Not all components of GDP are created equal. Some are very big, and others relatively small. Some tend to be very stable over time, and some tend to swing violently from quarter to quarter. The bigger and more volatile they are, the more they will impact the overall growth rate of GDP.
Thus looking at just the percentage changes in the components does not tell the full story. Of the 3.5% total growth, how many points were added or subtracted by each part of the economy?
The biggest part of the economy is the Consumer, or PCE — overall it contributed 2.36 of the 3.50 points of total growth. In the second quarter it caused 0.62 of the 0.70 total decline in the 2Q. In the first quarter it actually offset 0.44 points of the 6.40 total decline. In other words, excluding the Consumer the economy would have contracted 6.84% rather than 6.40%.
Within Consumer spending, spending on Goods added 1.79 points after subtracting 0.71 points in the 2Q and adding 0.56 points in the 1Q. Spending on Durables was the main driver, adding 1.47 points after subtracting 0.41 points in the 2Q and adding 0.28 in the 1Q. Non-Durable goods added 0.31 points after subtracting 0.29 in the 2Q and adding 0.29 in the 1Q.
While spending on Services is much more stable than spending on Goods, it is also a much larger portion of the Consumer wallet. Service spending added 0.57 points to the overall GDP growth in the 2Q — up from adding 0.09 points in the 2Q and subtracting 0.13 in the 1Q.
It is the volatility that gives Durable goods their importance to the economy, not the overall size. In the third quarter, total spending on Durable goods was at a $1.055 Trillion annual rate, just 15.4% of the $6.852 Trillion spent on Services, but Durable goods had an impact on economic growth that was 158% bigger.
Investment spending was a big swing factor in the 3Q. It added 1.22 points to overall growth. That is a HUGE improvement over the 3.10 point subtraction in the 2Q and the 8.98 point implosion in the 1Q. Unfortunately, 0.94 points of that contribution came from Inventories.
Inventory investment is the “worst” type of GDP growth, since large increases in one quarter are usually reversed in the next quarter — or in this case, large declines being reversed upwards. In the 2Q, Inventory investment subtracted 1.42 points from overall growth and in the 1Q it subtracted 2.36 points. Even in the 4Q, it subtracted 0.64 points from growth. Three straight quarters of sharply lower inventories is highly unusual, and we were due for a bounce. Perhaps we have one more quarter of a solid contribution from Inventory investment, but I would not expect it to last much beyond that.
Overall Fixed investment added just 0.28 points to growth, but that sure was a nice improvement over the 1.68 point subtraction and the 6.62 point disaster that was the 1Q. However, it was not coming from the business side. Business investment subtracted 0.24 growth points in the 3Q, so it is still very soft, but at least it is not imploding like it was earlier in the year. In the 2Q it subtracted 1.01 points and in the 1Q it took away 5.29 growth points.
Within business investment it was spending on structures that caused the problem, with a deduction of 0.32 growth points while spending on E&S offset 0.08 points of that. In the 2Q, both sides of business investment were drags on the economy with investment in Commercial real estate subtracting 0.69 growth points, and spending on equipment deducting 0.32 points. The 2Q was in turn a major improvement over the 1Q disaster, where spending on structures subtracted 2.28 growth points and equipment spending subtracted 3.01 points.
Housing finally helped the economy in the 3Q, adding 0.53 points to growth — after a string of 15 straight quarters where it was a drag on the economy. In the 2Q it was a 0.67-point drag and in the 1Q it was a 1.33-point drag.
The long decline has, however, made housing a much smaller share of the overall economy. In the 3Q, residential investment totaled only $360.9 billion, or 2.52% of the overall economy. At the peak of the housing bubble, it represented 6.34% of the overall economy. Thus the 23.4% increase in residential investment had far less of an overall impact than it did in the past.
While residential investment is still near a record low share of the overall economy, I have serious questions about the sustainability of the increase. The extension and expansion of the the tax credit by Congress might keep things going for the next few quarters, but after that things are likely to fall apart again. Just like we saw with the “Cash for Clunkers” (C4C) program, it is probably just encouraging those folks who might have bought later to buy now.
It is also tricking people into thinking that a house is more affordable that it really is — just the way that teaser-rate ARM’s did, and we saw just how well that worked out. The FHA is handing out mortgages with only 3.5% down, and people can use the tax credit for that ridiculously small down payment. This has future disaster of biblical proportions written all over it. The next bailouts will not be of the banks like Bank of America (BAC) and Citigroup (C) but of the FDIC and the FHA.
Direct Government spending had a small but positive impact on overall growth in the 3Q, adding 0.48 points — a fairly significant slowdown from the 1.33 contribution in the 2Q, but better than the 0.52 point drag in the 1Q. All the help came from Washington, not City Hall or the Statehouse.
The Federal government added 0.62 growth points, down from 0.85 points in the 2Q but up from a 0.33 point drag in the 1Q. The Pentagon was the main factor in all three quarters, with Defense spending adding 0.45 points in the 3Q following a 0.70 addition in the 2Q and a 0.27 point drag in the 1Q. Non-Defense spending was sort of a non-issue, adding just 0.17 points in the 3Q, not much difference from the 0.15-point contribution in the 2Q, and up a little bit from the slight 0.06 point drag in the 1Q.
State and Local governments are not allowed to run operating deficits, and so when faced with declining tax revenues they have to cut back, unless Uncle Sam helps them out. Well, Washington is helping, but it’s not enough, and S&L spending was a 0.14 point drag in the 3Q. The Federal help was enough in the 2Q and so the contribution to growth in the 2Q was a positive 0.48 points. In the 1Q, before the stimulus package could get much traction, S&L spending was a 0.19 point drag.
Net exports had been just about the only bright spot in the first half of the year — even though it came the wrong way, from both imports and exports plunging, only with imports falling more than exports did. That reversed in the 3Q, as both showed a nice expansion, but our appetite for foreign goods is outstripping the desire for U.S. goods and services abroad.
The increase in exports added 1.49 points to growth, but the increase in imports was a 2.01 point drag, for a net negative contribution from net exports of 0.52 points. In the 2Q, falling exports subtracted 0.45 points, but plunging imports added 2.09 points, for a net imports net help to the economy of 1.64 points.
In the first quarter, as world trade came to a near-standstill, net exports were just about the only positive you could find for the economy. Yes, plunging exports subtracted an awful 3.95 points of growth, but the fact that we were buying practically nothing from overseas added 6.58 growth points, for a net aid to the economy of 2.85 points. In other words, if the U.S. were a closed economy in the first quarter, growth would have fallen not at a 6.4% rate, but at a 9.25% rate.
Overall
Overall this is a very welcome report. It confirms that the recession is over and that we are on the right track. However, I am not thrilled about the overall composition of the growth. Over time we need to see the consumer become a much smaller part of the overall economy, and real business investment become a much bigger share.
Unfortunately, we seem to be headed in the wrong direction, with the growth in consumer spending nearly keeping up with the overall growth of the economy. This is especially true if you consider Residential Investment as primarily part of Consumption. We need net exports to play a bigger and more positive role in the economy, and ideally have that happen through exports growing faster than imports, not from a plunge in imports like we saw in the first half of the year.
Seeing net exports turn into a drag again is disappointing. A big part of that, however, is due to oil imports, and the increase in the price of oil. That is a long-term structural problem that needs to be addressed. Fortunately, the opening-up of the shale gas plays gives us a chance to finally do something about it, but I’m not sure how fast that will occur. That, along with more efficiency and alternative energy sources, can make a dent over time, but not overnight.
But it is a fertile place to see an increase in Investment spending, so it could have a double-barreled effect — on both the investment line and on the net exports line. The contribution from inventories is not sustainable long-term, but given how much they fell prior to this rebound, we might see a bit more of it in the 4Q, though not much beyond that.
The increase in Consumption spending was largely due to the C4C program, which is now over, so don’t look for a big contribution from Durable goods spending in the fourth quarter.
All in all, a better-than-expected report, but don’t be deluded into thinking that we are out of the woods and the coast is clear. We still face major challenges, and getting complacent here would be a big mistake.
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