The GDP Deflator Actually Deflates

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After a brief bout of enthusiasm Friday morning, when GDP came in at -3.8% vs estimates of -5.5%, investors quickly realized that the majority of the "beat" came because of an inventory adjustment. Inventories grew $6 bil vs. a decline of $28 bil last quarter. That artificially "lifted" GDP by 1.2%. In essence, companies were stuck with more inventories than the end market demanded. In a quirk of GDP reporting, this inventory build gets counted as growth.

Not as widely discussed were the import/export component of GDP. Net exports added to the GDP calculation, which is good. However, that's only because imports fell even more drastically than exports fell. And that's not particularly good for world growth. Demand all over the world is falling off a cliff. Therefore, statistically, Q4 may NOT be the low for the economy, as some are hoping.

However, that's not the most alarming and significant part of the GDP report. The headline numbers that are reported are typically "Real" GDP numbers, which are adjusted for inflation. Normally, inflation reduces "Nominal" GDP (GDP not including the inflation adjustment), yielding a lower Real GDP number. This adjustment is known as the GDP Deflator. However, nominal GDP declined significantly for the first time since 1960 and at a larger rate since 1958. In fact, this report was the first since 1952 when deflation actually added to the "real" GDP number. In other words, this is the first time the GDP Deflator has actually deflated in 60 years. This is deflation showing up in official government statistics for the first time.

GDP Deflator 013009

Source: Bloomberg

It's no wonder that companies can't cut expenses fast enough. Corporate profits are shrinking even if management does a great job on costs because sales are falling even faster.

Deflation is taking a wicked hold of the United States economy. So even though the Treasury is pumping money into the system like mad, they aren't pumping fast enough.

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