Friday, January 27, 2006

Fourth quarter shows the end of cheap credit

The end of cheap credit in America finally begins to show its effects in the broadest of measures, gross domestic product.
The economy grew at only a 1.1 percent annual in the fourth quarter of last year, the slowest pace in three years, amid belt-tightening by consumers facing spiraling energy costs. . . .

The Commerce Department report, released Friday offered the latest figures on gross domestic product, the best measure of the country's economic standing.

The 1.1 percent growth rate in the fourth quarter marked a considerable loss of momentum from the third quarter's brisk 4.1 percent pace. The fourth-quarter's performance was even weaker than many analysts were forecasting. Before the release of the report, they were predicting the GDP to clock in at a 2.8 percent pace.

The 1.1 percent growth rate was the smallest gain since the final quarter of 2002, when the economy expanded at just a 0.2 percent rate.
Three big changes from 2005:III to 2005:IV make up the slowdown. The one I least expected was government expenditures and investment which changed -2.4%. This is mostly due to a -13.1% change in defense spending, coming on the heels of a very big 2005:III increase. In the fourth quarter, defense spending actually dropped to its lowest real level in a year (since 2004:IV).

The second big contributor to the GDP slowdown was imports. Imports grew tremendously, almost four times faster than exports, and considering the US import bill is about 60% larger than our export tally, that makes for a big dent in GDP growth. Most of that big import bill was oil-related.

Which feeds into the third and largest contributor to the GDP slowdown: consumer spending. Overall real growth in personal consumption expenditures was a meager 1.1%, and real spending on durable goods tanked an incredible -17.5%. In fact, the durable goods tally in the fourth quarter was at its lowest since 2004:III.

Why the big cutback on spending? Obviously part of the answer is higher energy costs. But that is only part. The neglected side of the story is the American consumer's cutback in deficit spending. In the third quarter, the US personal savings rate was -1.8%, while in the fourth quarter Americans tried a little harder to live within their means, taking the personal savings rate to -0.4%. That cutback in spending on credit meant less spending on big-ticket items that need credit -- you guessed it, durable goods and especially the motor vechicles and parts subcategory which saw real spending in 2004:IV drop to its lowest point in over four years.

The US economy is profoundly dependent on consumer spending growth for its overall health. Note that of the seventeen full economic quarters since 9/11 (i.e. 2001:IV to 2005:IV), 15 of 17 have seen personal consumption expenditures make up over 70% of US GDP. Before 9/11 the US never had a quarter in which PCE was over 70%. Never. Yet now it is routine.

If you're a regular reader of General Glut's Globblog, you know that in 2005 all this consumption was fueled by debt. For the first time since the depth of the Great Depression, the US racked up a negative personal savings rate, and this consumption in excess of income was essential in keeping the US economy from actual contraction in the third quarter. The real growth rate of the US economy from 2004 to 2005 was 3.5%. However, of the $375.4bn in real growth (in constant 2000 dollars), $191.4bn (in constant 2000 dollars, deflated by the PCE price index) was in personal consumption expenditures over and above income -- i.e. negative personal savings. Without that extra credit-injected economic fuel, the real GDP growth rate for 2005 would have been a paltry 1.7%. That would put the US economy right back where it was in 2002.

Private job growth (of actual non-seasonally adjusted jobs) in 2005:IV was only +303,000 compared to 2004:IV's +508,000. Private sector year-over-year job growth by month hasn't been over 2 million since September (from July 1993 to September 2000 the monthly figure dropped below 2 million only for only one three-month stretch). Real average hourly earnings of production workers (i.e. the 80% of us who have a boss) have been sliding for two years.

No wonder Main Street isn't feeling the love this winter.


At 12:46 PM, Blogger Emmanuel said...

On a related note, the yield on the 10-year Treasury is above 4.5% in the wake of the lousy GDP figure. So, if the Fed hikes next week, there's good chance that everyone won't be in a tizzy over yield curve inversions.

At 2:49 PM, Blogger ilsm2 said...

The defense spending reflects the usual first quarter of their fiscal year continuing resolution drag.

I think the DoD is still under continuing resolution.

No new money only spend on things you had money last year etc.

At 7:00 PM, Blogger Scott said...

This GDP number is the "advance estimate"; let's wait until Commerce releases the final number before coming to any conclusions. The final number is often significantly different than the advance estimate.

At 2:50 AM, Anonymous Anonymous said...

Excellent take on the year's 3.5% GDP growth being only 1.7% if one takes care of the negative savings rate. I'm sure part of the Defence budget should be accounted for in this way as well. (Gross Domestic Destruction)
Is it the end of cheap credit or a temporary dip to be put right by a pause in the ff rate? (A quick return to cheaper credit.)
Should the Fed pause (choke on this GDP stat) before taking the next 2 25bp pills (that most of the pundits --yes the very same ones who calculated 2.5% GDP growth for Q4), that might shake whatever confidence the public has left.
The appearance of intelligence and stability are far more important than actual intelligence and stability when the announcement of ignorance/surprise or instability could precipitate full blown panic.
So it would seem likely that the end of cheap credit might be postponed in some way (--lower oil prices would help; new, improved federal assistance for first time home buyers; ) And the obvious way to do that is to drive the mortgage rates back down by retracing the ff rate --something that needs more preparation than the public has seen so far from the Fed.
Emmanual mentions the inverted yield curve and I fess up to having an interest (not exactly a tizzy), but so far I'm not seeing enough movement to make me think that the spread is easing. (Kasriel has a recent post on concurrent vs leading indicators that might interest some.) The thinning spreads for the lenders constitute (only in calmo's book) antidisintermediation of risks and hedge funds might be having problems in this environment.
Another month and we will know whether this is a dip or the dive some of us have been forecasting for years.

At 4:11 AM, Anonymous Anonymous said...

Mon Generale,
As usual the headline hits the hammer squarely on the nail. Its all about cheap money and we aint got it no more.

Great analysis.

At 4:08 PM, Anonymous Anonymous said...

I don’t understand why you and other writers emphasize total personal savings, and the fact that it has now gone negative. Since our country does not have a fixed number of dollars, why is the total amount of savings significant? I of course understand the significance of individual indebtedness, and the problem that will occur for those debtors, and for the country, when interest rates rise. But total personal indebtedness is a different type of quantity than total personal savings.

Since the Fed prints money, and banks effectively print money, and there is lots of flow of dollars across our borders, then why are total US savings, total private US savings, and total personal US savings important numbers? Many economists worry about total savings, but I have never understood why. I have noticed that investment in our infrustructure, which is supposedly the reason why we need savings, seems in practice to be independent of the savings rate. Perhaps savings is important for other countries that can’t print dollars, but why exactly is it important for the US?

At 8:55 AM, Blogger François Dubreuil said...

Let's wait a bit, that's agreed, things could turn out better for some weeks. May be imports were not that big, consumption that low (it's weird to see high imports and low consumer spending) and of course some of the defense spendings must have been pushed on next years budget (talk about next year's deficit, how might it look with 2% growth ? With 1% growth ?)

Anyway, the trend won't be reversed.

If walking from -1,5 to -,5 is so hard ... Just think how hard it will be to walk back to the 10% long term rate ...

At 10:19 AM, Blogger Kirk said...


Sure, it's possible - even probable - that the number will adjust. But let's put in a reality check. When is the last time you saw it adjust by over a point? Heck, when is the last time you saw it adjust by over half a point? If it manages the former it's going to be 2.1 against an expectation of 2.8. The more plausible "large" adjustment only raises it to 1.6. Frankly, I don't expect even that much change.

And any cheering for those numbers will be like cheering for the runner who came in next to last because "at least he wasn't last."

At 12:22 PM, Anonymous Anonymous said...

I need to say something to that annoying anonymous (4:08) whose insistence about questioning the significance of Savings Rate, is driving me nuts.
Thank you and are you after my job? Do you have sufficient qualifications to displace my impeccable credentials for being a pain in the butt? I am very experienced. [That is, skilled and wise, not tired and unmotivated. I will fight to the death to retain my Crown, Pain in the Butt, against any wannabe Pains.]
What steps have you taken other than posting here to answer your own questions about the notion, Savings Rate? Are you discarding the tools as inadequate or the reality they purport to measure? Your apparent lack of training in formal economics is disarming --calmo's PB title may be in some jeopardy.

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