Bearish U.S. GDP Revisions

The stock market futures rose after a supposedly good GDP report. Yet anyone who says this revision was bullish is one who hasn't really read it at all. At least not at any detailed level. With the exception of the small downward revision of inflation, virtually every revision is bearish. This is particularly true with regard to the semi-new information (By semi-new I mean that preliminary estimates were published in the flow of funds report, but not in the previous GDP report) on national income and corporate profits which both showed significant deterioration.

First of all, the claim that real GDP wasn't downwardly revised is based on the misleading volume methodology, which in effect says that if foreigners pay the people of a country less for an identical volume of exports, then they aren't worse off even though your purchasing power falls. Similarly, this methodology also says that if we have to pay more for an identical volume of imports then we aren't worse off either despite again losing purchasing power. This really makes no sense at all when trying to measure how well-off the people of a country are. So instead of deflating nominal GDP growth with the GDP deflator, one should deflate it with the domestic demand deflator. In this report, nominal GDP growth was downwardly revised from 3.3% to 3.0%, while the domestic demand deflator was downwardly revised from 3.9% to 3.7%, implying a decline in terms of trade adjusted real GDP of 0.7%, instead of 0.6%.

Bulls might on the other hand point to GNP, which rose 4.3% in nominal terms and thus rose 0.6% in real terms. The reason why GNP is rising faster than GDP is because the American factor income surplus is rising as falling interest rates and falling profits for foreigners who have been foolish enough to invest in America is reducing income payments to foreigners. Meanwhile, the falling dollar and strong growth in the rest of the world is increasing the profits of foreign subsidiaries of American companies. In principle, GNP is better than GDP as it better reflects the change in purchasing power for a country.

The problem here is that the other source of data, namely from the income side, is indicating far greater weakness than the GNP number. In theory, national income should be identical to GNP minus capital consumption. But in practice, there is always a small statistical discrepancy. And in the latest year this statistical discrepancy has changed from showing a national income $46.6 billion larger than GNP minus capital consumption to showing a national income that is $139.9 billion smaller than GNP minus capital consumption. In the latest quarter alone, the discrepancy rose from $84.8 billion to $139.9 billion. Because of this, national income was even weaker than GDP, up 2.8% in nominal terms and down 0.9% in real terms. This discrepancy, likely do not reflect lower increases in the factor income surplus than the production side data indicate, but rather more dramatic declines in domestic production.

This interpretation is supported by looking at one of these income data, namely corporate profits. Domestic corporate profits continued to fall dramatically for both financial and non-financial companies even in nominal terms, and much more so then in real terms. And this despite the fact that write-downs aren't included in these numbers as they are treated as "balance sheet items". However, because profits fell so much for foreign companies operating in America and because the profits of foreign subsidiaries of American companies, the overall decline in corporate profits received by American companies was much smaller. It still declined, but by much less than the decline in the profits of domestic operations. This decline in domestic profitability, along with the deteriorating cash-flow situation for American companies certainly indicate that business investments will likely decline significantly during 2008, something which is confirmed by the latest durable goods data.

Another interesting data is that the national savings rate is even worse than suggested by the flow of funds report. Gross savings was 12.5%, the lowest since the Great depression, and net savings was just 0.4%, also the lowest since the Great Depression with the exception of the brief dip into negative territory in Q3 2005 due to the massive capital destruction caused by Hurricane Katrina. The savings rate usually fluctuates in a pro-cyclical way, so we should not be surprised that it falls during the current recession. However, it never really recovered in any significant way during the housing bubble, and now the savings rate could drop to new lows, although it still has a long way to go before it reach the 1932 all time low of 6% gross savings and -7% net savings.