Sunday, December 02, 2007

Why the U.S. Recession is Already Here

This week, we were overwhelmed with statistics, including the Chicago PMI, the Beige book, durable goods orders, corporate profits, new and existing home sales, construction spending, consumer confidence, personal income and spending and jobless claims. And with the exception of the Chicago PMI who historically have often moved in a erratic way, all of these indicators indicated that the U.S. is already in a recession with negative growth. At least properly measured on a terms of trade adjusted basis, but probably also in the standard volume terms.

Just consider the various components of GDP:

-Residential investments: News on housing indicated that the downturn in the housing sector continues. Residential construction spending had another sharp downturn in October. The very low numbers of new and existing home sales indicate that this downturn is likely to continue in November and December. This means another big negative number in residential investments.

-Business investments: The input for equipment and software investments, shipments of non-defense non-aircraft durable goods orders fell in October. Although that followed two monthly advances, shipments should continue to fall in November and December given the much sharper declines in orders and the weaker gain in the previous two months.

Nonresidential construction spending also fell in October. While that too followed two monthly advances there are signs that the commercial real estate is heading down.

Meanwhile, the latest report on corporate profits indicates that corporate profits continue to fall even in nominal terms both in the nonfinancial and financial sectors. And these national accounts numbers do not even include writedowns. Nonfinancial corporate profits adjusted for capital consumption are down more than 8% in nominal terms in the latest year. Much more of course in real terms. Combine that with increased pessimism, it is difficult to see that business investments -both equipment and software and nonresidential construction or "structures"- could go anyway but down from here, something which will probably be reflected already in the November and December numbers.

-Personal Consumption Expenditures: Personal consumption expenditures fell marginally (0.035%) in October. That is still higher than 3 months earlier, but considering the likely much bigger decline in November it seems safe to say that once the August increase is removed from the base, the 3 month change will turn negative. And likely turn even more negative in December.

The sharp increase in energy and food prices likely means a relatively big decline in both real income and real spending. And with real income and house prices down, and with stock prices likely falling too and with the savings rate very low, consumption will likely continue to fall. The weakness in consumer confidence also makes falling consumption likely. This means that this quarter is likely to be the first since 1991 when real consumption falls.

But what about inventories, net exports and government demand? The outlook for inventory buildup seem uncertain and have historically often risen at the beginning of a recession, but the upside from this seem highly limited given the fact that inventories already went up so much in the third quarter. For inventories to give a positive contribution to GDP it is not enough for them to rise, they must rise faster than in the previous quarter.

The trade deficit declined in the third quarter, and given the weak dollar and the weak economy, the nonpetroleum deficit seems likely to continue to decline, which could give a boost to net exports in volume terms. However, the overall deficit is likely to be more stable as the higher oil price raises the deficit in petroleum. That means that in terms of trade adjusted terms, net exports will contribute only little or nothing at all to growth.

Government demand is very uncertain, but will probably rise to a new post-1993 high as a share of total GDP. However, as demand already rose so much in the third quarter and as state budgets are increasingly weak and as the price deflator for government demand usually rise faster than the GDP price deflator, this will mainly happen because of the weakness in the rest of the economy, rather than through it increasing particularly fast. The contribution to GDP should therefore be small.

Put it all together and it seems almost certain that GDP will fall in terms of trade adjusted terms as the large decline in residential investments and the declines in business investments and personal consumption will certainly outweigh the low and uncertain contributions from trade, inventories and government. In volume terms, the positive contribution from trade will be a lot bigger, so it is less certain that growth will be negative in volume terms. But it nevertheless seem more likely than not.


Blogger Jeff said...

Just came across your blog. Very well written summary of where the US is.

Would be interested in hearing where you think things will be in a year. Obviously imbalances exist in the housing sector and as those are corrected resources will be deployed elsewhere.

Government actions, reduced interest rates, consumer spending and capital investments, exports. All are obviously impacted.

My guess is that we will finally begin to see a reduced trade imbalances despite high oil prices. Government deficits will certainly increase via tax cuts which will help consumer's balance sheets.

The U.S. will finally begin to move away from all this silly investment in housing infrastructure; have to say I am excited about the potential!

Where do you think we will be in a year or two???

7:44 PM  

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