Final revisions to US GDP released June 25, 2014 show the US economy contracted this past January-March 2014 by -2.9%. Does the much larger than predicted decline reflect the beginning of new recession? A -2.9% contraction for the quarter is just about the average quarter decline during the 2007-09 last recession. Or is the -2.9% an indication of a continuing stagnation, with a moderate recovery in GDP to occur in the second quarter 2014? Or perhaps it was just an aberration, due to bad winter weather, as many mainstream economists and press pundits are now saying, with a robust recovery of 4%-5% GDP growth coming in the second half of 2014?
The larger than expected -2.9% contraction was a further significant reduction from the government’s GDP estimate of a -1.0% GDP decline for the quarter that was reported by the government in May; and an even bigger 3% ‘swing’ from the initial +0.1% GDP estimate reported in April.
The record-setting ‘swing’ of 3% represents the largest such adjustment in nearly four decades, raising a question of why the government’s initial GDP estimate of 0.1% was so far off the mark in the first place? It also raises a question of just how accurate are estimates of GDP in today’s post-2008 ‘great’ recession restructured US and global economy? Is estimation becoming more a game of ‘guestimation’?
The record 3.0% swing and final GDP revision should finally silence those forecasters who have been spinning the message for months now that the US economy’s first quarter poor performance was due mostly to ‘weather’ factors. As this writer has been saying in several prior published commentaries since March, based on a closer look at the composition and magnitude of the GDP decline in the first quarter it is impossible to attribute the huge -2.9% decline to weather factors. A -2.9% drop would have taken the onset of a virtual new mini ice-age—and not just ‘bad winter weather’. Something more fundamental is going on perhaps in the US economy that official government estimates of GDP aren’t initially recognizing, or even picking up.
The closer look at the composition of elements of GDP responsible for the -2.9% drop were unrelated to bad weather—as this writer previously pointed out in a prior article, ‘The Real ‘Real’ GDP’, on June 3, 2014, and in a prior piece, ‘False Positives: Analyzing Recent US GDP and Jobs Reports’, November 11, 2013, both available on the writer’s blog at jackrasmus.com. The major factors behind the first quarter major -2.9% GDP decline were:
- a big pull back of business inventory investment during the quarter, after a buildup of the same in the third quarter of 2013 in anticipation of a surge in end of year consumer spending that did not materialize;
- a similar major drop in US net exports in the first quarter that reflected a slowing global economy.
Final revisions to GDP just reported this week now show clearly that the inventory adjustment reduced 1st quarter GDP by a whopping -1.7 percentage points, and the decline in net exports by another -1.5%. A weakening of Net exports reflects a gradual and progressively slowing global economy. The business inventory slowdown represents business stocking up for a consumer spending surge that nonetheless repeatedly fails to materialize. Neither of these developments can be attributed significantly to ‘weather factors’
In addition, the final GDP revision reported on June 25, 2014 showed a third important element underlying the -2.9% GDP decline in general, and the big ‘swing’ from -1.0% to -2.9% in the final revision: Consumer spending the first quarter was initially grossly overestimated in both April and May GDP reports. A growth in consumer spending of 3.3% was actually only 1%. What was first thought as healthcare spending surge generated by sign ups to the Affordable Care Act, boosting consumer spending, turned out not to be the case. The ACA boost to consumer spending was minimal, not significant.
None of these major determinants of first quarter GDP can be attributed to ‘bad weather’. Weather does not impact inventory accumulation or exports. Both inventories and exports are sold and ‘booked’, and thus added to GDP, before transported to warehouses or shipped. Moreover, consumer spending on ACA sign ups occurs mostly via phone or online, and not by going to a government or insurance company office purportedly postponed due to bad weather.
Estimates of the ‘bad weather’ impact are at best responsible for only 0.5% of the GDP decline in the quarter. That leaves more than 2.4% of the decline to be determined by real causes, not weather. Weak inventory spending, slowing net exports, and stagnating consumer spending are more fundamental conditions that are due to the aftermath of a fragile ‘epic’ recession characterized by lack of disposable income generation by most of consumer households and minimal debt reduction for most since 2009 despite claims of economy recovery by politicians.
Consumer spending weakness in particular reflects the lack of real wage and income growth for the vast majority of households. Slowing inventory investment is a lagged consequence of the same. And net exports weakness is a reflection of a slowing global demand and/or currency exchange rate shifts. But none of the above is weather related. Nonetheless, many economists and politicians are still sticking to the ‘bad weather’ metaphor for the huge -2.9% drop. And now argue to corollary, that the end of bad weather will mean a robust 4%-5% recovery in GDP in the months ahead.
The key question now, therefore, is whether the above factors behind the big first quarter 2014 contraction (i.e. inventory investment slowdown, net exports slowing, consumer spending stagnation) will continue into the current April-June, second quarter 2014? Will those factors be offset perhaps by growth in other sectors of the US economy in the second quarter and the rest of the 2014 year—like residential housing, government spending, or business equipment investment? Will the long awaited sustained consumer spending recovery that has been predicted, but has not occurred since 2010, finally appear?
Or will the ‘recovery’ from winter ‘bad weather’ once again in the second quarter 2014—as in previous years—prove far weaker than official government, mainstream economists’, and politicians’ current predictions?
1st Quarter 2014 GDP: Even Worse Than Reported
The US economy has been on a ‘stop-go’ trajectory ever since the official end of the 2007-09 recession in June 2009, now a full five years ago during which the US economy has grown at best one half to two thirds the normal recovery rate at this stage following recession. During the best quarters of economic performance since 2009, the US economy has grown at a sub-par 3% or so, followed by what this writer calls economic ‘relapses’ back to zero or below zero GDP growth on several occasions—three to be exact.
After only 18 months of economic growth following June 2009, for example, the US economy experienced a negative GDP again in the first quarter of 2011. It thereafter’ relapsed’ again, falling into virtual zero growth in the fourth quarter of 2012. The latest, third ‘relapse’ has occurred now, resulting in an even more dramatic -2.9% growth in the first quarter of 2014.
But this past quarter 2014’s -2.9% is actually even worse in fact than reported. It comes after last summer 2013’s redefinition of US GDP that added $500 billion more annually to GDP by declaring certain business expenses involving research & development and other ‘intangibles’ were thereafter to be included in GDP numbers. (see my ‘The Real ‘Real’ GDP’ article explanation). That redefinition added at minimum another 0.3% to US GDP. Adjust for that ‘GDP growth by redefinition’ and the first quarter’s GDP decline was actually an even worse -3.2%. But that’s not all.
An even greater GDP overestimation effect derives from how the US ‘adjusts’ GDP for inflation. The US uses a conservative estimator called the ‘GDP Deflator’ that grossly underestimates the role of price changes on the economy. The smaller the estimated inflation, the larger the real GDP. If the government adjusted inflation using the Consumer Price Index (CPI), or even the Personal Consumption Expenditures (PCE) index, both of which better estimate inflation, then the real GDP for the first quarter 2014 (and previous quarters) would be less than reported—i.e. at least 0.5% lower than actually estimated. The US government’s ‘GDP Deflator’ estimates US inflation at well less than 1.5%. In contrast, both the CPI price index and the PCE price index register inflation today at around 2% or more, and rising.
Together just these two changes—the redefinition of GDP that artificially raises it and the failure to fully adjust GDP to real GDP—means first quarter GDP declined by -3.7% and not the -2.9%.
From ‘Bad Weather’ to ‘Second Half’ Hype: A Continuing Pattern
‘Bad weather’ metaphors have been repeatedly trotted out as explanations whenever the US economy weakens—as has been the case since 2011—in turn followed by claims that the second half of the year will finally bring sustained recovery.
For example, US GDP contracted in the first quarter 2011—i.e. the first ‘economic relapse’ following the formal ending of the 2007-09 recession. That ‘relapse’ was predicted by this writer in his book, ‘Epic Recession’ written late 2009. As is the case today in 2014, that 2011 GDP contraction was blamed on bad weather, and was followed up by economists and forecasters assuring a second half 2011 would result in sustained recovery. But it didn’t. The pattern was again repeated in the fourth quarter 2012 when the economy initially contracted again by 0.1% despite the year-end 2012 holiday spending season, and winter weather was blamed again. Once more a robust recovery was predicted that didn’t happen.
First quarter 2011, fourth quarter 2012, and now once again first quarter 2014—it’s the same old story: it’s the bad weather that’s responsible for periodic GDP contraction; and the ‘second half of the year’ will bring a sustained recovery. Whether that pattern changes in the second half of 2014 remains to be seen, although it appears economists and forecasters are now ‘doubling down’ and betting on an enormous 4%-5% second half US GDP explosion—a growth that hasn’t been seen in any quarter since the onset of the recession in 2007!
2nd Quarter 2014 and Beyond
In short, many who blamed the weather in the first quarter 2014 GDP -2.9% contraction are now grasping at straws once again, forecasting a big ‘snap back’ of the economy in the current 2nd quarter that will more than offset the -2.9% decline. But we’ve heard all that ‘second half of the year will be a boom’ prediction before. Time will soon tell if their predictions are part of the multi-year pattern of second half ‘hyping’ of recovery, following a ‘bad weather’ contraction or stagnation, or whether it is different this time.
So far it doesn’t appear their 4%-5% GDP forecast will prove any more accurate than their past forecasts. Much of the areas of main weakness in the first quarter US economy continued into early second quarter, during the month of April. Some improvements then followed in May. June figures are still incomplete and appear mixed thus far.
Looking at each of the critical areas behind the sharp first quarter -2.9% decline, business inventory spending should recover somewhat in the second quarter 2014 but only modestly. Businesses are not likely to over stock again on inventory unless consumer spending clearly recovers. And that does not appear to be happening as of late June.
Net exports are also inconclusive. As the US dollar continues to rise relative to other currencies, especially the Chinese Yuan and the Euro, headwinds will continue for a robust acceleration in net exports and its contribution to GDP this quarter.
Consumer spending, which is two thirds of the US economy, declined in both April and May, when adjusted for inflation. That does not portend well for consumers driving the 4%-5% GDP explosion being predicted. Moreover, consumer goods inflation has begun to rise this quarter, at a time when wages and household income still are not. Food prices due to a western states’ farm drought will no doubt rise faster in coming months, as will gas prices due to global factors like renewed conflicts in Iraq and elsewhere. Healthcare inflation, especially associated with health insurance premiums, are expected to again rise significantly at double digit levels in the wake of Obamacare. So too will education costs continue their double digit annual gains.
All this renewed inflation, combined with further stagnation of wages and incomes for median households, does not bode well for a robust recovery of consumer spending either this quarter or in coming months. Consumer spending adjusted for inflation has continued to decline in both April and May and there’s no reason to believe it is about to turn around sharply.
Business spending will recognize this consumer spending weakness and adjust in turn. It is unlikely business will risk being caught off guard once again, as it was last year, and add significantly to inventories in expectation of a surge in consumer spending not likely to occur in 2014 any more than it didn’t in 2013. The expected rise in the US dollar in relation to Chinese, European and many emerging markets’ currencies will also dampen US exports’ recovery as well, while also raising imported goods prices for US consumers still further, consequently adding further downward pressure on consumer spending in the US.
Meanwhile, the ‘Polyannas of Prediction’, forecasting their 4%-5% GDP snap back for the rest of 2014 point to recent and continued job creation. But they miss the fundamental point about recent job creation: i.e. jobs being created are overwhelmingly low paid and often contingent (part time, temp) jobs. Higher paid jobs are being churned out for lower paid. At the same time at least an equal number of workers are leaving the labor force altogether as new, low paid enter it. The US labor market is not really improving. It is ‘churning’.
In short, job creation, to the extent it is even occurring, is not producing the income growth necessary to generate a sustained recovery of consumer spending. The consumer spending that is occurring is largely by the wealthiest 10% households, or is household spending based on credit and debt for the rest. Consumers are also spending by withdrawing savings. Savings rates are now once again below 4% in the US. Without the debt increase/savings drawdown spending by average households, consumer spending would not be simply stagnant; it would be declining sharply. For example, extensive credit and debt are all that’s keeping auto sales going now. As food, gasoline, healthcare and education costs continue to rise in 2014 more rapidly, it is a growing possibility that by the second half of 2014 consumer spending may indeed shift from the general stagnation characterizing it today, in the second quarter of 2014, to actual decline in coming months.
What about housing and/or government spending giving the US economy its boost in the second half of 2014? Forget housing. Talk about the housing sector leading the recovery in 2014 is clearly mostly hot air projection. New housing is mostly high end housing available only to the wealthiest 10% households and not the general public. Tight bank lending still prevails and most homeowners are not able to ‘trade up’ to buy more expensive homes. At the low end of the market, students are massively indebted and unable to join the housing market as new home buyers. Mortgage rates will continue to drift up as the Federal Reserve gives signals of interest rate hikes coming within the year. Existing home sales add virtually nothing to GDP. What housing recovery that has occurred has been concentrated in select areas of the country that have now peaked. Housing price acceleration is now slowing, reflecting slowing demand. In recognition that housing has peaked, banks are laying off thousands of employees who process home loans, and institutional speculators like hedge fund investors have begun to exit the market as well.
Of course, the federal government could pump up government spending in the second half of the year. That may well occur, as the economy approaches the midterm 2014 congressional elections—just as it occurred in the third quarter of 2012 before the national elections in November that year. But it is hard to see occurring the massive amount of spending that will be required from the federal government to generate a 4%-5% GDP growth in the second half of 2014.
In other words, it is difficult to see any source from which the ‘hype’ of a massive 4%-5% surge in 2nd quarter US GDP will come from.
Recession, Stagnation, Recovery…Or?
While second quarter 2014 US GDP will likely not continue to further decline, neither will a GDP growth surge of 4%-5%, predicted now by mainstream economists, even come close to occurring in the second quarter 2014. At best, something between 1%-2% is more likely. That means a net average growth in the US economy in the first half of 2014 of virtually zero or even a little less. Like the rest of the global economy, the US economy is on a long run slower growth path five years after the recession of 2007-09. A slow drift to stagnation, punctuated by a ‘stop-go’, bouncing along the bottom type of recovery—some quarters with a boost to 3% or so; followed soon by other quarters with a decline in GDP to virtual stagnation or even negative GDP.
So is this a recession? That depends on one’s definition of what constitutes recession. Officially, a recession is not two consecutive quarters of negative GDP growth, contrary to the public impression that that defines a recession. A recession is whatever economists at the National Bureau of Economic Research define it to be. And they look at more than GDP, including exports, retail sales, employment, industrial production and other economic indicators. More importantly (and incorrectly this writer believes), they declare a recession as ‘over’ when the economy no longer continues to contract. So if the -2.9% (or -3.7%) GDP drop in the first quarter 2014 is reversed, and the US economy returns to a tepid growth trajectory of a mere 1.5% or so, then they will say there is no recession.
A better definition of a recession would be when all the major indicators return to a pre-recession level. And that of course has not happened to date, five years after the last recession was officially declared over.
The scenario for 2014 and beyond is one of continued long-run stagnation for the US economy. That means some quarters of no growth or negative growth, followed by weak, short recoveries of sub-par historic GDP recovery, followed in turn by GDP stagnation or decline short term again. That is this writer’s definition of what constitutes an ‘epic recession’. That kind of ‘stop-go’, bouncing along the bottom kind of recovery, punctuated by periodic economic ‘relapses’ (single quarter contractions) is the new normal for the US (and global) economy in the post-2009 world, as this writer predicted in late 2009 would be the best case scenario (see ‘Epic Recession: Prelude to Global Depression’).
That scenario could prove worse, of course. As this writer publicly predicted a year ago, in May 2013 in his annual forecasts for the US and global economies for Z magazine, this series of ‘stop-go’ relapses and short, weak recoveries could go on for years. But they could also descend into bona fide deeper and more protracted recessions. To quote from a year ago, “the US economy will enter a double dip recession around late 2013 or 2014, with the proviso that either U.S. policymakers will continue deficit cutting or a more severe banking crisis will erupt in Europe”. Of course, neither deficit cutting nor Euro banking crisis has intensified as yet. So the forecast at this point is for more ‘stop-go’ for the rest of 2014: a very modest recovery in the second quarter 2014, followed by much less of a recovery in the second half than forecast by the ‘Polyannas of Prediction’ mainstream economist-business media bureaucracies.
Expect a continuation, in other words, of more ‘bouncing along the bottom’, at an average 1.5% to 1.8% annual average GDP growth—that is, until the next unexpected event pushes the current ‘systemically fragile’ US and global economy into the next recession, or even worse.
For make no mistake, despite the tens of trillions of dollars and dollar equivalents that have been pumped into the US and global economies since 2008 by central banks and governments, the US (and global) economy has not fundamentally recovered. It remains ‘systemically’ fragile. That means both the vast majority of consumer households still languish in declining incomes and debt overload, businesses continue to take on massive debt, and governments’ balance sheets have not been repaired from the last recession bailouts. With the exception of the super and mega wealthy and their dominant corporations, fragility is system-wide and deepening. The US economy and global capitalist system is far weaker today than it was in 2007.
Jack Rasmus is the author of ‘Epic Recession: Prelude to Global Depression’ (2010), ‘Obama’s Economy: Recovery for the Few’ (2012), and the forthcoming ‘Transitions to Global Depression’ (2015). He hosts the weekly radio show, ‘Alternative Visions’ on the Progressive Radio Network. His articles, interviews, and public presentations are available on his website, www.kyklosproductions.com. He blogs at jackrasmus.com and tweets @drjackrasmus.