"Something" Happened: What The GDP Report Means

This article originally appeared in The Daily Capitalist.

Readers will recall that I had noticed that "something was happening" in the economy. After several years of ultra-bearish reporting, I reported that at the very least the economy was not declining further and that perhaps a bottom was forming which would indicate positive news for the economy. I cautiously reported that a "trend" to recovery was not yet evident but that indeed, something was happening. I noted that almost none of my bearish peers seemed to note this trend.

Much of this positive news is a result of quantitative easing (QE) and is not real.

Today's GDP report showing a 3.2% gain for Q4 2010 was more positive than I had anticipated, but it is trending in the right direction. In my November article I anticipated GDP would continue to be "flat" in Q3 and Q4. While I was mostly accurate with Q3, I underestimated Q4. Understand that these are preliminary numbers, and the revision on February 25 may be different, positively or negatively.

There are huge caveats to this GDP report which gives it a mirage effect, as I noted yesterday. But first let's examine the numbers.

Real personal consumption expenditures increased 4.4 percent in the fourth quarter, compared with an increase of 2.4 percent in the third.

Durable goods increased 21.6 percent, compared with an increase of 7.6 percent.

Nondurable goods increased 5.0 percent, compared with an increase of 2.5 percent.  Services increased 1.7 percent, compared with an increase of 1.6 percent.

Real nonresidential fixed investment increased 4.4 percent in the fourth quarter, compared with an increase of 10.0 percent in the third.

Equipment and software increased 5.8 percent, compared with an increase of 15.4 percent.

Real exports of goods and services increased 8.5 percent in the fourth quarter, compared with an increase of 6.8 percent in the third.

Real imports of goods and services decreased 13.6 percent, in contrast to an increase of 16.8 percent.

The change in real private inventories subtracted 3.7 percentage points from the fourth-quarter change in real GDP after adding 1.61 percentage points to the third-quarter change.  Private businesses increased inventories $7.2 billion in the fourth quarter, following increases of $121.4 billion in the third quarter and $68.8 billion in the second.

Real final sales of domestic product -- GDP less change in private inventories -- increased 7.1 percent in the fourth quarter, compared with an increase of 0.9 percent in the third.

Current-dollar personal income increased $128.3 billion (4.1 percent) in the fourth quarter, compared with an increase of $75.7 billion (2.4 percent) in the third.

Disposable personal income increased $99.6 billion (3.5 percent) in the fourth quarter, compared with an increase of $47.1 billion (1.7 percent) in the third.

Real disposable personal income increased 1.7 percent, compared with an increase of 0.9 percent.

The personal saving rate -- saving as a percentage of disposable personal income -- was 5.4 percent in the fourth quarter, compared with 5.9 percent in the third.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 1.7 percent for the year.

Excluding food and energy prices, the price index for gross domestic purchases increased 1.3 percent for the year.

The bottom line here is that consumer spending was up (4.4%), the biggest increase since Q1 2006, and imports were down 13.6%. Annualized, GDP was up 2.9% in 2010. Core prices were +1.3% for the year.

There are are several important caveats to note while interpreting GDP. The first is that it is a fictional assessment of the economy. It tries to measure aggregate output through spending which results in a meaningless statistic. I do not wish to get into this point as an abstract discussion of economic theory, but for those who are interested, here is an excellent distillation of an explanation of this idea.

The other fact to consider is that if all GDP measures is spending, then an increase in the money supply by the Fed would increase spending. Again, since fiat money cannot be a source of wealth, a rise in GDP as a result of Fed money "printing" cannot be a real economic gain. If it were, then Zimbabwe would be the richest country in the world.

But, the significance of GDP cannot be overlooked since it what the Fed looks at the determine monetary policy.

That aside, what can we take away from GDP?

1. Most of the increase in GDP is the result of QE1 and QE2 monetary stimulus. Ultimately the Fed will "print" $2.2 trillion and pump it into the economy. That has one initial destination: Wall Street.

2. Most of the increase in the stock markets is a result of QE. The increase in company bottom lines is a result of efficiencies, but exporters have had the best returns.

3. A declining dollar has lifted exports and inhibited imports. The dollar has been on a slide since June 2010 which makes US exports cheaper and thus more attractive to foreign customers. The cause of this is QE.

4. The concept that imports are bad and exports are good is false. History has shown that with the rise of imports (since the early 1980s) that the economy has not collapsed, but rather has benefited from trade. This is one of the fallacies of the economic concepts behind GDP. Thus, the decrease in imports and increase in exports will not be a real economic positive. (I am working on a major article on free trade.)

5. Spending is coming mostly from wealthier Americans, not the middle-class. Wage growth has been stagnant, real disposable personal income expanded a modest 1.4% for the year, and the personal savings rate continues to be historically high (5.4%). It appears that increases in wealth has come mostly from debt reduction, not the stock market.

6. Recent (post 2010) spending data is down.

7. Inventory was a drag on GDP, down 3.7% for the quarter. This was a "surprise." This is the biggest decline in 22 years according to David Rosenberg. This is significant: if consumer spending continues to drop off, one wonders what will happen to the manufacturing sector. The latest durable goods report was a -2.5% in December.

There continue to be the factors that act as a drag the economy. These are serious headwinds to a recovery.

• Unemployment remains high at 9.4% (16.7% on the broader U-6 scale). The recent report of initial jobless claims went up 51,000 last week to 454,000. I don't see much that would result in strong employment growth. This is one of the drivers of the Fed's QE policy: the more unemployment remains high, the more money they will pump into the economy.

• Real savings, the capital accumulated and saved from the profit or wages of productive enterprises, still appears to be deficient since production is not expanding sufficiently to expand employment. Banks and individuals continue to deleverage, and lending is still weak, further evidence of a lack of real savings.

• The Fed is inflating. The True Money Supply (Austrian theory) is up 10% the past six months and 15.2% the past three. This increase was measured before the impact of QE2. This monetary inflation will act as a drag on the economy as it eats up savings and capital.

• Home prices continue their slide according to the recent Case-Shiller report. In addition, the shadow inventory hangover is high: last year 2.8 million homeowners received default notices. More are anticipated this year. Commercial real estate is still declining and those foreclosures will continue to impact the ability of local and regional banks to lend.

• The deficit is anticipated to be $1.5 trillion this year. This is starting to have an impact on Treasury rates: they have been going up, making it likely that the deficit will increase further.

The bottom line is that we are seeing monetary inflation and it is impacting prices. Real savings is still in short supply and that is inhibiting growth. Spending will not revive the economy, but an inflated money supply will give the impression of economic improvement, but it will be an ephemera. It will further negatively impact real savings. I would expect similar GDP numbers in Q1 2011, perhaps a bit weaker (wait until the revised Q4 come out to see if I'm right). Unemployment will remain high. This is a recipe for stagflation.

This GDP report is much ado about not much.

Comments

[More Critical T...]

You have not addressed taking out a 1%-2% "loan" (incurring debt) for money not saved.

(I have addressed every point of yours that was worth addressing - and even some that were not worth addressing.)

Borrowing money, even at 0.25%, is a form of gambling.

As I said it before, taking out a 1-2% 3-year loan to support a prosperous, growing family business is generally not considered 'gambling'.

When easing is done for a whole country then taking out a 1-2% APR loan is called "creating jobs", "creating a business-friendly environment", "investing in the future" and "reducing unemployment".

You have some very weird definition of 'gambling'. Do not expect others to accept your nonsensical definition of 'gambling' and argue based on your weird terms - rational discussions do not work like that.

[ISEEIT]

Yours is not a rational conversation. Easing is NOT being done FOR a whole country, it is being done TO a whole country and if the motivations were to positively affect those political catch phrases you love to toss around, the proof says bullshit 'cause the rainbows and unicorns are not materializing (except for a very select few).

[More Critical T...]

Care to explain/prove your POV a bit more verbosely than "what you say is bullshit"?

I linked to various pieces of hard data and I explained the mechanics of these things. I really mean my nickname and I will change my opinion the moment I see conclusive contrary evidence - but right now I'm not aware of any contrary evidence - let alone conclusive one ...

[snowball777]

You've baked in the assumption that rates will remain low without any rational justification for that axiom.

[More Critical T...]

I've not baked in any assumption, I've linked to the yield curve:

http://www.treasury.gov/resource-center/data-chart-center/interest-rates...

that is the current estimation/expectations of the markets, for the next 10 years. The best estimation we have for now.

That yield curve for a long time predicted deflation rather than inflation. And just today came a 0.0% PCE core price index surprise.

So if you think inflation and high yields will happen there's no proof of it anywhere.

[snowball777]

The key adjective in your post is 'current'; there's no 'proof' of a forest fire either...until the smoke starts.

[More Critical T...]

Well, bond investors are generally pretty good at figuring out 'forest fires'. Witness the Greek and Irish bond CDS spreads which widened way before the crisis hit home. Witness the AIG and other key CDS spreads and yields which widened in the summer of 2008 - way before the crisis fully unfolded.

Is it fool-proof? Nope, but rest assured that if there's USG solvency trouble ahead then USG bond investors will be the first ones heading for the hills. (Or rather, heading for the rivers - the hilltops are not particularly the best place to be during forest fires.)

[snowball777]

The deadbeats you've identified as the current targets of the bond vigilantes are providing a useful distraction for the moment.

Safest place during a fire? Graveyard.

[ebworthen]

Okay, put your money where your mouth is, I'm ready for $90,000 at 1% APR.

You need an address?

[More Critical T...]

Sorry, while a bank might trust a family business to generate future income that can finance such a loan, I do not trust the financial viability a clearly confused stranger who does not even know what the terms 'borrowing', 'loan' or 'debt' mean.

[FreeMartinArmstrong]

I would not trust you to deliver anything but paper promise. I would prefer paid in full with debt junkies, so there could never be business at all

sorry

[More Critical T...]

He asked me for a loan in hard cash and I gave him my answer.

The US Government is asking me for a loan as well, in form of a treasuries market. So far they have proven to be a reliable borrower (they have borrowed from me in the past and paid back in full plus interest), but right now the yields are still a bit too low for my taste. Plenty of others are finding it a good deal though - that is why the yields are low.

They USG is a credible borrower to me not just because the US is a rich, productive and innovative country, but also because all data suggests that the public debt of the US is clearly servicable.

One datapoint is that the deficit has been reduced in the past - it has even been reversed for a few quarters and turned into an actual surplus. See this data of the deficit from 10 short years ago:

http://research.stlouisfed.org/fred2/graph/fredgraph.png?bgcolor=%23B3CD...

Absolute debt levels reversing at the end of the Clinton presidency:

http://research.stlouisfed.org/fred2/graph/fredgraph.png?bgcolor=%23B3CD...

That reduction was not continued during the Bush presidency though.

Other historic data shows that the USG has recovered from much higher GDP-to-debt proportions in the past than the ~100% today.

For example the US had 300% of debt-to-GDP ratio in the early 30s:

http://www.princeton.edu/~pkrugman/debtdepressionwar.PNG

Reducing debt is possible - even 300% is recoverable for a country so rich in natural resources, it is a matter of political will.

[4of8]

The US did NOT have a 300% debt to GDP level in the early 30s.  It had a 30% debt to GDP level.  Your graph is missing the scale for debt to GDP.  If the scale given was for debt to GDP then the US was above 100% for the entire graph - NO!

Here is a graph of the debt vs GDP over a longer time frame-

http://www.ritholtz.com/blog/2010/05/federal-debt-as-a-of-gdp/

And considering the unfunded programs (social security, medicare, obamacare...) that are not included in the "debt," we are actually worse the ever before.

Also, since much of the industrial world was destroyed during WWII (the last debt/GDP peak), we were in a unique position to recover from our high debt load of 1940-50.  That situation is unlikely to happen this time.

[Astute Investor]

+300%

Your comments are spot-on.  MCTW is the master of the specious argument and comparing apples to oranges is one of his specialties.  You are correct that US Goverment debt was only 30% of GDP in the 1930s.  The 300% debt / GDP figure cited by MCTW via Krugman is not government debt, but TOTAL DOMESTIC CREDIT MARKET DEBT (i.e. government AND private sector).  Jeff Gundlach from DoubleLine had a chart in his year-end presentation showing historical credit market debt / GDP.   In 1933, the figure was 299%.

So, the credibility of the "US Government debt was once 300% of GDP and everything turned out okay" argument goes right in the garbage.

[More Critical T...]

True, and I corrected that in the reply further below.

1946 was the peak of the public-debt-to-GDP ratio, at around 150%.

Today's 100% is still a far cry from that.

[More Critical T...]

No - that figure in the graph is really 300% - see my reply further below.

[FreeMartinArmstrong]

they jumped off the empire state building, they are half way down, so far so good, the reliable part of the deal is the pavement.

[More Critical T...]

I disagree with that characterisation.

A more fitting analogy for the hard data I linked to would be: they ate a third of a cake they ate in the past. They managed a full cake in the past without puking and I'm confident that right now, at a third of a cake, that they are no going to puke on me either. They also have a good kitchen and a huge refrigerator full of ingredients, and they are baking a full cake per day - and they have proven in the past that they can fast as well, if they want to.

So yes, based on the data I'm not too worried about this US cake baking and eating business, right now.

Now, if I look at Ireland's and Greece's cake baking and eating track record, I become worried: even at the 7%+ yield they are offering. It does not look sustainable.

[FreeMartinArmstrong]

my pavement will be much harder then your data my friend

[More Critical T...]

(The correct spelling is 'than your data', not 'then your data'.)

Good luck investing based on your data-less, faith based hypothesis - you will be a nice counter-party to my trades.

[FreeMartinArmstrong]

I am not a trader, I am a buyer. I don't need luck. I need strong hands.

I can't edit the then for the than anymore. Not being native can make such mistakes in the hurry. would correct when could. have no problem admitting or correcting little mistakes at all. do you ?

[More Critical T...]

I'm ready to change my opinion when my logic is shown to be wrong or when I am pointed to contrary evidence - and I do it every now and then.

Are you ready to do that? Are you willing to reply to the data I cited, in substance?

[LowProfile]

So if we could have been buying our own debt with no consequences, then why the fuck haven't we been doing it all along?

You stupid fucking douchebag.  I hope you have all your money in AAPL.

[More Critical T...]

So if we could have been buying our own debt with no consequences, then why the fuck haven't we been doing it all along?

Easy: because the yield curve has never been so flat in the past 80 years, since around 1930 or so. QE became possible, became necessary and became viable due to that extreme yield flatness.

(Btw., I mentioned this in the post above - I even linked to today's yield curve numbers.)

If you do QE with the 3-year yields at 5% it's of course stupid (and unnecessary). With 1% it's viable and necessary.

[ebworthen]

Oooh, yield curve.

Is that like plastic surgery? 

Because when the FED is ginning the markets with $2+ trillion dollars of taxpayer liquidity and money printing AFTER bailing out the banks, bank holding companies, and "insurers" who caused the collapse to begin - with I find it hard to believe any "historical" figures.

[More Critical T...]

Oooh, yield curve.

Is that like plastic surgery?

No.

[snowball777]

Soo....to continue your analogy...if the family takes on the $10k debt when rates are low, but they have a variable rate card, a habit of forgetting to pay their bills on time, and their business isn't actually growing?

[More Critical T...]

Yes, that analogy would be applicable roughly to Zimbabwe's track record as a debtor, or maybe to Greece. I wouldn't buy their bonds.

The US has never defaulted on any of its bond obligations in the past 100 years or so, and the US economy is actually growing and the level of debt is manageable considering the amount of natural resources the US owns: see the references to various pieces of data I posted further below in this discussion.

[Sancho Ponzi]

1) Flat yield curves enable politicians to continue spending recklessly while not raising taxes.

2) Flat yield curves punish the retired and others on fixed incomes.

3) Long term, flat yield curves drive down private sector profits because money is virtually free.

Flat yield curves don't exist without consequence.

[More Critical T...]

Re 1): Wrong. A flat curve of this level was unique, it never happened since the Great Depression - flat yield curves are highly abnormal, that's why QE was needed

Re 2): Wrong. Fat yield curves benefit the retired and others on fixed incomes, because they foreshadow deflation.

Re 3): Wrong. There's no need to guess: even short term the flat yield curve depressed investments to dramatically low levels in the past 2 years: US businesses were sitting on record levels of $1 trillion of cash and bonds they could not invest because they were already running very under-utilized, at 70% of existing, built-out capacity.

So you were wrong 3 times out of 3 - wow! I really hope no-one else depends on your investment decisions ...

[Thorny Xi]

Short term thinking and analysis based on the economic paradigm of the past 100 years of exponential growth in basically free oil energy - the "growth model" required by finance, to pay the rents from an increasing pool of 'wealth,' when actual energy production has been flat for over 5 years, assures long term failure.  Go ahead and invest in promises.  I've never defaulted on a loan in my half century either, but apart from direct investments in energy production facilities suxh as small hydroelectric operations, I don't loan funds to anything/anyone anymore.  Loaning money to an oil dependent government that requires over 1mm bbls/day to function, 3/4ths imported and much paid for at a huge premium in occupation zones is not rational.