Q3 GDP: Proceed At Risk

By Jeff Harding
The Daily Capitalist

The Commerce Department announced Thursday that GDP grew 3.5% in Q3 2009. This is the "Third Quarter Bump" I had been expecting.

Economists and the news media are jumping on the "It's Over!" bandwagon. Their conclusion is based on the premise that government spending ("stimulus") will actually create real economic growth. It won't and never has.

The numbers on their face look pretty good. "Real GDP" (i.e., adjusted for inflation) grew for the first time in 4 quarters. Here's how the government played the news in the BEA release:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.5 percent in the third quarter of 2009, (that is, from the second quarter to the third quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP decreased 0.7 percent. ...


The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, federal government spending, and residential fixed investment. ...

(Emphasis added)

There are some significant "buts" in their report.

The Clunkers program was responsible for most of the increase in PCE:

... vehicle output added 1.66 percentage points to the third-quarter change in real GDP after adding 0.19 percentage point to the second-quarter change. ... Real personal consumption expenditures increased 3.4 percent in the third quarter, in contrast to a decrease of 0.9 percent in the second. Durable goods increased 22.3 percent, in contrast to a decrease of 5.6 percent. The third-quarter increase largely reflected motor vehicle purchases under the Consumer Assistance to Recycle and Save Act of 2009 (popularly called, “Cash for Clunkers” Program).

This is not real economic growth. As many observers have pointed out, Cash for Clunkers just borrowed sales from the future, so that we can expect that Q4 will show a substantial decline in car sales unless the government renews the Clunker program. Without auto related activity, GDP was up only 1.9%. The Clunker program increased sales from $306 billion in Q2 to $342 billion in Q3, I would assume some of those sales were real economic transactions, but my guess is that we'll end up in Q4 closer to Q2 results. Which would lop off about 1.5 points from Q4 GDP.

Today's report showed personal consumption expenditures (PCE) increasing 3.4%. If most of the 3.4% PCE was from the Clunkers program, then PCE was essentially flat, unless you believe that the Clunkers program will actually work to create future growth in the Keynesian manner. I don't believe that.

It was also reported that real residential fixed investment increased 23.4%, in contrast to a decrease of 23.3%. You can ignore the impact of this since most of the real estate activity has been spurred by the $8,000 federal tax rebate. While the housing market is starting to find a bottom because of declining prices, this current flurry of activity will stop when the tax credit disappears. Re-inflating the housing market is not a cure for our economic ills.

The next interesting item is federal spending as a component of GDP. This item increased 7.9% in the third quarter, compared with an increase of 11.4% in the second. Defense spending as a component of this actually went down in Q3. These expenditures do not add to economic growth in the sense that the government never creates wealth, it only spends it. Since the money comes from us, you may well ask what you would have done with that money. You can argue that it serves a purpose, roads, defense and the like, but that doesn't create wealth necessary to grow the economy.

Then there are inventories:

The change in real private inventories added 0.94 percentage point to the third-quarter change in real GDP after subtracting 1.42 percentage points from the second-quarter change. Private businesses decreased inventories $130.8 billion in the third quarter, following decreases of $160.2 billion in the second quarter and $113.9 billion in the first.

Inventories are shrinking because retailers are dumping goods to avoid being stuck with unsold goods. Retailers have been very cautious in ordering new inventory. If they perceive consumers are actually increasing their spending they will order more goods and production will ramp up, which would be a good thing. But if the PCE numbers are a Cash for Clunker mirage, will there be a surge in production?

It depends. Some new production will occur because it is not as if the economy is completely nonfunctioning; people still buy things they need, and, as inventories shrink, retailers will still have to meet basic demand. But, will inventory growth fuel 6 points of GDP growth over the next two quarters as some economists believe? It depends on what you believe about consumer spending.

Let's dig further into the numbers from the BEA report:

  • Current-dollar personal income decreased $15.5 billion (0.5 percent) in Q3, in contrast to an increase of $19.1 billion (0.6 percent) in Q2.
  • Disposable personal income decreased $20.4 billion (0.7 percent) in Q3, in contrast to an increase of $138.2 billion (5.2 percent) in Q2. Real disposable personal income decreased 3.4 percent, in contrast to a Q2 increase of 3.8 percent.
  • Personal saving -- disposable personal income less personal outlays -- was $364.6 billion in Q3, compared with $533.1 billion in Q2.
  • The personal saving rate -- saving as a percentage of disposable personal income -- was 3.3 percent in Q3, compared with 4.9 percent in Q2.
  • The Conference Board, a private research group, said its index of consumer confidence fell to 47.7 this month, from 53.4 in September. The percentage of those who think jobs are hard to get rose. Their pessimism of future earnings could restrain holiday spending. (From WSJ)
  • In today's report from the BEA, the Commerce Department announced that consumer spending declined 0.5% in September.

What all this means is that consumers are still cautious, if not frightened, and it is more likely that PCE will revert to the rate seen before Cash for Clunkers, which is to say, flat to maybe a little higher. It is disconcerting to see personal income and disposable personal income decline. While consumer savings are down from the high of Q1, it is still well above the average savings rate in recent times.

It comes back to the underlying trends that are driving the economy. These fundamental megatrends have been discussed before by me and I see nothing in this report that w0uld change them. Recall Megatrend No. 1: "The culture of consumption is broken and won’t return to former levels. This is the key to everything." And Megatrend No. 2: "Consumers will continue to increase savings to prepare for retirement." It's a different playing field for consumers.

These megatrends will impact consumer spending and I don't expect it to recover to its former conspicuous level. This has negative implications for the future of the economy and growth.

This leads me to conclude that we'll have a sluggish economy, propped up by stimulus spending. Like most government projects, the impact of the $787 billion stimulus spending will not have a lasting effect, and will leave us with high debt, high taxes, and a lackluster economy. I would expect Q4 GDP to show positive, but close to flat, growth, most of it will be from government stimulus.

After that it will depend on the state of our personal, bank, and institutional balance sheets. If toxic debt is wiped out from bankruptcy, write off, foreclosure, or recapitalization, then we'll see real growth and recovery, although it will be subdued. If the government continues to discourage its liquidation, then credit will remain scarce and the economy will stagnate.