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:
- Personal consumption added at an annual rate of + 1.5%
- Business investment added + 0.8%
- Residential investment added + 0.4%
- Inventory changes subtracted – 1.3%
- Net exports subtracted – 0.2%
- 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.
