The level of retrenchment was not unexpected and only
slightly less bad than the -6.3% in the fourth quarter of
2008. The surprise was that the contributors of that decline
defy conventional wisdom. Let me try to summarize the
conventional wisdom on this recession.
The American consumer’s debt-funded spending spree came to
an end in early 2008, coinciding with the burst of an
overheated housing market to bring down a shaky (and
shadowy) banking system. The collapse of all securitized
and/or short lending culminated in mid September of 2008
with the failure of Lehman Brothers and the government
takeover of AIG. At this point, Wall Street’s problems
became the problems of the real economy, leading to:
- An abrupt halt in international trade and global business investment
- A sizable decline in consumer spending
- A need for government stimulus spending to fill the demand gap left by consumers
The peculiarity in the GDP data is that only item number 1 was validated. The Bureau of Economic Analysis also releases detailed data that breaks down that -6.1% figure. It determines which segment of the economy contributed to (or partially offset) the decline. The four high level segments are business investment, foreign trade, personal consumption, and government spending. As expected business investment extended its staggering decline that began in fourth quarter. The U.S. runs a large deficit in international trade. All things being equal, a reduction in overall trade is positive for GDP growth. It was consumer and government spending that showed counterintuitive results.
Business Investment is still in freefall. The category “Gross private domestic investment” captures the dynamics of companies making investments in property, plants, and equipment. It is also highly influenced by what companies do with their inventories. In addition to putting most major expansion initiatives on hold, U.S. businesses reduced their inventories to the tune of $100 billion collectively. This was in reaction to the consumer spending reduction in the second half of last year and the complete collapse in confidence from October ’08 through March ’09. These ugly numbers are mirrored in industrial economies around the world, most noticeably Japan. The only positive thing to say here is that the inventory correction has been so large (considerably bigger than the consumer pullback) and so abrupt that it a recovery in this sector is likely to be swift when it comes.
The Trade Decline
Adds to GDP. Foreign trade is captured in the
category “Net exports of goods and services” which has been
slowing for a few quarters now. As is well known, the U.S.
runs a sizable trade surplus in services but runs a much
larger deficit in goods with the rest of the world. As it
grows, this deficit subtracts from GDP in the growth
calculation. In recent years this category might be better
labeled Net Imports. Now, as this
trade gap narrows and the deficit shrinks, its drag on the
GDP numbers reverses and contributes favorably to quarterly
GDP growth calculations.
Presently imports to the U.S. are declining at a faster rate
than exports as the American consumer has adjusted to a new,
lower level of spending. It is likely that this trend will
remain favorable to U.S. GDP growth for a number of quarters
to come.
The Consumer
Spending Showed Stability in Q1. For the
American consumer, the recession began long before the
problems of AIG and Lehman became headline news. The end
of the housing bubble and a weak stock market caused the
growth rate fell below 1% at the end of 2008 was weak
for the first half of 2008. It likely would have been
negative had it not been for the first round of
government stimulus in the spring of 2008. As that one
time burst of cash ran out, consumers were forced to
confront personal debt once and for all. Against this
backdrop, the surprise was not the consumer retrenchment
in 3Q’08 and 4Q’08 but rather why did it not continue
into the first quarter of the year. The more direct
monthly consumer spending data showed increases in
January and February of this year but showed a moderate
pullback in March.
Barring stimulus affects, it is likely that the consumer
will be more a drag on than a boost to future numbers
given heavy indebtedness and falling house prices. Going
forward, though, it will be hard to tell how much is the
result of a natural healing in the economy and how much
is the result of stimulus efforts. Since the government
stimulus efforts did not start hitting the accounts of
the American consumer until last month (April ’09), it
is clear that last quarter’s results were unaltered by
stimulus.
Where Did
Government Spending Go? In height of the
economic panic last fall most economists (from the left
and the right) seemed to be arguing for a strong role
for the government. Commentators were quick to quip, “We are
all Keynesians now!” a reference to the late John
Maynard Keynes that argued for government to step in to
fill a demand gap left by the private sector in a deep
recession. Yet in the most recent quarter, government
spending contracted rather than expanded. Much of the
government stimulus money given to banks never ended up
in the private sector but rather parked back at the
Federal Reserve to boost their capital reserves and help
them pass stress tests.
State and local governments were forced to quickly
reduce spending as tax receipts dropped late last year,
making this decline somewhat logical. Yet the
state/local drop in spending (-3.9%) was edged out by
the Federal government’s reduction (-4.0%), mostly in
the area of reduced spending on national defense. While
this is strange for now, it is nearly impossible for
this to be a trend. Treasury is frantically issuing new
bonds to support deficit spending. Sooner or later that
money will pour into the economy.
One Caution:
Last weeks’ GDP growth number was the first of three
readings (known as the “advance” reading) to be followed
by the “preliminary” and “final”. The revisions for the
previous period (4Q’08) turned out to be substantial so
changes this time are likely. The advance reading came
in at -3.8% only to be eventually revised at the final
to -6.3%. Business investment and net exports segments
experienced the greatest changes. One would think the
figures on government spending are better than that of
the private sector, though.
If the Consumer
Can Stabilize Without the Help of the Federal Dollars,
it is Prudent to Be Wary of Inflation. Last week
yields on 10-year treasuries moved above 3% for the
first time since the middle of March. We have two
government organizations, the Treasury and the Fed,
spending furiously to prevent deflation. I worry much
less about Fed spending (which tends to be temporary)
and more about Treasury programs. It is hard to tell
when, but it is likely that in the next 12 to 24 months
the Fed will move from deflation-fighting to
inflation-fighting. At that point, it will need to start to
dump the Treasury bonds that it is presently
buying. This will drive up interest rates just as the
federal government is trying to fund high-speed rail,
green energy and other stimulus projects.
Investors can seek inflation protection in ETFs of gold
(GLD),
commodities (RJI),
or in inverse treasury (PST). All
have their draw backs. Gold moves more with the whims of
the central banks and markets, with underlying
fundamentals harder to judge than oil. Even noted
commodities bull, Jim Rogers, recently expressed near
term caution on investing in gold due to the likelihood
of the Internal Monetary Fund unloading much of its
reserve.
With oil and other commodities, I fear that so many have
already piled into them already that their prices are
artificially high. U.S. Crude oil inventories are at
multi-decade highs with demand yet to bottom. This could
lead to another drop down before the cycle fully bottoms
out. I, for one, am waiting. Lastly, inverse and
leveraged ETFs like PST are notoriously inefficient over
the long term as they slowly drain your capital based on
daily volatility. Going long the S&P500 (SPY)
is a less spectacular position but it does allow you to
capture the upside as the business investment correction
runs its course.
Disclosure: No positions in the ETFs discussed
but generally long the U.S. and other markets in
individual stocks.
Blog
U.S. GDP: Consumers Are Spending but the Government Is Not
I wouldn’t normally write about the mundane topic of last week’s GDP figures if it were so, well, peculiar. The headline figure had the U.S. economy contracting at an annualized rate of 6.1% during the first quarter of 2009. This is one way to measure economic growth. The alternative way of viewing GDP, the year over year decline, revealed a more subdued -2.6% growth from 1Q’08 to 1Q’09. By either measure, the country has not seen such large sequential declines in 50 years.
