At the end of October I took a closer look at the advance reading on third quarter US gross domestic product (GDP).
My conclusion: There were a number of artificial boosts to third quarter GDP data, including cash for clunkers and the first-time homebuyers’ tax credit. As this stimulus fades, GDP growth will face additional headwinds. However, there’s enough slack in inventory data and additional stimulus in the pipeline to keep the economy growing for the next few quarters.
Earlier this week, the Bureau of Economic Analysis (BEA) released its preliminary estimate for GDP, revising growth lower from its advance estimate of 3.5 percent down to around 2.8 percent.
The fact that GDP was revised is nothing at all unusual; the BEA always releases three estimates of GDP for each quarter: advance GDP, about a month after the end of the quarter; the so-called preliminary data a month after that; and the final number one month later. And even the final number isn’t really the last word on GDP. The BEA can revise GDP data years after the “final” estimate.
It can often be instructive, however, to examine the main factors behind GDP revisions. Here’s a look at what caused the negative 0.7 percent revision to third quarter GDP.
Source: US Dept of Commerce Bureau of Economic Analysis
The figures in this table show the impact of each factor on the change in real GDP.
The largest driver of the GDP revision was trade. The important point to remember is that exports add to GDP, while imports subtract from GDP. The BEA revised both imports and exports sharply higher.
That being said, exports rose considerably less than imports, so the net effect was a negative; in fact, the 0.3 percent downward revision in net trade is equivalent to nearly half the total downside revision to GDP.
Clearly, a widening trade deficit isn't good news for the US economy. A good chunk of the import jump represents rising commodity prices and, in particular, the rising costs of oil imports. In September, crude oil imports jumped about $4.1 billion to $19.6 billion.
Another cause of rising imports is, somewhat ironically, the “cash for clunkers” program that was touted as a means of stimulating the US economy. Import dealers sold down their inventories during “cash for clunkers” and now have to import cars to restock their lots. In September alone US imports of automobiles and parts jumped by $1.7 billion to $16.4 billion. This compares to total auto-related imports of barely $10 billion back in May.
There is a positive side to the trade data: The jump in US exports signals growth outside the US is picking up. Civilian aircraft was a leader on the export side, though consumer goods exports have also picked up significantly since the beginning of the year.
Outside trade, the top negative revision on my table is motor vehicles and parts expenditures. As I noted in the October 29 issue, the main driver of GDP growth in the third quarter was a jump in personal consumption expenditures (PCE); motor vehicles and parts are included in the PCE number.
The BEA stated clearly in its October advance release that much of the strength in motor vehicle and parts was due to “cash for clunkers.” The 0.2 percent downward revision to motor vehicle PCEs in the preliminary release this week suggests the positive impacts of this program on the economy are somewhat less profound than previously thought.
Nonetheless, motor vehicles contributed about 0.81 percent to third quarter GDP, roughly a third of total growth. The positive impact of this program should continue to fade in the fourth quarter.
One final component of the negative revision worth mentioning: inventories. The change in inventories added 0.87 percent to third quarter GDP. While that was revised lower from the advance estimate of 0.94 percent, the change in inventories was clearly a key driver of growth overall in the quarter.
I suspect that’s likely to continue. The fact that inventories contributed so meaningfully to GDP in the quarter doesn’t mean that inventories rose. In fact, inventories continued to decline at a 13.4 percent pace year-over-year in September and declined at the second fastest pace in history for the quarter as a whole.
However, the record decline occurred in the second quarter; the simple fact that inventories aren’t declining at quite as fast a pace as prior quarters adds to GDP growth.
Inventories are now extraordinarily lean across most industries. That means there’s not a great deal of scope for companies to slash inventories further. It’s far more likely they’ll be looking to build their stocks back to more normal levels. I see inventory restocking as a significant driver of upside to GDP over the next few quarters.
Overall, although the downside revision to GDP data isn’t positive news, it was widely expected. After all, the September trade data suggested that the trade component in GDP would be worse than the BEA initially estimated. As I’ve been saying for months, the US economy exited recession over the summer and will now enjoy a cyclical recovery.
It’s also useful to compare the current quarter to prior quarters when the economy was recovering from recession.
I’ll ignore the 2001 recession because it was mild and move back to the 1990-91 contraction. According to the National Bureau of Economic Research’s (NBER) Business Cycle Dating Committee, the 1990-91 recession ended in March 1991, so the first full quarter of recovery was the second quarter of 1991.
In that quarter, US GDP grew 2.7 percent, actually a bit worse than was the case in the third quarter this year; of course, the 1991 recession was also much milder by comparison. In the second full quarter of recovery--the third quarter of 2001--the economy expanded by 1.7 percent.
There are some key differences in the drivers of recovery between the early 1990s and today. For example, back then, without the benefit of “cash for clunkers,” PCEs related to motor vehicles were much slower to recover. Total orders for durable goods--products used more than one year--contributed just 0.16 percent to growth in 1991 compared to 1.34 percent this cycle.
This time around, however, spending on services is much weaker. In particular, spending on housing-related services, food service and accommodations recovered quickly in 1991 but has been extremely sluggish this cycle.
For example, spending on food service and accommodation actually added 0.35 percent to GDP in 1991 but subtracted slightly from GDP this quarter.
This is further evidence that high unemployment, weak consumer credit conditions and the lack of real accumulated savings will make it much tougher for the US consumer to act as an engine of growth this cycle. I’m looking for the consumer to remain sluggish, and I see a much more gradual recovery in spending compared to 1991.
Inventories featured prominently back in 1991. Although inventories actually were a minor headwind for GDP in the second quarter of 1991, they added 1.16 percent to GDP in the third quarter and a whopping 1.95 percent in the fourth.
The growth caused by inventory restocking helped to give the recovery some momentum back in 1991 and could be even more dramatic this cycle because inventories are far leaner than was the case 18 years ago.
One final point to mention: Change in net exports (trade) added about 0.65 percent to GDP back in 1991 but is actually subtracting almost 0.5 percent from GDP this quarter. If US exports continue to pick up due to growth abroad, trade could become less of a headwind going forward; this will be an interesting component of GDP to watch in future periods.
But the 1991 recession was mild. Let’s compare the current cycle to the recession that lasted from November 1973 to Mach 1975. That cycle bears considerable resemblance to the current downturn in duration and (arguably) severity.
In the first recovery quarter of that recession, the second quarter of 1975, the economy expanded by 3.1 percent, a bit better than the third quarter this year. Of course, back in 1975 the recovery gained steam quickly; the US economy grew more than 9 percent in the first quarter of 1976. That’s not going to happen this cycle. This will be a much more sluggish snap-back.
Once again, the jump in durable goods PCEs back in 1975 was more sluggish than the current period due mainly to the fact that “cash for clunkers” didn’t exist back then. However, PCEs for non-durable goods and services were a much bigger boost to GDP in 1975; food and beverages added 1.08 percent to GDP in the second quarter of 1975, and clothing and footwear spending added 0.56 compared to 0.21 and -0.02 in the current quarter.
Inventories actually subtracted 1.23 percent from GDP in the second quarter of 1975 but became a key component of growth as the recovery progressed. In the third quarter of 1975, the change in inventories added almost 3.1 percent to GDP. That’s close to half the 6.9 percent growth logged in that quarter. And in the first quarter of 1976, inventories added almost 4 percentage points to GDP growth.
The current recovery looks sluggish when compared to recoveries from prior recessions of this magnitude such as 1973-74. The main reason for the sluggishness is a less robust recovery for the consumer.
However, inventories have been critical to prior recoveries, particularly in their early stages. And the current inventory cycle could be particularly robust given the record pace of de-stocking witnessed in late 2008 and 2009.
Add in some artificial stimulus and you have the case for a modest recovery through 2010.