Thursday, December 01, 2005

Fourth Quarter U.S. Production Growth To Slow-But Income Growth Strengthen

I discussed the "advance" estimate of third quarter GDP about a month ago. In it I highlighted the paradox that it showed strong GDP growth-but falling real income and falling NDP (Net Domestic Product). The reason for this was that Katrina sharply increased the level of capital consumption, and capital consumption is deducted from Net Domestic Product and National Income (and Household Disposable Income to the extent it effects property owned by them)-but not from Gross Domestic Product.

The first revision have only increased this paradox with GDP being revised up (A large upward revision of domestic demand owerwhelming the higher than expected trade deficit) while household disposable income have been revised down.

As the basic analysis of the third quarter I made a month ago still stands, despite the revisions in some details I am not going to comment this issue further.

Instead I am going to turn to the issue of the outlook for the third quarter. This is likely to be a partial reversal of roles with production growth likely to slow sharply even as income growth turns positive.

The main reason why production growth is likely to slow sharply is because private consumption is likely to show barely any growth at all. Indeed, it is set to fall unless we see really strong growth in November and December. As we can see in today's report on personal income and spending, third quarter consumption growth was based almost entirely on the temporary surge of car sales in June and July due to the discounts from GM and Ford. Both August and September by contrast saw significant monthly declines in real consumption. And this means that despite the marginal 0.1% monthly increase in October, October spending was in real terms 1.2% lower than in July. Because of this, we'd have to see 0.5% real monthly gains to even have a unchanged quarterly number-and that is highly unlikely given the negative savings rate.

But while personal consumpton is likely to fall, this doesn't mean that overall GDP will fall. Business investments will likely continue to expand strongly, residential investments will likely continue to expand albeit at a slower rate and government spending will likely continue to soar. Moreover, inventories will also likely give a positive contribution. More uncertain is the outlook for the trade gap, but even though the monthly deficit will likely fall from the September peak, the fourth quarter deficit will probably still be greater than the third quarter gap and that will lower GDP growth. All in all, we are likely to see a significant sowdown in growth, certainly well below 3%, but likely still well above zero.

Because capital consumption will fall from the third quarter peak caused by Katrina (althoug it will certainly be higher than in the second quarter), income growth will likely rebound and be higher than the likely low production growth.


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