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Q4 GDP: Consumer Bacchanal

Jan. 28, 2011 1:04 PM ET
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The Commerce Department reported that the economy grew at a 3.2% real annual rate in the final quarter of 2010, which was below the 3.5% expected.   The figure withstood a huge drag from the inventory segment (I can’t say the inventory cycle is dead due to the near-record low inventory/sales ratio, but it certainly shows businesses remain extremely cautious) thanks to the huge degree of consumer spending – which had been telegraphed by the strong holiday-shopping  and car sales. 


For the year, GDP rose a real (inflation-adjusted) 2.8%, which is exceptionally below what it should be coming off of the worst contraction in the postwar era.  (Economic growth should have run above a 7% rate at this point in a recovery from deep contraction, using history as a guide.)   Nevertheless, we can now technically call this recovery an expansion as real GDP has finally eclipsed the peak hit in 2007.  It’s by a scant 0.1%, but technically we are talking expansion now.



So to the specifics:


Personal consumption, the largest segment of GDP, surged 4.4% as holiday shopping and auto financing was strong -- accounting for 95% of the quarter’s economic growth, which is so unsustainable it’s laughable; I’ll touch on this a bit more below. 


Net exports contributed a large 3.40 percentage points as import activity slid 13.6%, while exports rose 8.5% -- this was the first time net exports contributed in a year. 


Of course, when you get such a huge decline in imports you know what’s going to occur on the inventory front.  Inventories subtracted 3.70 percentage points from GDP, which follows six quarters in which the segment accounted for at least 50% of GDP growth. 


Fixed investment added 0.50 percentage point as commercial and residential building was essentially flat, while nonresidential investment (machinery) added 0.43 percentage point.  Business spending on equipment and software added 0.41 percentage point.  The segment rose 5.8% at an annual rate during the quarter, which is quite the slowdown after averaging 18.8% over the preceding four quarters – a topic we touched on in Friday’s letter.


Government spending subtracted 0.11 percentage point, which was only the second subtraction in 15 quarters.  The figure was dragged down by state & local government spending.  Federal spending has been offsetting the decline in state & local spending for a couple of years now, but the Washington’s ability to do so was of course temporary. 


Bottom line:


Fourth-quarter GDP was completely driven by personal consumption as the growth in business spending tailed off and inventories weighed heavily. 


A segment of GDP that we’ve talked about each quarter during this recovery exploded to the upside – real final sales.  This number is essentially the proxy for final demand as it is GDP minus inventories.  As we’ve been explaining, this figure had averaged just 1.1% at a real annual rate during this recovery (a number that should be growing at 4%-plus for this point in the cycle).  During the fourth-quarter, however, real final sales jumped to 7.1% -- a reading that has been hit only 4% of the time over the past 30 years. 


So the figure went from trending well below the average to jumping to a level that is rarely seen, and all while the jobless rate remains at heights rarely seen, the housing market I think is safe to say is in shambles and organic income growth is tepid.   Spending has clearly been goosed by a rising stock market (the affluent consumer accounts for close to 50% of spending), a record level of government transfer payments and to some extent defaulters able to live in their homes payment-free for 16 months on average.  The aforementioned realities do not suggest that GDP can depend on the consumer for 2011.  The next several quarters must see inventory rebuilding and business spending return to drive growth.   

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