non-residential investment

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GDP: Good or Fair?

The initial reaction to today’s GDP report has to be positive. The economy grew at an annual rate of 3.2% in the fourth quarter of 2010, up from a revised 2.6% during the third quarter. So the recovery seems secure and well on track. Here is my usual breakdown of the parts of the economy and how much they all contributed to the total:

  • Consumption: added +3.0%
  • Private Investment: subtracted -3.2%
  • Trade: added +3.5%
  • Government Spending: subtracted -0.1%

The interesting number here is that consumption figure. Personal spending rose at the sharpest pace for four years, driven particularly by a strong showing in durable goods. This is encouraging because these ‘big ticket’ items are normally easily postponed when households are adjusting their balance sheets and when fears of unemployment prevent people making long term financial commitments. So this gain may be a sign that consumers are feeling better bout the future and might suggest the economy will move ahead well during 2011. Notice all those words like ‘might’ etc. We need to wait and see whether the numbers are not revised downward as better information is analyzed. And we need to see this momentum, if it turns out to be real, maintained throughout the year. Even with all these caveats, the news is good. Sales of services seem stuck in a bit more of a rut and grew at pretty much the same pace as they did all through last year. There has been no acceleration in that sector. So we could easily construct a more negative narrative: consumers postponed their big ticket purchases as long as they could but eventually they were forced to buy – things wear out after all – and the underlying rate of household consumption is closer to the growth rate of services than that of durable goods. Hence the need to wait and see. Incidentally durable goods sales jumped 21.6% from the third to the fourth quarters, hence my mild skepticism about the sustainability of that pace.

The picture in investment was also very distorted. Here it was the run down in inventories that muddled things. Non-farm inventories suddenly shifted into reverse as businesses ran down their stocks during the holiday sales, so after several quarters of helping keep GDP rising, inventories actually knocked a big hole in growth. This change masked a very mild recovery in residential investment which managed to record only its third gain in the last nineteen quarters. Having said that the gain was negligible, but that it existed at all is noteworthy.

Trade too was subject to a big shift. Exports have been recovering quite well for several quarters and continued to rise at a decent rate. But imports suddenly dropped which is why the total impact of trade was so beneficial. Given that worldwide demand for commodities is putting a great deal of pressure on prices I suspect that the trend in imports will turn negative again during the summer. Plus there seems to have been a modest amount of stockpiling of imports during the late summer and early fall which meant importers could reduce their activities subsequently. This too probably shifted the numbers around a bit and so the sharp turn in today’s report may not be representative of a ling term trend.

Lastly, the government spending line is something of a warning. The effects of the stimulus are now well worn down, which leaves us with the increasing drag on GDP caused by the continued, and increasing, austerity at the state government level. This is something to watch. As the austerity hawks gain more control we can expect government spending to taper off somewhat. This will press down on growth and harm our prospects during 2011 and beyond. Today’s report could simply be the beginning of that downward trend.

So, overall, the report is good. Remember it is preliminary and subject to revision. Typically those revisions can be quite large. So keep a large asterisk against this data. Having said that it is good to see GDP running at a rate above 3.0%.

One last thing though: even at this pace we will not work unemployment down very quickly. We lost an enormous amount of GDP activity during the downturn. Had we not had a recession the economy would be about 7% larger than it is today. That’s a lot of jobs. Moreover, at a steady 3.0% rate of growth we would need years – maybe a full decade – to get catch up to where we would have been. So although this is a good report, it isn’t really good enough to get too excited over. We need more rapid growth for a while to make that catch up period more tolerable. There’s not much evidence we will see such an acceleration.

Which means we are in for a long, steady climb, rather than a rapid ascent.

Translation: good, but not quite good enough.

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GDP and Housing: Better and Worse

More mixed messages. Today’s release of the revised GDP figures for the third quarter was better than expected, whereas the report on sales of existing homes continued to disappoint. Add in yesterday’s hints that the Fed is in the process of downgrading its views for growth in 2011 and we end up with a decidedly murky view of what’s going on. Evidently we are stuck somewhere in the mire of slow to middling growth with chunks of the economy acting as anchors preventing much acceleration.

First GDP.

GDP grew at an annualized rate of 2.5% in the third quarter. This compares with an original estimate of 2.0%, and 1.7% in the second quarter. The fourth quarter of 2009, and the first quarter of 2010 were 5.0% and 3.7% respectively. So, after fading sharply at the beginning of the year, growth has been restored at a moderate pace. Not enough to cut into unemployment, but enough to fend off any concerns of further contraction.

The key facts to consider in the report is that growth is fairly wide spread. Personal consumption grew at its best pace for several years, with services picking up well and sales of autos particularly strong. Investment is slowing down after the normal early recovery spurt. Residential investment plummeted back tom earth after the false dawn of growth in the second quarter. And government spending was decent, with the notable feature of positive spending at the state level, so the states were not a drag on the Federal level stimulus efforts.

Frankly growth was better than I expected. For the last twelve months we have seen GDP grow by 3.2%, which is steady rather than great coming out of a recession. It is more than I predicted, but still not enough. The early predictions for 2011 are all in the 3.0% range, but rumors abound that the Fed is downscaling its own view: they had been at the more optimistic end of the spectrum. I think the reason for the new caution is the realization that the growth we have, and the growth we are likely to see, is not sufficient to tackle unemployment. There is a growing realization that our problems are more deeply rooted than some analysts originally thought. Personally I put this realization down to the result of a revision in the basic theories used to drive analytical thinking. The re-emergence of Keynes and his followers, especially Minsky, coupled with all the new research on post banking crisis recoveries has dampened even the most ardent neoclassical zealot’s views. I hope this realism persists and informs policy.

Meanwhile unemployment appears intractable to anything other than direct government intervention. Since we are not going to see that, it will last. The latest Fed thinking is that we will have an unemployment rate in excess of 8.0% well into 2013.

Second, Real Estate.

Sales of existing homes took yet another beating, dropping 2.2% in October. They are now down 25.9% year on year. There seems to be no end in sight for the malaise in housing. All the factors playing into the market are working against sellers. The glut of foreclosures hangs heavily on prices; this induces huge uncertainty as to what a good price should be, thus deterring buyers; credit is very tight as banks over react to their own stupidity; and unemployment is making many people fearful of big ticket commitments. None of these are likely to change for a while, and with the fall selling season now behind us a recovery will have to wait until spring. Whether things will change even then is highly disputable. I don’t see anything on the horizon to suggest a radical improvement. The aftermath of the bubble will linger well into late 2011 and early 2012. Only then will we see increases on a regular basis, and they will be from a very low base of activity.

So: even though GDP looks to be in better shape than I predicted, I think the economy is still more lurching along than sprinting. While growth seems well established across the board, nowhere is it truly good. The best characterization is still one of steady, insufficient, and halting growth. GDP will expand in the 2.5% to 3.0% range from here on out. That is not enough. Meanwhile we all have to be concerned about continued disinflation and its impact next year.

Are we out of the woods yet?

No.

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More GDP Muddle

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.

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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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GDP: When Is Growth Not A Recovery?

Today’s revised GDP numbers for the Third Quarter are disappointing. You may recall that the original estimate last month was that we saw the economy grow about 3.5% in those three months. As better data has been accumulated, that growth is now estimated to have been smaller, at 2.8%.

While any growth is good, especially after the crisis of the past year or so, this level of activity is scarcely sufficient o keep us treading water on the one big issue we have to fix: jobs.

First let me show you the numbers:

  • Personal Consumption added 2.07% to GDP in the third quarter, compared to a negative 0.62% the prior quarter
  • Private Non-Residential investment reduced GDP by 0.4%; which was better then the second quarter’s -1.01%
  • Residential Investment bounced back a bit, adding 0.45%; it had been-0.67% in the second quarter
  • Inventories showed a big swing, adding 0.87% in the third after having reduced the second quarter by -1.42%
  • Trade was a problem: exports added 1.71% to GDP in the third quarter after being a -0.45% drag in the second; but imports grew rapidly as well to offset that export improvement, imports reduced GDP 2.53% in the third after having added 2.09% in the second quarter
  • Government Spending was positive both quarters: Federal expenditures added 0.65% in the third quarter slightly down from the 0.85% contribution of the second; State spending fell rapidly and has become a drag on growth, it reduced GDP by -0.02% in the third quarter after having added 0.48% in the second.

If you add all these figures together you arrive at the -0.74 reported for the second quarter and the 2.79% announced this morning.

So here’s the problem:

This is just not strong enough to make a goodly dent in our enormous overhang of spare capacity. I was very disappointed to see that both personal consumption and private non-residential investment were both adjusted down from the initial announcement. Even a cursory review of the results makes it obvious that all our talk about an inventory and stimulus led recovery was spot on. The basic economy is still quite weak and shows no real sign of gathering much momentum. The pick up in exports was easily offset by the acceleration in imports as the economy began to suck in more oil and manufactured goods. Plus there seems to be a problem developing in the level of state expenditure: as states struggle to balance their books they will reduce spending which will act a significant drag on the economy. Already the Federal level spending burst is beginning to dissipate, so when we add in the movement in trade and in state spending activity, the burden for the next few quarters shifts decisively to the private sector, which while not dormant is not exactly humming along either.

The big problem is that capacity gap. This is the difference between what GDP would be if we were utilizing all our resources, and its level given the percentage of our resources we are actually using. Currently this gap is huge. We have the capacity to be generating a GDP several points higher than that we are actually producing. Such is the collapse in private sector activity that this gap will take years to close if we meander about at the pace of growth we achieved in the third quarter.

It is this enormous overhang of spare capacity – most of it in the form of unemployment – that makes the economy feel as if it were still in recession, even though the data says it is growing again.

We are simply mired in fear. Consumers are afraid to spend as they struggle with debt loads that now seem out of whack with income and wealth prospects, and business keeps moderating its expectations for the future and refuses to ramp up employment. This is beggar thy neighbor writ very large. Until the fear subsides we will wallow about in mediocrity.

Oddly the one hope we had is the government and that now seems to be getting ready to step aside. All the talk in Washington and in the financial media is now fear driven too. Fear of the Chinese bailing out on our debt; fear of the bond market; fear of the dollar sliding some more; fear of a burst of inflation resulting from the money supply binge needed to prop up the banks; and fear of just about anything else you can imagine that could cost money. Except defense of course. Always except defense. These fears are all unfounded, but are easy to exploit politically in the absence of strong leadership.

Compound this fear by adding in a political system that has become totally unresponsive and easily ground to a halt, and we look set of a long period of frustrating and sub-optimal economic behavior.

No one wants to fix the problem.

I think this gridlock is a natural outcome of the crisis in economic thinking itself – where the free market ideology is being uprooted at long last – and in politics where the basic tenets of right wing economic policy beliefs have been overcome by reality.

So we are undergoing a sea change. A shift in worldview away from the Reaganite free market, free wheeling, laissez-faire system towards something that has yet to emerge. The rearguard from the free market crowd is fierce at all levels – in Washington as well as in academia – and it is this rearguard action that is stalling our progress: as an example, it prevents us from moving quickly to implement jobs programs because the free market folks object to more government spending.

Couple this with the health care reform ‘debate’ which has surfaced deep ideological divisions even in the Democratic Party and nothing much gets done. What legislation is passed comes at an increasing cost in terms of time and pent up emnity.

Our political system is teetering on the brink of failure. In particular the gentlemanly rules of engagement in the Senate are breaking under the strain of an increasingly entrenched ideological separation between the parties. The GOP has moved sharply rightward over the last few years and actively uses arcane rules to reduce the Senate to a standstill. The threat of filibuster essentially ends any chance of major legislation by either party. Unless the rules are changed neither will get a coherent program through and the Senate will deteriorate into a farcical debating chamber incapable of addressing big issues. Perhaps this is what the GOP wants. It certainly acts to their advantage currently. But in politics what goes around …. at some point the Republicans will suffer the same. Much of this will go away with time as the old time methods of reaching across party lines evaporate and legislation becomes more party line oriented. For this to happen we need to rid ourselves of the centrists who like to wheel and deal: they trade their votes for bundles of pork barrel spending in their home states. They also like the attention and power they get from being able to hold up action.

This clubbiness is a major deficiency of the American system as long as the nation is deeply divided along cultural or ideological lines. Those divisions are now so deep that reaching across party lines to form consensus on anything significant is just not possible. This slide towards dysfunction has been going on for a while. The American system was never designed to handle or reflect ideological divisions as deep as we now have. It was designed to operate best on a middle ground where there was general agreement on national goals and characteristics. Yes of course horse trading took place, but once that was done most major votes were very lopsided. Now the very notion of horse trading is limited to those few centrists. The Republican central committee has even banned cooperation, saying that it will not support candidates who reach out across the ideological divide.

I don’t know if this is good or bad. I come from a very confrontational style of politics with deeply rooted ideologies, so I am empathic with anything that simplifies party lines. At the same time the American system, which is unique and very parochial in its mechanics, has served well. It is only in the light of the culture wars and social changes of the past thirty years that it has been under strain.

What I do know is that unless the political fog clears and allows us to eliminate anyone’s ability to exploit fear, we are more likely than not to stay mired in the mess we just created for ourselves.

That could result in a ‘lost decade’. Which would be tragic.