Wednesday, January 30, 2008

U.S. Real GDP Growth Turns Negative

While the headline volume number for real GDP in the U.S. stayed above zero in the fourth quarter of 2007, the more relevant terms of trade adjusted real GDP fell below zero. Nominal GDP rose 3.2% and the domestic purchases price index rose 3.8%, implying that real GDP fell with 0.6% instead of the 0.6% increase implied by the volume number. This means that properly measured, the recession began during the fourth quarter, just as I predicted back in early December.

It gets even worse if you only look at the private sector. Government demand rose from 19.4% to 19.7% of GDP, the highest since the fourth quarter of 1992. Excluding government demand, GDP fell 1.1%.

The outlook for this year looks even worse, as the increase in consumer spending and business investments during the fourth quarter of 2007 were based on large reductions in financial savings and increases in debt. With corporate profits falling the increase in business investments is very much unsustainable, although yesterday's surprisingly strong durable goods orders report indicate that many business executives are still in denial about the state of the economy. Ultimately, the weakening corporate balance sheets and the weakening economic outlook will force them to cut back on investment spending, despite the Fed's agressive rate cuts.

A similar story is true for consumers, whose zero savings rate looks very unhealthy and unsustainable considering the decline in house prices and stock prices. It therefore seems safe to say that the economic contraction will continue during 2008, and probably at an ever faster pace.


Blogger Pete, your Tour Guide said...


You've hit it right on the head. Over the last few months, I've found bullish arguments based on recent - and limited - economic data to be specious at best. As a trader, my viewpoint of the markets is that they are moved by human psychology.

Exemplifying this are the 5 stages of grief (denial, anger, bargaining, depression, acceptance). I feel that, economically, we are still in the first stage. Consumers, businesses and the government all seem to be in denial about what's going on. The housing crash has eliminated the last ATM for consumers and, in an economy propped up by consumer borrowing and spending, this is huge.

Those who argue that because housing assets represent a small percentage of overall US asset values, the housing bust's effects will be negligible are missing the boat. The wealth effect cannot not be overstated. If it led to such huge excesses, it is reasonable to assume it will likewise lead to a huge bust.

Consumers are notoriously slow to change. Our society is one of constant binging. When the dotcom bubble burst, consumers simply turned to their houses as the next source of credit. Instead of addressing their root problems - spending more than they have - consumers have decided to continue to binge. We are addicts and only a strong, painful detox has any hope of breaking that addiction. I've heard countless stories of people in debt who continue to take on more debt, simply for the purposes of having more stuff. This is simply folly. We are only at the beginning.

As for businesses, I do not believe many businesspeople are good judges of economic health. They may be able to judge the health of their industries, but, by and large, I do not feel that most business owners and executives have a broad understanding of the economy. Moreover, most of those who appear on the media have it in their best interests to spin as positively as possible.

And, finally, the government. If we're relying on the government to get us out of this mess, than we're really in trouble. That's akin to a drug addict asking his dealer to send him to rehab. Given that the Fed's unofficial mandate seems to be propping up asset prices at all possible costs, it is not reasonable to expect that Bernanke and Co. will suddenly begin making the tough decisions to address real systemic problems.

Doing so would require political will that is rarely present in American politics and which is invisible during election years. Instead, the various government agencies will continue to talk about stimulus while ignoring the reality that one cannot borrow and spend forever.

Please continue with your terrific insights. Many of your comments remind me of Jim Rogers and Marc Faber. And that is a good thing.

8:56 PM  

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