The final numbers on second quarter GDP were released today, and they show that the decline was only 0.7% — rather than a 1.0% decline as was reported in the second pass at the numbers and a 1.2% decline in the first stab at the numbers. This was a major positive surprise since the consensus of economists was for a return to the down 1.2% level.

The better picture compared to the previous estimate was broad-based, stemming from a smaller decrease in Non-Residential Fixed Investment (NRFI), less of a fall-off of exports, more government spending (both Federal and State & Local), less of a decline in inventories and less of a decline in Residential Investment (RI). These were offset by a smaller fall-off in imports and a lower-than-originally-estimated decline in Personal Consumption Expenditures (PCE).

The second quarter was dramatically better than the first quarter in almost every respect except that real PCE fell in the second quarter by 0.9% and actually rose by 0.6% in the first quarter (mostly due to an increase in transfer payments, including a large increase in Social Security checks due to very high headline inflation — remember $4 gasoline in 2008). Under normal circumstances, a 9.6% decline in NRFI would be horrifying and that is what happened in the second quarter, but it was a dramatic increase from the 39.2% decline in the first quarter.

NRFI has two parts. Investment in structures declined at a 17.3% annual rate in the second quarter vs. at a 43.6% rate in the first quarter. Investment in Equipment and Software (E&S) declined 4.9% rather than at the 36.4% rate in the first quarter. RI, which is mostly homebuilding, fell at a 23.3% rate, which while awful in any absolute sense is much better than the 38.2% rate of decline in the first quarter.

Overall trade contracted in the second quarter, but at a much slower pace than in the first quarter. Our exports declined at a 4.1% rate in the second quarter instead of the 29.9% rate they fell at in the first quarter.

Unlike falling exports, falling imports is a good thing for GDP growth. In the first quarter they were declining at a 36.9% rate, but that slowed to just a 14.7% rate of decline in the second quarter. Still, it is a very good thing that they are falling faster than our exports. Not as good as rising slower than our exports are rising (with the same differential), but still a good thing.

Falling inventories were still a problem for the economy in the second quarter, and the decline in inventory investment subtracted 1.42% from GDP growth. In other words, when you exclude the change in inventories to get real final sales, the economy actually grew by 0.7% in the second quarter. However, in the first quarter, inventory cuts resulted in a 2.36% subtraction to GDP, so the decline in real final sales was -4.1% in the first quarter.

If I had to choose any single component of GDP to be responsible for a decline of GDP, it would be change in inventories. Normally a big decline in one quarter results in a big bounce-back the next quarter. Clearly these are not normal times, and inventories have subtracted from GDP for three quarters in a row now, and in six of the last seven quarters.  At this point overall inventories have to be very lean, and poised to help with a rebound in GDP growth for the third quarter.

While the private economy showed much slower rates of decline in the second quarter than the first quarter, the only real source of growth to offset the declines came from the government. Federal spending increased at an 11.4% rate in the second quarter rather than declining at a 4.3% rate in the first quarter. Now keep in mind that this measure of spending does not include transfer payments including Social Security — those get sent out to individuals, and if they are spent, they are counted in PCE.

It was not all stimulus spending. Spending on Defense rose at a 14.0% rate rather than declining at a 5.1% rate as it did in the first quarter. Non-Defense spending rose at a 6.1% rate after a 2.5% decline in the first quarter. With the help of the stimulus bill, State and Local governments were able to expand their spending at a 3.9% rate rather than contracting at 1.5% like they did in the first quarter.

While most of this news will be considered ancient history by the markets — after all, we are talking about where the economy was in April through June — it is important to consider just what a huge improvement it was. The improvement is just short of miraculous. Yes, unemployment is still a huge problem and is still rising, but just consider where it would be if the economy had continued to contract at an over-6% rate like it did in the fourth quarter of last year and the first quarter of this year.

In all likelihood, the budget deficit would have been even higher than it is now. By substantially slowing the rate of decline in the economy, a large percentage of the stimulus spending has probably already paid for itself. It has also produced huge humanitarian benefits. There are over 3 million people who are getting extended unemployment benefits who otherwise would have no income at all. That is three million people (many more if you consider that many of those people have children) who would not even be able to shop at Goodwill, let alone Wal-Mart (WMT) or Kroger’s (KR).
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