US GDP Flunks Smell Test

Flashback January 31, 2007 - Bloomberg reported: U.S. Economy: Growth Quickens, Propelled by Spending.

The U.S. economy grew at the fastest pace in a year last quarter as declining energy costs helped power consumer spending and contain inflation, enhancing Federal Reserve Chairman Ben S. Bernanke's stature at the start of his second year.

Gross domestic product increased at an annual pace of 3.5 percent, the Commerce Department said in Washington today. That was more than forecast and up from a 2 percent pace in the prior three months. Other figures today showed manufacturing and construction still struggling to shake off a slowdown.

Stocks rose after the Fed, which left its benchmark interest rate at 5.25 percent today, said inflation has "improved" at the same time data have shown "somewhat firmer economic growth."

Central bankers, in a statement accompanying the rate decision, said that "readings on core inflation have improved modestly in recent months'' and that price pressures would likely "moderate over time."

Higher Stock Prices

The Dow Jones Industrial Average increased 106 points, or 0.8 percent, at 2:40 p.m. in New York. The Standard & Poor's 500 Index rose 9.4 points, or 0.7 percent.

In less than two weeks the 4th quarter US GDP was revised lower from +3.5% or so to something closer to +2.0 to +2.5%. I remember all the fanfare from everywhere touting US 4th quarter growth. The odd thing is, today I am scrambling to find much of anything on the revised lower estimates. This is the best mainstream media report I can find. It happens to be from Australia.

The Sydney Morning Herald is reporting US trade gap drags down GDP.

An unexpectedly wide December trade gap and pared down business inventories are certain to slice a big chunk off the government's gauge of fourth-quarter economic growth, showing the year ended on a subdued note.

In fresh data on a key piece of the economic pie, the government on Tuesday reported that the US trade deficit widened 5.3 per cent to $US61.2 billion ($A79.43 billion) in December, pushing the full year's shortfall to a record $US763.6 billion ($A991.11 billion).

The latest trade numbers, which reflected surges in oil imports and goods from China, showed US consumers were buying more goods from overseas, which acts as a drag on US producers and ultimately economic growth.

The government reported two weeks ago that gross domestic product, the broadest measure of overall economic activity within US borders, expanded at a 3.5 per cent annual rate during the October-through-December quarter.

Now economists are expecting a revision in the GDP data due on February 28 to show a leaner reading for the quarter, after the bigger trade deficit and data showing wholesalers pared their inventories at the end of the year. When businesses meet demand by unloading stockpiles it detracts from growth because there is less need to ramp up production.

"Q4 GDP will be revised down; it didn't really pass the smell test in the first place," said Keith Hembre, chief economist at FAF Advisors in Minneapolis.

It is much easier to find decent news reporting outside the US mainstream media, especially when it comes to the US economy.

In the US, Nouriel Roubini was on top of this story with his blog entry US Q4 GDP Growth Likely to be Revised Down to 2.0-2.2% from Initial 3.5% Estimate.

It now looks like the alleged growth rebound in Q4, from the 2.0% of Q3 to the 3.5% of Q4 was an illusion based on incomplete data. Based on recent data on inventories for December (much lower than initially predicted by BEA) and today’s December trade balance figures (much worse than initially forecasted by BEA) the initial estimate for Q4 growth will be revised downward to 2.0% or at best 2.2%. Indeed 2.2% is today’s revised estimate by JP Morgan, one of the most bullish – on US growth - investment houses. In a research note today they said: “A wider than expected December trade deficit leaves fourth quarter GDP growth tracking 2.2%, down from the advance estimate of 3.5%.”.

So, the alleged growth rebound in Q4 actually did not occur. Indeed, as BEA had estimated strong consumption in Q4 and in December, it was odd that one would expect an improved trade balance in December: all those plasma and LCD TVs and consumer electronics - that were at the center of the holiday consumption binge - are imported. And indeed the December trade figures today showed the obvious: a large chunk of the consumption boom during the holidays went into imports.

One of the more interesting things I suppose is the fact that stocks rose on the report of a higher GDP and stocks rose on a revised lower GDP. Does any one care about anything or is there simply a mad panic to get into stocks before it's too late? I recall a similar panic to get into housing in the summer of 2005 "before it's too late". Here's a free tip: When everyone is rushing to get in to something "before it's too late", it is already way too late.

For a very timely (in advance) article on that concept I refer you to this short article: It's Too Late. Mish readers may wish to check the date on that article.

Let's now return to the GDP. I consider +2% to be the stall rate. I say that because the first 2% of the GDP is total nonsense (hedonics and imputations) that simply do not reflect any real economic activity. I have reported on this before but imputations include the concept of "paying oneself rent" and the GDP value of "free checking accounts".

If there was value delivered in "free checking accounts" banks would be charging for those services. In essence they already are. When you deposit money into your checking account, a "sweep" process takes that money and on a nightly basis "sweeps it from your account" into a general lending pool so that banks can lend that money out. In the meantime banks pay you 0% interest while lending it out for profitable returns. To top that off some bureaucrat comes along and decides that GDP should be higher because of the "value" you receive for that "free" checking account.

Believe it or not, there is similar nonsense in the GDP that says that if you do not own your own home, then you would be renting it from someone else. In those cases the GDP is revised upwards as if you rented your house from yourself. Given that close to 69% of the US owns their own home, the concept of paying oneself rent adds a decent chuck to the GDP. Unfortunately there are delays of close to two years on reporting of these distortions. I hope to have the next report on this, with actual figures, sometime in April.

So what does this mean? It means that a recession that seemed very unlikely a mere two weeks ago is now very much in the limelight. I am waiting to see the revision to the revision of the revision but if the next revision comes in at or below +2.5% then the first sub +2.0% will likely have me declaring the start of an "unofficial recession".

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/