"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.