state spending

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GDP Revised Sideways; Jobs Edge Up

Todays has seen a little flurry of news, so lets’ just take a look:

The latests revision of GDP was released, and showed practically no change. At 1.7%, GDP growth was mediocre in the second quarter to say the least. The details are worth looking at because they give us insight into the probable course of the third quarter.

  • Personal Consumption contributed +1.5%
  • Investment contributed 2.9% [Fixed Investment being +2.1%; Inventories being +0.8%]
  • Net Trade contributed -3.5% [Exports grew 1.1%; offset by Imports growing 4.6%]
  • Government Expenditures contributed +0.8% [Federal growth being +0.7%; State growth being +0.1%]

The clear story here is that consumption is growing slowly, certainly not enough to push the economy out of the doldrums, but enough to prevent the onset of renewed recession. Add in the growth in investment, particularly in fixed investment, and the basic private sector is chugging along at a slow but decent pace. One spot of concern is that we have reached the end of the inventory cycle, so the addition to growth from that activity is declining quite sharply from the levels we saw at the end on 2009. That’s fine as long as fixed investment takes up the slack as it appears to have done in the second quarter, but we need to keep close watch on this in the coming months.

The other big news was the big shift in trade. Exports ticked up moderately which reflects the recovery going on around the world. Unfortunately there was a very large growth in imports that swamped exports and took a lot of the steam out of GDP overall. A couple of things seem to be going on there. One is that importers of finished goods appear to have brought in an unusually large amount of goods, possibly to re-stock shelves in anticipation of growth, all at once. Another is that the pick up in GDP generally always has the effect of sucking in things like oil: as the economy moves up a notch, so too do such imports. I doubt that the surge in imports will be repeated in the third quarter, so that alone will tend to boost GDP beyond its second quarter level.

The last factor to note is that government spending at the state level shifted into a positive gear, albeit at very low levels. One thing I try to point out relentlessly is that government spending at the Federal level is stimulative – its adds growth – but at the state level it has been negative as states try to balance their budgets. So much of the stimulus that attracts the eye of voters and media alike has been offset or neutralized by this state level contraction. In effect the states have worked against the Federal government and its effort to get the economy going. This is one reason that I have advocated allowing states to run deficits and have the Feds write checks to pay for them. That way local services and jobs are not sacrificed, and the national stimulus is not neutralized. I doubt that the positive shift at the state level can be maintained for long and thus expect the local drag on the economy to re-assert itself either this quarter or next.

Overall, this report is a sideways revision from the last release of data. We learned very little we didn’t know already. The economy is not declining, nor is it brimming with health. Most importantly there is no sign of sufficient health to get job creation out of its cellar dwelling existence.

Speaking of which:

Today’s release of the weekly numbers on new claims for unemployment assistance was a modest pleasant surprise. New claims declined by 16,000 to 453,000. While the absolute level is still way too high for this point in a recovery, we should acknowledge the modest progress. This is the third week of very slight improvement, which is better, obviously, than the alternative.

Nonetheless, businesses are now reporting weaker sales forecasts and are reacting by downgrading their hiring expectations. This is just awful news.

The entire outlook hinges on business expectations. As long as the prospect of weak demand lingers, so too will the prospect of a poor job market. Eventually the two interplay with each other and the poor job market creates the conditions in which businesses see poor sales. The economy is operating well below its potential, which is based upon the amount that could be produced were we at full employment and businesses were producing at or near full capacity. The gap between where we are and where we could be is now between 6% and 8% of GDP. That’s almost $1 trillion in lost wealth this year alone. Assuming that it will take us a while to get back to close to potential, this recession will end up costing us more than $6 trillion in lost wealth. We should be willing to spend, and borrow if need be, in order to reduce that lost wealth total. That’s one reason why people who wring their hands about the cost of the stimulus are wrong: they are looking only at the cost. They ignore the payback from that debt. The payback being the decrease in wealth lost as we recover.

The social benefit of stimulus far exceeds the social cost. We should think of it as an investment in our future. As long as the job market stays in its current funk we should be willing to endorse any plan to get it moving. If that means borrowing, so be it. The benefits outweigh the costs. By a lot.

I am tired of saying this: we need more stimulus.

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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 Growth Surges … Or Does It?

Calm down everyone. Today’s report that GDP grew at an annual rate of 5.7% in the last quarter of 2009 is a very misleading statistic. Yes, the economy grew, and, yes, growth was a little higher than in the third quarter, but the growth trajectory is a lot lower than that 5.7% suggests.

Here’s why:

Look at the sources of growth …

  • Consumption added 1.4% to the overall figure
  • Investment added 0.4%
  • Trade [exports minus imports] added 0.5%
  • Government spending was flat i.e. added 0.0% [ A drop in state spending zeroed out a gain in federal spending]
  • Inventory adjustments added 3.4%

What leaps out from these numbers are two things.

First state and local government cutbacks are offsetting the federal level stimulus. That will come as no surprise to those of you who read my comments regularly. I have been warning that we have 50 small Hoovers at work trying to undermine the national economy by cutting expenditure – mainly by cutting jobs – in order to maintain balanced budgets. I have argued against those locally imposed constitutional amendments forcing the states to balance their books over the years, and today’s report offers up a great example of the calamitous effect such ideas can have. In order to balance their books the states are plunging themselves deeper into trouble by eliminating jobs and therefore reducing the capacity of their local populations to consume or save. Worse still: their collective miserly approach is now reducing almost to zero the beneficial effects of the federal stimulus. This is yet more evidence that the federal stimulus should have been much larger and should have included aid to the states in order to forestall their negative actions.

It takes no brilliance to foresee that the sum of all this local thrift is combining to harm the union as a whole.

Oh well at least I tried.

The second major theme to jump at us from the report is that inventory adjustment figure. 60% of the entire GDP growth comes simply from an inventory shift as firms restock shelves. Final sales – the bit of growth that is sustainable or likely to be repeated contributed only 40% of the total. That is the big story today, not the headline number.

Given that the inventory adjustment is probably now over, we should subtract its effect if we want to project the likely course of GDP over the next few months and quarters. Once we do that we reduce our forecasts to the 2.0% to 2.5% range, which is where the bulk of commentators have been all along.

So the story is this: the economy is clearly growing. This is the second quarter with safely positive numbers. Inventories have added a short term boost right through the last six months of last year. It is doubtful that inventories will contribute anywhere near that much going forward so growth will have to rely on ‘recurring’ activity – consumption, investment, and trade – during 2010 and beyond. Right now the combination of those activities is creating a growth trend of between 2.0% and 3.0% a year. Lastly, as noted above, state budget cuts are hurting the national economy and are likely to stay as a negative influence for a while.

What does this all mean to the average person. Not a heck of a lot.

Until growth is reflected in more optimistic forecasts at the business level it will seem to be an abstraction rather than as reflecting reality. More upbeat business expectations will drive renewed hiring and thus will cause unemployment to drop. How many successive months or quarters of growth businesses need to see before they turn up their hiring is anyone’s guess. As with anything incorporating something like ‘expectations’ business hiring goals are immune to precise prediction.

I think it is safe to say that there will be a steady improvement all year long, but that with growth stuck at low levels and therefore with the margin for error so fine, businesses will be very hesitant to add to their workforces. They will more probably try to squeeze extra productivity from their existing workers. So the best guess outlook is still one of slow growth along with a very slow improvement in unemployment. Ironically, as I have said here many times, the longer that unemployment stays stuck at elevated levels, the more risk is associated with those growth predictions. I think we can rule out a double dip style recession for the immediate future, but most of the risks to the outlook remain on the negative side.

Look for GDP growth of 1.5% at the low end; 3.0% at the high end; and a most likely of between 2.0% to 2.5% for this year.