Lesson 7 GDP: Hitting on Fewer Cylinders

GDP makes my heart flutter.  GDP is to macroeconomics as corn and oak barrels are to bourbon. Each quarter the Bureau of Economic Analysis publishes data on US GDP along with revisions of many of the numbers for past quarters. These announcements generate a lot of oohs and ahhs. Most of us want a bigger number each quarter because it shows how sexy we are as a nation. A higher GDP means our nation produced more stuff. That usually means more people were employed, companies made better profits, and Donald Trump passed more gas. In quarters when GDP slows or declines, we have sad faces and we ask friends and relatives – what did we do to deserve such a fate?

So when the latest numbers came out recently for Q2 2015, I decided to see what’s up. Like you I know that the US economy is not growing as fast as we want it to grow. I know that because Joe Biden said so. Also the stock market said so and has been side-ways waffling as it tries to decide if we are ever going to grow as in the good old days when Gene Autry rode Lassie. For example, in the 8 years from 2000 to 2007 the average annual growth rate of real (as opposed to unreal) GDP was about 2.5%. Although that was nothing to write home about, real GDP rose by an average of only 1.1% in the following 8 years – from 2008 to 1015. Both time periods included recessionary quarters.

If you are good with numbers you realize that 1.1% is less than 2.5% and that makes for a lot of unsmiley faces on the BEA’s Facebook account. If you are even better with numbers you could proudly announce that our national growth rate was only about 44% of what it was. Clearly we have been experiencing a prolonged slowdown.

This post is not about blame though I do blame a lot of people. You can ask my spiritual advisor/bartender about all that. What this post is about, however, is looking deeper at real GDP to see if we can identify weak spots. The IU football team has a weakness in the defensive secondary such that even when the offense scores 179 points against any opponent, we always lose in the last seconds on a Hail Mary Pass. By focusing on the weak spots we might be better able to understand why we are doing so poorly.

There is more than one way to look more deeply at real GDP. Today I am looking at the buyers of all that stuff we produce. The BEA breaks down the buyers into four groups – shirts, skins, stripes, and plaids. No that’s not right. The four key buying groups are households, firms, governments, and foreigners.

Average values of GDP contribution for the two eight year time periods are found in the below table for key GDP components by purchaser.  These contributions are measured in percents but are not the percentage change for the category. These contributions show how much GDP would have grown in that time period were it only for that one component. 

For example, from 2000 to 2007 of those 12 categories, Spending on GDP for Consumer Services accounted for GDP growing by about 1.14% over those eight years. Since GDP grew by about 2.5% per year, spending on consumer services alone accounted for a little less than half of that growth.  There were six buying categories that made major contributions well above zero percent.

Now let’s see what changed in the next eight years. Recall that real GDP grew by only 1.1% on average from 2008 to 2015. Consumer services alone accounted for .56% of that. That is a healthy share but notice that it is half the 1.14% of the previous eight years.

More strikingly is that only three other sectors were supporting 0.10% or more growth per year from 2008 to 2015. In 2000 to 2007, 8 buying groups accounted for .10% or more points of GDP growth. Growth has become much less balanced from 2008 to 2015. The household is driving the wagon, albeit slower. Business firms are smoking Js in the back. The government seems more willing to increase transfer payments than spend more on goods and services.

Worse, most of these buying groups contributed much less to GDP growth in the last eight years (compared to the previous eight years)

58 points less for Consumer Services

29 points less for Consumer Durable Goods

25 points less for State and Local Governments

21 points less for Consumer Nondurable Goods

18 points less for Federal Government Spending on National Defense

13 points less for Business Equipment
12 points less for Business Structures

  9 points less for Exports to Foreign Buyers

What can we make of this? Economic growth continues to be disappointing because we are not spending.  We are essentially hitting on no cylinders because the weakness comes from households, firms, governments, and foreign buyers. We have this widespread lackluster performance despite strong government stimulus and a central bank that keeps interest rates at zero. As government spending turns away from military and other goods to social programs the impact of government at all levels of GDP seems to be lacking. More worrisome is the behavior of businesses. Why are they so unwilling to bet on a vibrant future? 

Contribution to Real GDP

(percent)

       00-0         08-15        Change

0.52	0.23	-0.29	Durable goods
0.37	0.16	-0.21	Nondurable goods
1.14	0.56	-0.58	Services
0.04	-0.08	-0.12	Structures
0.22	0.10	-0.13	Equipment
0.14	0.12	-0.02	Intellectual property products
-0.05	-0.07	-0.02	Residential
0.47	0.38	-0.09	Exports
-0.68	-0.28	0.40	Imports
0.16	-0.02	-0.18	National defense govt
0.08	0.04	-0.04	Nondefense govt
0.15	-0.10	-0.25	State and local govt

   

Hiccup or Real Concern -- April's Drop in Real Consumer Spending

The BEA (www.bea.gov ) published April’s Real Consumer Expenditure (RPCE) with a press release heading that read “Real Consumer Spending Falls in April.” Following this announcement I saw quite a few reactions. Most of them lamented the 0.3% April decrease and worried loudly that the general slowdown experienced in the first quarter might continue into 2014. The Wall Street Journal on May 31 wondered if economists’ projections might be too rosy for the coming year.

Note: This paragraph has changed thanks to an alert reader Danny finding an error in a calculation. See my comment below for more information. The newest data releases contain valuable information. They always do. They are news. But it is safe to say that one month’s spending data can also be highly misleading. For example, while April’s RPCE did fall by .3% it is also true that RPCE rose by .5% in February and .8% in March. If you average over these three months you get an average monthly gain of approximately 0.33%. Dig a little farther. These data are presented in real terms and are one-month growth rates. They have not been annualized. A 0.33% average annual compounded real spending gain amounts to almost 5% per year. If the three month Feb to April annual average gain were to keep up for the rest of the year – RPCE would increase by about 5% more than the inflation rate. That would be a pretty good year. I am not saying that growth rate will keep up. But if you get away from one month and take a longer look at what happened in the last three months – you get torrid growth in consumer spending.

While pessimists have focused on various disappointments in wages, this BEA report for April contained more hopeful information about personal income (PI) change. During the three months from Feb to April, PI rose an average of .4% per month. Removing consumer inflation and taxes you get real Disposable PI rising just shy of 0.3% per month. If you annualize that you get about 4% per year. While not spectacular, a 4% growth in real DPI means households were earning a lot more than inflation and taxes – with room left to spend and save to the tune of 4% more per year. I should also note that the personal saving rate averaged about 4% during those three months.

Monthly data is crazy. Suppose…

·        After a successful 10 month diet where you lost 40 pounds, you gained a pound yesterday.

·        After 22 miles into a marathon run, you averaged a slower pace over the last half mile.

·        After 45 years of marriage your faithful spouse was late for dinner last night

·        After winning 90 percent of their games your favorite sports team is behind its opponent at halftime.

·        After eating seven chili dogs your burp.

Okay, so I had a few JDs. But you get the point. The last observation is only the latest one. It might be a wonderful indicator of what is to come next. Maybe you will gain another 39 pounds. Maybe you will not go on to eat 12 chili dogs and not get your name on a plaque at the Corner Bar in Rockford Michigan. But then again, maybe the last observation is an aberration.

Monthly data bounces around. Stuff that usually happens in April this year might have been done late in May because of holidays, or weather, or because someone forgot! This is why we usually do not make too much out of last month and often either wait and see – or we combine last month with a longer stream of information to get a broader picture. When we do this with BEA’s spending, income, and saving data we get a pretty positive picture.

I am betting on momentum. Look at all the housing and stock market wealth that has been created in the last year. And while much of it went to high income people, a lot of it went to elderly and other people whose income depends on housing and stock prices. Employment gains have been slow but cumulative with a 2.3 million increase in workers on nonfarm payrolls in the past year. Note that while real GDP did contract in 2014 Q1, real consumer spending was up by 3.1% at an annual rate in that otherwise dubious quarter. The down quarter in real GDP came after four quarters with rates of 1.1%, 2.5%, 4.1% and 2.6%.

Betting on momentum and inertia does not translate into a record growth rate for 2014. But it does suggest a year in which overall real GDP and consumer spending will continue to gather steam and grow.  Analysts had fun getting all pessimistic about April’s consumer spending decline. But I doubt it is anything more than a little hiccup in an ongoing and fretful economic expansion.

            

Stock Futures are Down Because of Good News?

Imagine the following conversation....Mom, the good news is that my temperature is down and my white cell count is back to normal. I feel much better. The doctor says I am definitely on the road to recovery. But I am really depressed. The doctor says he will have to reduce the amount of pain medicine I am taking.

I don't usually post short blurbs on Thursdays. But it is 9:20 am and the stock futures are falling like a rock. According to one Bloomberg article the markets do not like newly published indicators that show a stronger economy because it means the Fed may start tapering soon.

Does this make any sense to you?

How can good news be bad news?

Or maybe the so-called good news about the economy is really bad news about the economy? These snipets of news about last month's unemployment and inflation are simply heralding bad news about future inflation and unemployment?

Maybe the stock market was already over-valued and the sell-off this morning has nothing to do with monthly economic data.

Maybe journalists have to write about every little thing that happens.

Lots of maybes. My first reaction upon reading the news this morning was to try to understand a market that hadn't even opened yet. My better senses tell me to ignore all this noise and go back to playing darts.

It will be interesting to see how all this plays out in the coming months....

Employment, US Profits, Jack Rabbits, and the Elephant

I recall the story about the blind-folded man who had never seen an elephant was asked to guess and describe an elephant by touching only one small part of it. One can only imagine which part of the elephant the blind-folded man touched as he tried to decide what an elephant looks like. If 1000 blind-folded people touched different parts of the elephant one can begin to see the chaos and humor in this project – and the various guesses made as to the shape, texture, and size of this elephant.

This is the way I think about the national economy. This is why one of my favorite “spouts” relates to the ways journalists, economists, politicians, and others react each day to the news that peppers them with information.  Let’s call the direction of the economy the “elephant”. The direction of any nation’s economy has so many pieces to it that no one person can digest it all. Thus, we all sample or taste little pieces of the economic growth day to day as a way to form an opinion about its direction. Once we sample enough and feel confident, then we can make decisions that are based on our view of the elephant. If the pieces of the puzzle are diverse, lack tangency or are otherwise unconnected, then we might go for some time without any strong feeling for the direction of the economy. Our decisions would reflect this indecision about the elephant.

This indecision reflects a very conservative reaction to information gathering. This conservative approach envisions a person as being reluctant to make decisions until he or she feels that she has a dominant view of the economy. But that’s not the way all people behave. Less conservative behaviors magnify the importance of the latest piece of information. I just ate a huge piece of chocolate cake (with chocolate icing). From that I might deduce that I am on my way to being the new fat man at the circus. Tomorrow I have a bowl of kimchi jjigae laden with tofu. That would make me feel slim and healthy and I might enroll in the next Iron Man event. It sounds ridiculous that on two adjacent days I might want to check myself into the fat-reduction clinic and enroll in an Iron Man contest. But it seems to me that this is exactly the way people behave and think when it comes to the national economy.

Headlines this week and last week reflected what happened to US employment, business profits, and what will happen to inflation, retails sales and other economic barometers in the US and abroad. Each announcement brought a barrage of new conclusions about the progress of the economy. This barrage came despite the fact that one month’s worth of information is about as reliable as a fly perched on the end of the elephant’s nose. Does an elephant look like a fly? I don’t think so.  I thought the top was going to fly off the US economy last week when the employment number came in under expectations. Republicans peed in their pants as they faulted Obama’s policies and leadership. Republican point – this data point proves the economy is losing steam.  Democrats pointed out how despite the slowdown in March, they have rescued the economy from the evil policies of George Bush and Dr. No.  This one data point to Democrats reflected a general trend of rising strength in the economy.  This one data point relating to US employment in March 2012 became the focus of millions of words, electronic or otherwise. It’s like the blindfolded guy who happened to touch the weiner of the elephant explaining to us all what an elephant looks like.

The Financial Times wrote a very nice piece (Monday, April 9 “US job figures become a fickle political football) in which they pointed out many reasons why one’s month worth of employment figures tell us absolutely nothing about the health of the economy or the direction of employment. Yup I am not exaggerating. Nothing. Zip. Yet our experts spent days using that data point as if it meant everything. Why? Because some people think that if they react to every piece of news they can beat the rest of us to the jewels and gold. These folks are the pouncers. Data comes out. Pouncers draw quick conclusions and pounce. Tomorrow new data comes out and then they pounce again.

I am not trying to say that the pouncers are any better or worse than the non-pouncers. I am just saying they exist and they or their actions or their spokespeople make us non-pouncers sometimes think we are missing the boat – or the elephant. I am in Asia today and I am writing on a Monday morning August 9. I am wondering how the stock market will perform in the US when it opens in about 6 hours. The pouncers have declared the US a bad place to invest this week. The negative interpretations of the pouncers to the employment disaster and to the expected declines in business profits makes me worried that my precious retirement account will be worth less in a couple of hours.  So the pouncers are making me wonder if I should be buying or selling today. If they are right that these bits of news are part of a more long-term US decline, I might want to sell today. But if they are wrong and these news bits mean nothing – then maybe I should use the expected stock market decline as a buying opportunity. Since I am not a pouncer I will probably ignore the whole thing and ponder my next bottle of Soju.

One more example has to do with the profits or earning announcements of this week. The reports are saying that profits are falling and I can see why someone might be concerned about falling business profits. It does not bode well for employment or the economy in general. But if you read a little closer you find that the profits are regressing back to their means. That is, this means that profits are expected to fall to something normal and sustainable. To me the words normal and sustainable suggest a good outcome. Yet the fact that profits are falling seems to be dominating the idea that they are converging on sustainable and normal. Once again, the jack rabbits (I got tired of pouncers) are ready to hop at every piece of news. The word “decline” can be understood by anyone. The phrase “regressing to the mean” is somehow less easy to comprehend and less definitive. Thus even though the profit news is not necessarily bad, the rabbits are ready to sell and possibly in numbers. Perhaps they are wrong and this is another buy opportunity for the rest of us. After all, the rabbits have to have someone to sell to.

Okay so the elephant is hard to discern with the bits and pieces of information. But that does not mean that one cannot come to more realistic conclusions about the general direction of the national economy. For one thing, one can pounce or hop (or do a jig) after pulling together enough information over enough time. It is possible to ignore all the individual daily announcements and pull together what you learned over the span of a quarter or over six months. The last bit of information you received on April 17 might sway you more than the one you got on January 17, but surely you will get a better feel for the general momentum in the economy using three-six months of data than from one day’s. Second, it really helps to have a little understanding about cause and effect and global macroeconomics. The US profits figure for one month surely pales in importance to an understanding of the effects of shocks and policies that have impacts that last for months or years. What are the experts saying about the impacts of oil prices? What do they say about China’s economic growth? Is the EU making any progress with sovereign default? Will the US election cycle and the lack of any serious attention to deficit and debt cause economic problems?

It seems to me that we do not have to be pouncers or jack rabbits. Maybe some people prefer that approach. But it is possible to use more information in an intelligent way to make our important decisions. This approach might not sell daily newspapers but hopefully if followed it will create a larger perspective about  the chaos that follows news announcements.