Thursday, May 25, 2006

Mixed News From U.S. GDP Revision

The revised number for U.S. GDP growth for the first quarter came in at an annualized 5.3% versus the fourth quarter of 2005 and 3.6% versus the first quarter of 2005. This was higher than the 4.8% annualized quarterly rate initially reported, but a lot lower than the average market forecast of 5.8% (with some analysts predicting a number of over 6%).

The reason why the number came in lower than predicted was that some of the boost from a downwardly revised trade deficit and upwardly revised inventories was cancelled out by lower consumer spending and business investments.

Looking past the headline number, the details offered both positive and negative news for the U.S. economy.

The big positive was that corporate profits continued to power ahead, with after-tax profits (adjusted for capital consumption) rising 8.8% (which to make the number comparable to the GDP numbers is 40.1% at an annual rate)in nominal terms compared to the previous quarter and 24.8% compared to the first quarter of 2005. At $1155.1 billion, net corporate profits are now over 10% of national income for the first time ever. By comparison corporate profits were 8.3% of national income in 2003, 8.6% in 2004 and 8.9% in 2005. At the previous cyclical peak in 1997, corporate profits were only 8.5% of national income.

This is certainly very bullish for the prospects for business investments, which is indeed booming. However, while corporate profits are one important factor determining business investments, there are other factors involved too. Interest rates is another important factor and that factor is currently working in the other direction. And the sluggish stock market indicates that there is increasing worry that the current high profit levels won't last. Still, the short-term outlook for business investments is nevertheless positive as the record high profitability levels combined with rising capacity utilization outweighs the higher but still fairly low interest rates and the increasing but still not high level of pessimism about the future profit outlook.

There could however be negative political implications from the shift in the distibution of income from workers to the owners of capital that these statistics again confirm. The falling ratings for Bush in terms of handling the economy despite strong growth largely reflects the increasing income inequality that this implies and this could lead the way to large Democratic gains in November's congressional election and in 2008, something which in turn could lead the way for big tax increases, protectionism and increased regulations.

The big negative in the report is that the household savings rate fell sharply, to -1.3% as personal income was sharply downwardly revised. Apart from the low reached during the third quarter of 2005 due to Katrina-related costs, this was the lowest since the Great Depression. This, combined with higher interest rates and higher prices of oil and other commodities does not bode well for consumer spending, which will likely slow sharply again in the second quarter. Although the savings rate is arguably underestimated due to the fact that it does not include individual's stake in retained corporate earnings, it is still ominously low even taking that into account.


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