1Q2013 Gross Domestic Product: First (Advance) Estimate

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The Bureau of Economic Analysis (BEA) estimated 1Q2013 growth in real U.S. gross domestic product (GDP) at a seasonally adjusted and annualized rate of +2.5 percent, 2.1 percentage points higher than the current 4Q2012 estimate. Personal consumption expenditures (PCE) and private domestic investment (PDI) added to 1Q growth, in that order; government consumption expenditures (GCE) -- especially defense-related purchases -- and net exports (NetX) dragged on growth.

The 1Q headline number was a significant improvement over 4Q2012 and indicates moderate mid-cycle growth. However, the change was substantially less than consensus expectations (+3.0 percent) and represented the biggest “miss” since 3Q2011. Inventory and fixed investment came in well below expectations, comprising -- respectively -- 1.03 percentage points (of which autos represented 0.24 percentage point) and 0.53 percentage point. 

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For this report the BEA assumed annualized net aggregate inflation of 1.20 percent. In contrast, the Bureau of Labor Statistics’ seasonally adjusted 1Q CPI-U recorded a 2.10 percent annualized inflation rate. Understating assumed inflation increases the reported headline number; in this case the BEA's relatively low deflator (nearly a full percentage point below the CPI-U) boosted the published headline rate. If the CPI-U had been used to convert the nominal GDP numbers into "real" numbers, the reported headline growth rate would have been a much more modest 1.63 percent.

 “On the surface a 2.5 percent annualized growth rate at nearly full four years into a recovery is good news,” Consumer Metrics Institute (CMI) wrote, “and a growth rate that many other global economies would currently be pleased to be reporting.” The details provide CMI with some reasons for optimism:

* Consumer spending was sustained in spite of tax increases (although that spending came at the expense of the personal saving rate, which may actually be negative since “saving” includes debt pay-downs)

* Fixed investments continued to grow

* Exports swung back to growth after a quarter of contraction

But two major components within the data suggest reasons for continued caution:

* Inventories are growing once again, with the quarter-to-quarter swing in inventories (+2.55 percent) contributing more than the entire improvement in the headline number,

* Real per capita disposable incomes took a major hit, and (as mentioned above) consumers had to dip into savings to sustain spending levels in the face of increasing taxes.

“Clearly the last two items are cause for concern for the long term health of the economy,” CMI concluded. “We have argued before that an ongoing contraction in real, per-capita disposable income has been the most critical feature of the BEA data releases during the past several years -- and we see no reason to change that argument now.”

CMI is not the only group sounding warning bells about future growth. Bloomberg’s ECO Surprise Index, which shows the degree to which economic analysts under- or over-estimate the trends in the U.S. business cycle, has exhibited lower highs during the last three years of cycles and recently experienced the largest slump in 22 months. I.e., the economy has been performing worse than expected, with a serious degradation during the past several weeks.

Moreover, the Chicago Fed’s National Activity Index three-month moving average fell to the lowest level in five months during March. Also, consumption of gasoline and other finished petroleum products, which has typically been reasonably well correlated with economic activity, fell to levels last seen in the late 1990s. “The economy does seem to have downshifted a bit,” said Mike Materasso, co-chairman of the Franklin Templeton Fixed Income Policy Committee. Economists polled by MarketWatch forecast GDP to taper off to 1.8 percent in 2Q.

All bets are off, though, because of upcoming revisions that will add the value of “intangible assets” to the GDP calculation. As the Financial Times explained:

“The U.S. economy will officially become 3 percent bigger in July as part of a shake-up that will see government statistics take into account 21^st century components such as film royalties and spending on research and development.

“Billions of dollars of intangible assets will enter the gross domestic product of the world's largest economy in a revision aimed at capturing the changing nature of U.S. output.

“Brent Moulton, who manages the national accounts at the Bureau of Economic Analysis, told the Financial Times that the update was the biggest since computer software was added to the accounts in 1999.

"‘We are carrying these major changes all the way back in time -- which for us means to 1929 -- so we are essentially rewriting economic history,’ said Mr. Moulton.”

Ignoring the speculation regarding the motivation behind this change, it seems to us that the addition of R&D constitutes double counting. As Karl Denninger pointed out (emphases in the original):

“The problem with this sort of thing is that [R&D] expenses are already part of GDP. 

“That is, when I expend funds on R&D someone gets paid to perform the R&D and the goods used in performing it also show up in GDP, since they have to be purchased before they can be consumed.

“Further, innovation -- that is, the fruits of R&D -- show up in GDP anyway in the form of increased spending by consumers on good or the increased gross profit on sales from new and better processes and procedures, which winds up in the hands of either employees or owners (e.g. shareholders) of the companies and thus gets spent (and captured in GDP.) 

“The argument that we need a further addition to the ‘I’ line (Net Investment) in GDP seems to rest on a pretty thin foundation, but this is what the BEA intends to do.  I believe it's entirely unjustified as this is, in my view, already captured in the numbers (and thus this ‘revision’ amounts to double-counting)….”

In the final analysis, we suspect that -- after the dust has settled and the smoke has cleared -- the revision is likely to show the U.S. economy is improving no more rapidly than is presently the case. That is not to say one shouldn't be concerned, however.

“The shenanigans played by government may fool some people into thinking that growth in the U.S. is gaining strength,” economist Michael Pento wrote. “It may even convince some investors that the debt and deficit to GDP ratio is falling. In addition, it may cause politicians to claim that government spending as a share of the economy is shrinking, so it’s OK to ramp up the largess…. However, the BEA and our leaders in Washington have overlooked the most important point, as they so often do, which is that revenue to the government cannot be faked. Even if D.C. desired to include all the sea shells washed up at the beach as part of our gross domestic product, it would not increase the amount of tax receipts to the government. Therefore, it cannot alter the only metric which really counts; and that is our nation’s debt and deficits as a percentage of government income. It will not increase by one penny the amount of revenue available to the government to service our debt, and this, in the end, is all our creditors are really concerned about.

“Revenue to the government was $2.58 trillion in fiscal 2007. But despite all the government spending and money printing by the Fed, revenue for fiscal 2013 is projected to be just $2.7 trillion. The growth in Federal revenue has been just over $100 billion in six years! Nevertheless, our publicly traded debt has grown by $7 trillion during that same time frame. The fact is that the U.S. economy isn’t growing fast enough to significantly increase the revenue to the government, but our debt is still soaring.

“It all comes down to this, the U.S. government will not be able to service its debt once interest rates normalize,” Pento concluded, “and that will be the sad truth regardless of what voodoo tricks Washington uses to report GDP. It’s a shame they won’t just implement real measures to grow the economy like reduced regulations, simplifying the tax code and balancing the budget.”


The foregoing comments represent the general economic views and analysis of Delphi Advisors, and are provided solely for the purpose of information, instruction and discourse. They do not constitute a solicitation or recommendation regarding any investment.