Wednesday, November 29, 2006

Is the GDP report really all that good?

The wire services and the stock market are both taking the revised 2006Q3 US GDP report as an overall good sign that the US economy is on track for the fabled "soft landing". Mark Zandi sums up the general sentiment well:
"It was a tough quarter, but not as tough as previously estimated," said Mark Zandi, chief economist at Moody's "But there's reason to be optimistic that the expansion will remain intact. With businesses so flush with profits, they will continue to invest and hire and the economy will continue to move forward," he predicted.
A close look at the revised numbers does indeed show that nonresidential investment surged ahead in the third quarter at an annualized 9.6% rate. Of course, this only just balanced out the rather stunning -19.4% annual change in residential investment. Overall, gross private domestic investment rose in the third quarter a microscopic 0.04% annualized, and over the last two quarter a meagre 0.5% annualized.

With overall investment at a standstill thanks to the housing market collapse, the economy has unfortunately become ever more dependent on consumer spending, which motivates the title of this posting. From 1983 to 1999, personal consumption expenditures as a percentage of GDP reguarly hit a ceiling of 68%. The big shift came during the bursting tech bubble in 2000 and the investment-led recession of 2001. Once the dust settled in 2002, the US economy found itself profoundly reliant on consumer spending as never before. Ever since 2001Q4, consumer spending has been at least 70% of US GDP as the below graph shows.

The result? A tremendously falling savings rate both in households and government, and a concomitant reliance on external savers to fund US investment (and consumption), producing current account deficits of 6.6% of GDP and tremendous pressure on the US dollar, which has fallen (on the major currencies index) some 3% in just 7 weeks.

From its peak in 2005Q2, the US economy's reliance on consumer spending began to relax. The percentage of GDP composed of personal consumption expenditures fell or remained steady each quarter after that -- until now. 2006Q3 saw this figure rise yet again, to 70.84%. The personal savings rate for 2006Q3 rang in at -1.3%, only slightly better [sic] than last quarter's -1.4%.

Quite frankly, the US economy needs to be shifting into saving, not yet more consumption. If it doesn't, the chances of a dollar crash becoming increasingly likely. In 2004 Paul Volcker claimed there was a 75% chance of a "dollar crisis" within five years. In the wake of this quickly declining dollar, it's about time we did something to avoid that most unpleasant of scenarios.


At 5:03 PM, Anonymous Anonymous said...

Excellent post --esp the illustration that PCE has not always been ~70% of GDP. The 'Spend!' admonishment from The President seems to have lifted us to this new position or as you might say, precipice.

At 5:20 AM, Anonymous Sam said...

nice post... keep it up!

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