The percentage changes I talked about in my previous blog do not paint the total story of the second quarter, since not all segments of the economy are of equal size, and a 5% decline in a big segment can be more damaging than a 20% decline in a small segment. It is thus useful to look at how each part of GDP contributed or detracted from the overall 0.7 point decline rate.

The analysis will follow the basic macro economic formula that says that GDP is equal to the sum of Consumption (or Consumer) spending plus Investment spending plus Government spending plus Exports minus Imports, or Y = C + I + G + (X – M). Memorize this — it will be on the test.

Starting with the biggest part all, Personal Consumption Expenditures (PCE), or “C,” it subtracted 0.62 points of growth. In other words, if the consumer were excluded, GDP growth would have been nearly flat in the second quarter. In the first quarter, PCE actually added (offset) 0.44 growth points. In the fourth quarter it contributed 0.62 points to the decline.

However, by falling slightly less than the overall economy in the second quarter, and actually going up in the first quarter, PCE has actually increased its share of the overall economy in this downturn.  This is a very bad thing, long-term.

The U.S. is far too dependent on consumption for its GDP. In the second quarter, PCE was 71.2% of the economy. For all of 2008 it was 69.8%, and the post WWII average is 64.5%. Our high and rising share of consumption in our economy is one of the most critical fundamental imbalances in the overall world economy.

By way of comparison, in China PCE is only 35% of the economy. Clearly that is way too low, just as ours is way too high. On the other hand, which economy has been doing better over the last five or six years? China is in the position to substantially increase its GDP growth rate by increasing Consumption’s share. We are going to be facing gale-force headwinds as we bring our share of Consumption down. This isn’t a problem that has developed over the last few months — it has literally been decades in the making.

Turning next to Investment, or “I,” real gross private domestic investment subtracted 3.10 points from growth in the second quarter after subtracting 8.98 points in the fist quarter and 3.91 points in the fourth quarter of 2008. There are several subcomponents to overall investment, and Investment tends to be the most volatile part of the economy. It is this volatility, rather than its overall size, that makes changes in Investment so important to the overall economy.

Real Non-Residential Fixed Investment (NRFI) is business investment in hopefully productive assets (other than inventory). It subtracted 1.01 points in the second quarter following a horrific 5.29 point subtraction in the first quarter and a 2.47 point decline in the fourth quarter.

NRFI has two major parts: investment in structures (office buildings, factory buildings, stores, etc.) and investment in equipment and software (machines, computers, trucks, etc.). Structures contributed 0.69 points to the overall 0.7% decline in the second quarter, after being responsible for 2.28 points of decline in the fist quarter and 0.31 points in the fourth quarter. E&S spending subtracted 0.32 points from growth in the second quarter after sucking out 3.01 points in the first quarter and 2.15 points in the fourth quarter.

Business spending is not the only part of fixed investment — there is also Residential Investment (RI), which has been a consistent drag on GDP growth for 14 straight quarters now. In the second quarter it subtracted 0.67 points after subtractions of 1.33 points and 0.81 points in the first and fourth quarters, respectively. RI is now down to a record low 2.67% of the economy.  While we really don’t need a lot of new houses right now, it seems unlikely that it will shrink much further as a share of the overall economy.

Changes in inventories (a.k.a. non-fixed investment) subtracted 1.42 points following subtractions of 2.36 points and 0.64 points in the first and fourth quarters, respectively. We will probably see a snap back in inventory investment soon, and that should significantly boost GDP growth — but that improvement could be relatively short-lived.

Moving next to Government spending, or “G,” it added 1.33 points to growth in the second quarter after subtracting 0.52 points in the first quarter and adding 0.24 points in the fourth quarter. Federal spending contributed most of that, adding 0.85 points after a subtraction of 0.33 points in the first quarter and a addition of 0.49 at the end of last year. However, most of the swings came from changes in Defense spending, which was responsible for 0.70 points of the 0.85 overall for Federal spending. It subtracted 0.27 points in the first quarter and added 0.20 points in the fourth.

Swings in Non-Defense Federal spending have actually be fairly tame, adding 0.15 points in the latest quarter, subtracting 0.06 points in the first and adding 0.29 points in the fourth quarter. State and Local spending added 0.48 points after subtractions of 0.19 points and 0.25 points in the first and fourth quarters, respectively.

Finally net exports, or at least the change in them, have really been helping to keep this economy afloat. This has happened because our imports have plunged much faster than our exports have. Falling imports boost GDP growth, falling exports cut it. Thus the decline in our exports sliced 0.45 points off of growth in the second quarter after subtracting 3.95 points in the first quarter and 2.67 points in the fourth quarter.

If that was all that had happened, we would have been in pretty sorry shape (or much sorrier than we are now). However, as world trade shut down, our imports really plunged (much of it due to lower oil prices). Falling exports added 2.09 points to growth in the second quarter, following additions of 6.58 points in the first quarter and 3.12 points in the fourth quarter. As a result, net exports (X-M) resulted in a net benefits of 1.64, 2.63 and 0.45 points in the second, first and fourth quarters, respectively.

This is extremely good news. We need to move the economy more in the direction of better net exports, ideally actually exporting more than we import (we can dream, can’t we?). However, our level of imports is largely a function of the price of oil.

Remember that C + I + G + (X-M) has to add up to 100% of GDP. If C has to fall as a share, then one or more of the other parts has to increase to take its place. Investment has fallen to dangerously low levels of the economy. Gross private domestic investment was just 11.3% of the economy in the second quarter, by far a record low since the end of WWII. That is probably unsustainably low and we should see a rebound in it (it always tends to fall in recessions), but if consumers are going to be cutting back, there will not be that much of an incentive for businesses to go out an build new stores or office buildings, or buy new machines or trucks.

Residential Investment will probably come back a bit from its current low levels, but we have a surplus of housing not a shortage, so I fail to see how in the long-term a substantial increase in RI would be a good thing. It would be absurd to see it go back up to the bubble level days of more than 6% of the economy.

That leaves either a substantial further improvement in net exports, or an increase in Government as a share of the economy. Those who rail about too much government spending do not understand this very basic fact about economics.Zacks Investment Research