Why U.S. GDP Will Decline in Q4

Includes: CYB, FXE, UDN, UUP
by: Howard Richman

The news on trade, housing starts, and exchange rates show that US GDP will likely decline during the fourth quarter. Let me explain:

  • Trade. The widely reported statistic that real GDP rose by 3.5% during the fourth quarter was obtained by multiplying the actual increase of 0.87% by four (by assuming that the same rate of increase would continue for the next four quarters). And that was before the September trade deficit data came in much worse than expected. It will be revised downward when the final estimates are reported.
  • Housing Starts. During the third quarter, first time home buyers moved forward purchases planned for future quarters because they thought that the tax subsidies for first time home buyers would expire. The 0.87% increase in GDP during the third quarter was led by a 5.4% rise in fixed investment in residential structures. But housing starts declined by an "unexpected" 10.8% from September to October. As a result, there will be a decrease in fixed investment in residential structures during the fourth quarter.
  • Exchange Rates. There is no prospect for further exchange rate fall for the dollar. The dollar-euro exchange rate has stabilized at below $1.50 per euro. The dollar-yen exchange rate has stabilized at above 88 yen per dollar. President Obama just came back from an Asian trip during which he failed to persuade Chinese leaders to stop pegging the dollar-yuan exchange rate. Nonresidential fixed investment in the American economy fell by 0.64% during the third quarter. It has now fallen for five straight quarters and is likely to fall during the fourth quarter of 2009.

The key underlying problem in the American economy has not yet been fixed. Non-residential fixed investment in our economy has been steadily declining ever since China resumed pegging the dollar-yuan exchange rate in the second quarter of 2008.

Fixed investment is not only the key to GDP growth, it is also the key to long-run growth. In the short-run fixed investment is purchases of equipment and new factories. In the long-run the new equipment and factories make American workers more productive. Until fixed non-residential investment turns around, the American economy will likely stagnate, at best.

So long as we let China manipulate trade balances so that they get manufacturing investment while we do not, the long-term decline in non-residential fixed investment will result in economic stagnation. The supposed 3.5% third quarter GDP growth (actually 0.87%) will turn out to be a temporary upward blip in the long-term stagnation of the American economy.

Disclosure: I own Chinese yuan through CYB.

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