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GDP Data Shows Resiliency of U.S. Economy

On July 30 the Bureau of Economic Analysis (BEA) released an advance-estimate version of its GDP numbers for the second quarter of 2015. For the first time since before the Great Recession it looks like there is some real strength building in the economy. First, the summary from the BEA:

Real gross domestic product -- the value of the production of goods and services in the United States, adjusted for price changes -- increased at an annual rate of 2.3 percent in the second quarter of 2015, according to the "advance" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.6 percent (revised). The Bureau emphasized that the second-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency ... The increase in real GDP in the second quarter reflected positive contributions from personal consumption expenditures (PCE), exports, state and local government spending, and residential fixed investment that were partly offset by negative contributions from federal government spending, private inventory investment, and nonresidential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased.

There are three reasons to be cheerful about these GDP numbers.

  1. Private consumption. For four straight quarters now, household spending has grown in excess of three percent per year, adjusted for inflation. This is a sign of strength in the economy. Not since 2005/06 have we seen four straight quarters of 3+ percent consumption growth. Overall, the trend in private consumption is still too weak to signal a return to historic growth numbers – on the contrary it is very likely that there will not be any such return. However, these four quarters of good (but not excellent) expansion in household spending show that if given a chance, the American economy can still produce reasonable levels of prosperity.
  2. Investment in inventories. Traditionally private businesses signal swings in overall business confidence by changes in their inventories. Having products and raw materials stashed away in inventories is generally not a good idea, as it extends the period from the cost of acquisition (raw materials) or production (goods) to sales (or the point of cash inflow). When businesses feel confident enough to build inventories, it is because they anticipate a short lag between costs and revenue. Therefore, it is encouraging to see an upward trend in the growth of business inventory investments: in 2011 inventory investments grew by 1.7 percent; in 2014 they were up 2.4 percent.
  3. Consumption of durable goods. While part of private consumption, this variable deserves recognition on its own. Over the past five years American consumers have increased their inflation-adjusted spending on durable goods (for example, cars, TV sets, computers, appliances) by more than four percent on an annual basis. The average annual growth rate since first quarter 2010 has been a very good 6.9 percent. This is not quite at the 7+ percent levels when the latest growth period peaked in 2005-2006, but it is close.

These signs of strength show up in the national accounts data at a time when the federal government is expanding regulations at troubling rates, and when the Affordable Care Act still spreads its shadows of costs and uncertainty over the economy. On the one hand, this could be interpreted as a sign that the weight of government is not that heavy after all on the private sector. On the other hand, the conclusion could be that the economy could do formidably well if relieved of the heavy hand of government.

In support of the latter conclusion, consider Figure 1 and its data on private consumption spending over the period 1950-2015:

Figure 1

b2ap3 thumbnail C5015

Source: Bureau of Economic Analysis

Here is how to read Figure 1.

  • The thin blue line with high amplitude represents annual, inflation-adjusted quarterly growth rates for private consumption;
  • The thick, straight blue line represents the three-percent growth threshold;
  • The thick, straight red line represents the Industrial Poverty threshold;
  • The thin, short, black lines represent average growth rates per decade, from the 1950s and on.

When consumption grows at rates above three percent, the economy is doing well and consumers in general have good finances. Prosperity is growing. When consumption grows in the 2-3 percent bracket there will be discrepancies between socio-economic groups and only some segments of the population will be advancing their standard of living.

When consumption growth fall below the Industrial Poverty threshold the vast majority of the population will be stuck in a static standard of living. They will be able to replace old cars with new ones, old appliances, computers and furniture, but only with the present equivalent standard of their previous items. Life is stagnant and if the economy prevails in this territory over time children will grow up to a life less prosperous than that of their parents.

As shown by the short, black lines, the American economy has slowly been sliding down toward the critical zone where private consumption grows at less than three, then less than two percent per year. The second to last black line represents the period 2000-2009, when consumption grew at an average of 2.4 percent per year. Since 2010 the average is 2.1 percent per year, though if the current strength of consumption growth continues that average will no doubt tick upward for the rest of the decade.

The big word is, of course, “if”. It is improbable that the current growth period will continue to gain strength; it is in fact more probable that it will lose speed and we will see a new recession in a year or so. All things equal, it will not be a deep one, just a cool-off period much like the recession in 2001-2003. There are two reasons to believe this:

  1. Growth in private inventories is exceeding growth in GDP. While the two variables track one another closely, the normal situation is that GDP growth is slightly stronger than inventory growth. Today that relation is reversed, showing that businesses may be over-estimating growth in demand for their products. This could cause a downward adjustment in overall non-residential investment in the next six to eight months.
  2. Despite the strong growth in “driving” parameters like private consumption and gross fixed capital formation (business investments) GDP growth still has not managed to nudge above three percent. It remains stubbornly well below that threshold, an indication that the strength seen in consumption and some investment variables is not strong enough to cause an economy-wide rise in business confidence.  Many businesses are still holding back, acting more cautiously than otherwise. For example, construction of new homes is only ho-hum: a decade ago when we were in the midst of a growth period residential construction constituted more than 30 percent of total capital formation in the economy; today its share is below 20 percent. Home construction is the “ultimate” indicator of long-term household confidence, which in turn is essential to macroeconomic stability and solid growth.

The bottom line in the national accounts data for the second quarter of 2015 is that the U.S. economy is still fundamentally sound, that the big presence of government is having a dampening effect on private-sector economic activity but that so far that presence has not broken the backbone of the economy. (It has done just that in Europe.)

If the taxation, spending and regulatory presence of government was rolled back, there is enormous growth potential in the economy. GDP growth in excess of three percent is easily attainable; 4-4.5 percent within reach.

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