Guest Post: Q2 Economic Contraction Highly Probable

Tyler Durden's picture

Submitted by Tony Pallotta of Macro Story

Q2 Economic Contraction Highly Probable

Recently I have been discussing the possibility that the US economy is in fact in a period of contraction.  I want to revisit that call as I don't loosely throw out such a statement without backing it up with real data.  Q1 2011 GDP was 1.77%, a 43% reduction in Q4 2010 GDP of 3.11%.  Although Q1 GDP could be revised higher over the next two revisions it did highlight three sources of contraction.

Initial data for April has further supported potential economic contraction with four regional Fed manufacturing surveys showing a sharp reduction in growth, near outright contraction in ISM Services, a very sharp increase in weekly unemployment claims and a deteriorating trade deficit.

You don't need to be an economist to understand GDP in its most simplest terms.

GDP = Consumer + Government + Investment + Trade

The following table shows how each component has contributed to economic growth over the last two years.  The red highlights are those the economy is most vulnerable to.

Consumer: The consumer continues to hold up relatively well and has averaged 71% of total GDP since January 2009.  Needless to say the consumer needs to be able to hold on here. There is no reason to count them out in Q2 or in the foreseeable future. 

The one caution though is disposable personal income (income after taxes) on an inflation adjusted basis over the past six months has contracted when adjusting for the temporary reduction in FICA taxes. The combination of government aid and delinquent homeowners (average time without paying a mortgage is now 400 days) are keeping the consumer afloat.

Bottom line the consumer should continue to support the economy in the short term regardless of their lack of real organic income growth.

Government: The government was a net drag on economic growth the past two quarters. State governments are forced to balance their budgets and as tax revenues fall (falling property tax a big source) it is probable they will continue to contract. This leaves a big question mark with the Federal government and the reality they cannot expand further stimulus such as the FICA tax reduction.

Bottom line government is likely to contract further with a low probability of it contributing to growth in Q2.

Investment:  There are two components to investment (1) inventory and (2) fixed investment. After five quarters of growth and rebuilding bare shelves inventory contracted -3.42% in Q4 but saw growth of 0.9% in Q1. Current inventory to sales levels suggest inventory could see further growth but why the sudden deterioration in economic data in April, primarily jobless claims? Did manufacturers and retailers get spooked in which case they are less likely to expand inventory levels? That is quite possible.

The contribution from Fixed Investment dropped from 0.8% in Q4 to 0.09% in Q1 driven from a 75% reduction in growth in non residential, primarily structures.

Bottom line investment could easily contract versus contribute to growth in Q2. Are manufacturers willing to expand current inventory levels? Who will finance new construction spending and is there demand for such investments?

Trade: This appears to be the most vulnerable source of contraction in Q2.  In Q4 the trade deficit improved and in fact was a positive contribution to growth of 3.27% (when total growth was 3.11%) but then reversed to -0.08% in Q1.  Most recent trade data shows the trend deteriorating further.

Bottom line trade will be the most likely source of contraction in US GDP as exports fail to maintain the pace of rising imports.

In closing I want to visit one final reason why economic contraction may very well come sooner than most expect.  There is no growth in credit formation.  Since Q4 2008 total loans and leases (credit outstanding on bank balance sheets) for JPM, C, WFC and BAC contracted 7.1%.  In other words the largest sources of private credit are not lending but rather pulling in credit. 

Without private lending this leaves the real "Bank Of America," the US government. The most recent consumer credit data shows the role the government is playing in expanding credit.  Since 2009 government funded credit has risen 91%. Since 2006 it has risen 285%.

Lastly, the above scenario is based on one highly probable reality.  The US government fails to address the growing national debt and is able to kick the can beyond the 2012 presidential election.  As the data shows without the real "Bank Of America" or the Fed the level of contraction will be unprecedented.

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PulauHantu29's picture

Contraction seems to be double-edged; i.e., a little deflation is good for purchasing power of the workers but may increase job losses.

Inflation weakens the dollar but may lead to more job creation.

Does that sound right?

Confuchius's picture

John Williams at points out that GDP simply = total spending by whomever on whatever.

It therefore means nothing. Nada. Zip.

masterinchancery's picture

Correct. You don't have to be an economist, and it helps not to be one, to understand that debt-fueled consumption does not constitute any kind of national "product."  The entire GDP as it has been reported for years, is a sham.

cossack55's picture

Again, I say (quite stridently, in fact), go "Bhutan". Its a little like going Galt.  Change GDP to GDH (Gross Domestic Happiness). Of course, we would have to kill all the bankers, politicians and Wall St. scum first. Small price to pay.

Al Gorerhythm's picture

There's a price equation in there?

fxrxexexdxoxmx's picture

Market opens in less than minute... many equations in there:)

mt paul's picture

treked the " snowman "

gross domestic happiness

was surviving ,that little hike 

Bhutan...where pigs fly ..

"The most recent consumer credit data shows the role the government is playing in expanding credit.  Since 2009 government funded credit has risen 91%. Since 2006 it has risen 285%."..consumer credit down 7 %

reality101 ...quoted from article

Al Gorerhythm's picture

"GDP simply = total spending by whomever on whatever."

Yup, we've all been reclassified from citizens to consumers. I'm a consumer now. Fuck me dead, I hate that term.

Quixotic_Not's picture
Eclipsing a terrible milestone as home prices fall harder than the 1928 through 1933 Great Depression Collapse: Lessons from the Great Depression Part 32. Housing prices continue to fall as other costs eat up disposable income.

"Home prices have been falling steadily since the summer of 2010.  The fact that we still have close to 7,000,000 homes in the shadow inventory tells us that we still have a long way to go before any normal housing market is restored.  This by far is the worst housing collapse ever and it is still ongoing.  This isn’t some closed chapter in our history books. "

"When the bubble unfolded in our current crisis nearly 70 percent of Americans were homeowners with massive amounts of mortgage debt.  Most Americans derive their net worth from their home.  So a collapse in housing values has sent a ripple through the balance sheets of the vast majority of Americans.  Even if you are part of the one-third of homeowners with no mortgage your home values just cratered 32 percent on a nationwide basis."

"As many of you are well aware in the last decade U.S. median household growth was non-existent.  Families are earning what they did going back to the late 1990s.  Yet the cost of a gallon of gas is now up over $4 in many areas, local and state governments are raising taxes for dwindling budgets, medical care costs are soaring, and the cost to feed your family is also sky high.  So the fact that home prices rose in light of all of this is a stunning reflection of the mania we have lived through."

And voila!  Now you know...

Hephasteus's picture

Option arms are resetting this year to finally tank the dollar. So they'll try to liquidate us soon.

oh_bama's picture

Please realize that consumers are still buying ipads!!!

Muir's picture

Well, ordinarily, I'd say this was deflationary, after all, for weeks and weeks (and weeks) I've been pointing out deflationary indicators as well topiness and an overly enthuthiastic exuberance in PMs; however, I now see the truth; this is just an awesome opportunity to BTFDs.


edit: Moreover, I want to sincerely apologize to ZH for ever doubting that QE( infinity -1) was both inevitable and that holding physical was the best (only) way to preserve (store) wealth 
css1971's picture

Well, ordinarily, I'd say this was deflationary, after all, for weeks and weeks (and weeks) I've been pointing out deflationary indicators as well topiness and an overly enthuthiastic exuberance in PMs

Really? All I remember are bouncing tits.

Quixotic_Not's picture

Yep, hard to take anyone seriously that relys on meat-market bait to get attention...

topcallingtroll's picture

If you want to change kool aid brands, well fine.

None of you understand bernanke and the fed. Finally people are beginning to realize it isnt a straight line to inflation, but possibly some swings back and forth for a while.

There will be no qe3 unless we have some serious contraction, not a minor upward blip in unemployment.

The earliest is august. We wont need more than two qe's.

Sudden Debt's picture

Europe is going to tax Chinese government subsidized more than others.

To save jobs and protect what's left of the industrial base, the US should do the same.

Just tripple tax the cheap stuff from china, and put a low tax on national produced products.

The US can make a lot of money on that, create jobs and even cut the deficit.


Confuchius's picture

Are all Belgians as dumb as you?

Muir's picture

Well you should have pointed out to him that QE(n + 1) is a stealth tariff.


"Just tripple tax the cheap stuff from china, and put a low tax on national produced products."

rocker's picture

All's fair in industrial warfare. China plays with Iran. Yet benefits from us fighting in the middle east. China actually taxes many items imported to them from the US. Why not tax their exports to us. Hell Yeah.

Sudden Debt's picture

Oké, why is that dumb?

So strange that the simple minded always need to insult people without making a point.

Clearly you're a sad person who needs to hide himself behind a keyboard to channel his personal shortcomings.

You should get out of your parents basement and try to talk to normal people. It might help you cope with your complexes.


cossack55's picture

Maybe he can't find the stairs or they keep him locked in.

duncecap rack's picture

Protective trade barriers are a big nono. They are widely blamed for the severity of the colapse in the last great depression.

Sudden Debt's picture

Still, our European largest industrial countries are growing at a increasing rate.

Cut away the parts like greece, portugal and spain. Same like your detroit kind of cities that are large enough in our terms to be countries and you'll see that the EU is outpacing the US in a big way.

We've had antidumping for 4 years now and it's starting to show it's effects.


Caviar Emptor's picture

@Sudden Debt: this is one component of what I've been predicting for a couple of months: protective tariffs. But it won't end there. Price controls and capital controls are sure to follow. And that's in addition to continuing interventions in the stock, bond and commodities markets which have already begun. We won't see truly free again in our lifetime. It's the only way for them to hold things together sine they can't erase massive mistakes. 

Al Gorerhythm's picture

"Protective barriers" are a means by which local workers can protect our living standards, against a supplier who uses underpaid labor (in comparison to ours), as an means to dump their products in our market.

If we have to compete against that, we are going to be paid at the same average rate of a third world peasant. Our manufacturing sector has been relocated overseas, because the wage arbitragers, using the "Globalization is Good" meme, have made a bundle selling the goods we used to manufacture, to us, asking for payment in a currency ($) that is more valuable than the Yuan. They make a killing in both currencies. These companies are run by your fellow countrymen. They are prepared to sacrifice the historic soundness of our markets and currency, our living standards, our way of life, just to make a $profit for themselves. We're broke because all of the profits go off shore, compounding the situation that we are now in.


zippy_uk's picture

Why would anyone in Washington want to do that when the Chinese have bought the place out ?

US politicians serve the people alright, but none of them are US citizens (themselves excepted).


And as for EU - well even if they try to succeed with Taxes as you suggest, they could not organise a shower in a monsoon..

Dollar Bill Hiccup's picture

The Corporate Dream is to sell into the billion man market. If you put up tariffs, so will the Chinese. They don't make enough dough yet for western corporate profit margins to withstand tariffs on their side. While the Transnationals wait and try to work themselves into the Chinese Market, the little guy in the West, the ephemeral middle class, gets unemployment, foodstamps and inflation. The Chinese get a devalued dollar on their trillions, more inflation and a not so gentle nudge to let the RMB revalue. But heh, those trillions of dollars were not accumulated strategically or on a profit and loss basis, they were accumulated to keep Chinese employed, period. Hundreds and hundreds of millions of Chinese workers, working for relatively nothing. That chapter is getting ready to turn, especially if you can believe sources like BCG discussing the closing wage gradient. Three more years of not paying for your mortgage but living in your house, staying on the dole and eating Rice Krispies for dinner is a small price to pay for GM to sell cars in Hunan. Maybe you'll never work again, but S&P earnings will be $150 ...

High Plains Drifter's picture

Tony, will you please go talk to Leo.....

Franken_Stein's picture


Does the Fed balance shite conform with the U.S. Generally Agreed Accounting Principles (US-GAAP) ?


A-hahahahaha !

That was a good one, wasn't it ?

No ? Oh, come on.


Don't be such a Spielverderber (game spoiler).


cossack55's picture

Yes it does. They are both written in English.

Hushups's picture

I'm sure most have seen this, but seems relevant anyway. Interesting take on deflation.

RockyRacoon's picture

Let's get this show on the road....  Give us a huge black swan and stop the teetering in the edge.   This crap is wearing me out!

I'm ready.   You?

MacroStory's picture

I've been ready for two years now.  Pantry is full, inflation is hedged, family has been read the riot act.  Most of my friends don't take my calls anymore.  Wonder why?  On a side note, I must be getting old as I need the calculator to answer the captcha.  Just got the first one wrong.

JimBobOMG's picture

Sooooo buy more gold?

Muir's picture

No silver!

How about silver minis!?



Contract Type Futures Country/Region United States

Closing Price 35.528 CurrencyU.S. Dollar (USD)Contract Identifiers Conid 42320984 Futures FeaturesFutures TypeMetalsFirst Notice Date First Position Date28/11/2011

Last Trading Date28/11/2011

Expiration Date28/11/2011Multiplier2500

Margin Requirements

Intraday Initial Margin15,280Intraday Maintenance Margin8,000



css1971's picture

No. Understand what money is.

Credit contracting means deflation, not inflation. Gold will appear to lose it's value during deflation just along with everything else. Take a look at the chart of gold during 08, it's on kitco. Gold has some useful monetary properties, but it is not money (yet).

The stock, commodity, bond markets are all levered out of their minds. Everyone wants to get rich quick, and the way to do that is leverage; loans. Well, if credit is contracting, the loans to traders to buy assets is also going to be contracting. We've already seen the margins on silver, oil being raised.

I think 2008 caught the banks by surprise but they've been playing the inflation/deflation game for centuries, possibly millenia. They know Bernanke is ending support. They have mountains of cash. This time they're planning to take everything down in a grind. All they need is for everything to be cheap at the end.

The Bernanke reset isn't over till his employers own everyone.

Muir's picture


Go ahead and teach your competition in a zero sum game.

css1971's picture

Nobody here is my competition. This isn't what I do. This is a meaningless freakshow where nothing productive (rent seeking) happens. Little more than the colliding of egos. I'm not here to beat anybody, I'm not even trying to get rich. I'm simply here to make sure that nobody steals the value I have earned. Do you understand just how fucked up it is that I have to do that?

The manipulation of money is too easy.... Any particular trade on the stock market is a zero sum game, but in the real economy it is not. When I buy a car it's because I want the car more than the money, the car is useful to me. Both sides of the trade benefit, it is not zero sum. That's the fucking point of trading.

The more people who understand money, the harder it's manipulation becomes. The better life will be.

Muir's picture

What, no sense of humor?

Or sarcasm?

Or aesthetics?

ethancasta's picture

That's a great avatar. I notice it everytime I read comments.

Quinvarius's picture

You might want to actually compare a chart of gold vs the S&P during 2008.  It is pretty clear gold was at all time highs when the S&P was at 666.  That is because gold is money. 

css1971's picture

Gold declined.

Doesn't look like much now, but that was a big scary fall, just like everything else. Gold buyers are leveraged as well.

Al Gorerhythm's picture

No. Understand what money is.

Paper gold buyers are leveraged but not this one, and I'm about as far away from debt as my little feet will carry me. Gold is and always has been, as nature's gift, the only true form of money, when used as a numeraire against all others. Disprove its historic record over time, not just some little blip in its chart.

jaffi's picture

"The consumer continues to hold up relatively well and has averaged 71% of total GDP since January 2009"


And, here I thought that government spending (local, state, and federal) was currently 46% of GDP.  

falak pema's picture

you can't get structural rebalancing on macro economic scale w/o some selective protection play, the first of which is curbing the world wide financial casino, especially NAKED derivatives plays.

RunningMan's picture

Whether there is QE or not, we are in a bizarre operating mode in the economy. Some elements flying high (construction, infrastructure, certain areas of finance), while others have outright stalled. We've got the standoff with the USD - up or down? Risk on or off? It won't matter much, as those in the money - IB, HF and perhaps some PE - will be hiring us in teams to cut their lawns blade by blade this time next year.

Lndmvr's picture

My part time insurance inspection job turned into full time. Had to put a new front end under the car last month due to crappy roads. Now it needs another grand or so plus tires if i want to keep working. I'm thinkin I'm ready to quit and take a break for a year. Any one want to drive 300-500 miles a week for 500 to 700 bucks minus gas? If your in iowa and nedd a job, watch the want ads. My economy is contracting.