarter’s anemic 1.6%. So clearly there has been some acceleration. Early reports indicate that the pick up has carried over into the fourth quarter also – retail sales were fairly strong in October. Unfortunately this pace is unlikely to be sustained since it came on the back of a reduction in savings rather from rising wages.

So what do we make of today’s revision?

Not a whole lot.

Until incomes get on a steady upward track we can expect to experience a repeat of the recent choppy pattern in the numbers. Rising final sales give us some hope that the economy is growing well enough to avoid falling back into recession. But there are still no signs of a definitive break out to stronger sustained growth. Third quarter growth of 2.0% is better than the first half of the year, and the best rate of growth since late in 2010, but it is still pathetic in the context of either historic averages or a sufficient pace to reduce unemployment any time soon.

So I am sticking to my view that we are muddling along in a sideways stagnant pattern, with GDP likely to average around 2.5% through the end of 2011 and into 2012. That’s not good, but it’s better than nothing.

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