GDP Much Weaker Than Headline Numbers

The 2nd quarter 2008 preliminary GDP numbers are out.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.3 percent in the second quarter of 2008, (that is, from the first quarter to the second quarter), according to preliminary estimates released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.9 percent.

The increase in real GDP in the second quarter primarily reflected positive contributions from exports, personal consumption expenditures (PCE), federal government spending, nonresidential structures, and state and local government spending that were partly offset by negative contributions from private inventory investment, residential fixed investment, and equipment and software. Imports, which are a subtraction in the calculation of GDP, decreased.

Incomes Lag, Corporate Profits Down

Bloomberg is reporting Lagging Incomes Signal U.S. Economy Weaker Than GDP Suggests.

The meager gains in earnings over the last year signal the U.S. economy is in much deeper trouble than the growth estimates indicate, economists said.

Gross domestic income (GDI), or the money earned by the people, businesses and government agencies whose purchases go into calculating gross domestic product, rose 0.3 percent in the 12 months ended in June after adjusting for inflation, according to Bloomberg calculations based on today's Commerce Department growth report. GDP expanded 2.2 percent.

"The income side of the economy, with profits down for four straight quarters and employment falling, looks like a recession," said John Ryding, chief economist at RDQ Economics in New York.

"What you are seeing is more legitimate economic weakness in the income numbers," said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. "The GDI numbers raise the potential that GDP is overstating growth."

The 1.9 percentage-point difference between the GDI and GDP over the last 12 months is the biggest in the post World War II era.

Corporate profits were down 7 percent in the year to June, the biggest drop since the last economic contraction in 2001, according to the Commerce Department.

"I'm looking at the labor market, and the GDP income numbers make more sense," said Ryding. "It certainly did not feel like 3.3 percent growth."

The disparity between income and growth may take a long time to be resolved, if ever. Once Commerce issues its final estimate for second quarter growth next month, the figures will not be updated again until the annual benchmark revisions are issued in July 2009.

Last Hurrah?

Bloombereg is reporting U.S. Economy Probably Expanded at Faster Pace on Export Gains.

"The second quarter GDP numbers will mark the economy's last hurrah," said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. "Exports will continue to expand, but at a much slower pace."

Separately, initial jobless claims will remain near a six- year high, indicating the job market has weakened, economists forecast a Labor Department report at the same time will show. Applications fell to 425,000, from 432,000 a week earlier, according to the survey median. Claims totaled 457,000 in the week ended Aug. 1, the most since March 2002.

A weakening labor market is one reason consumer spending is likely to slow after the government sent out about $92 billion in tax rebate checks. The U.S. has lost 463,000 jobs so far this year and wages haven't kept up with inflation, according to Labor Department data.

The longest expansion in consumer spending on record will probably end this year, according to economists surveyed by Bloomberg earlier this month. Retail sales fell in July for the first time in five months, led by a slump in auto purchases, according to Commerce data.

Government Consumption Expenditures

Count me in the group that is skeptical of any rises in GDP associated with government spending, but here are the numbers from the government report.

Real federal government consumption expenditures and gross investment increased 6.8 percent in the second quarter, compared with an increase of 5.8 percent in the first. National defense increased 7.4 percent, compared with an increase of 7.3 percent. Nondefense increased 5.5 percent, compared with an increase of 2.9 percent. Real state and local government consumption expenditures and gross investment increased 2.2 percent, in contrast to a decrease of 0.3 percent.

I question the merit of adding all government spending, no matter how useless, to the GDP, but that is what is done. Government consumption expenditures added .76 to the total.

GDP Deflator Manipulation

Barry Ritholtz at Big Picture is asking Is BEA Measuring Growth or Inflation?

Part of the reason the GDP number looked so good was because the GDP price index for the second quarter was marked at just 1.2. In other words, BEA subtracted from nominal GDP 1.2% in order to produce their version of "real" (inflation-adjusted) GDP.

[Mish Note: The CPI is running at 5.6%. A reasonable person would have expected the GDP deflator to be somewhere near 5.6% as opposed to 1.2% but a reasonable person would have been wrong. GDP would have been negative if a lager deflator was used.]

Mike Panzner sends along the chart below, along with these comments:

"Call me a skeptic, but based on the accompanying graph of the GDP inflation figure and headline CPI (which most people already believe is lower than reality), there seems to be something of a disconnect between the two (which would imply, of course, that U.S. economic growth is a lot lower than reported)."



click on chart for sharper image

Hedonics And Imputations

Of course one needs to add hedonics and imputations to the list of GDP distortions. Imputations are a part of GDP that the government decides to estimate value, where no cash actually changed hands. In other words, if I scratch your back and you scratch mine but no one gets paid, then back scratching is undercounted in the GDP.

One such imputation is the value of "free" checking accounts. The reality is bank checking accounts are not free. Banks are sweeping out nearly every penny every night and lending the money out. What's "free" is banks having free assess to your money. Nonetheless the BEA assigns a value to those free checking accounts and adds it to the GDP. Given that nearly every adult in the country has a checking account, the amount is non-trivial.

It goes far beyond that however, into complete fairy tale absurdities. For example: If you own your own house, the government recalculates your income as if you were really renting from yourself and paying yourself rent.

Imputed rent just happens to be one of the most frequently asked questions of the BEA. Here is their response: The BEA treats homeowners as businesses, which pay rent to themselves. Therefore, homeowners contribute to the real estate industry's GSP even if not employed by the industry. In addition, like businesses, homeowners' property taxes paid to state and local governments are included as part of real estate TOPI.

One can believe the GDP numbers or not. I don't. The US economy is contracting and the assumptions used to show expansion are getting more and more absurd with each report.

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