US Q2 GDP: How Bad Was It?

Will we see a double-dip recession?

Advanced GDP estimates for the second quarter came in at minus 1% versus consensus estimates of minus 1.5%. While several news stories quoted various business economists declaring the end of the recession, the market reaction told a different story.  Stocks finished higher but just barely and below their pre-open futures indication before the release. More telling, while the US dollar sold off (generally a sign of increasing risk appetite), it not only sold off against commodity-bloc currencies and Sterling but also strongly against the Yen. Normally, a strengthening Yen is a sure sign of increasing risk aversion. What happened then was a general sell-off of the dollar as investors realized how weak the US economy really was. This offset any safe haven demand for dollars that was instead expressed in a repatriation of Yen.

In fact, the primary driver of GDP (final sales) was especially weak if one excludes public sector spending. In an almost exact repeat of the Q2 2008 GDP numbers, stimulus spending in the form of quick tax rebates as well as defense spending led to a large increase in government spending. Christina Romer, the Chairman of the President’s Council of Economic Advisors,  estimated the Obama stimulus program contributed 2-3% growth. However, these are largely one-off items that can be expected to disappear next quarter (taking away from growth in GDP).  The other major contributor to GDP was Exports less Imports. Exports contracted by a mere 7% while imports contracted by 15%, adding 1.5% to GDP. In other words, while the rest of the world contracted, it contracted less quickly than the US.

Against these pluses, we saw business investment contract again, personal consumption contract much more than expected,  and residential housing investment drop again (belieing any pick-up in housing). Inventory depletion, as retailers and wholesalers attempt to reduce inventory to levels that make sense compared with the much reduced level of sales, also pulled down GDP. Well-known business economists hailed the reduction in inventories declaring that inventory restocking will contribute to positive growth in Q3. However, I suspect that we may only get a modest restocking and that the effect of President Obama’s hugely expensive stimulus program will recede somewhat.

Moreover, other data showing increasing job losses and a progressively shorter work week are inconsistent with the number we saw and suggest the strong possibility of a larger negative number once revisions are made to the advance number.

Benchmark revisions to GDP that were released showed that GDP growth became negative earlier than had been previously thought, that the contraction was greater than previously thought and that growth in consumer spending has been negative since the beginning of 2008.  In fact, overstretched household balance sheets will probably restrain consumer spending for some time to come. In fact, as households continue to try to reduce the value of debt to net worth, we should see the US savings rate rocket up into double digits. Given that consumer spending makes up close to 70% of US GDP, this will put a heavy drag on GDP.

Household de-leveraging will continue for some time here in the US.  We seem to repeating the Great Depression experience in the US closely. 1930 was a year of optimism as the market seemed to have stabilized from the violent crash of late 1929. However, as the year wore on optimism faded as consumers and businesses waited for definite signs of a pick-up in the economy before spending any money themselves. We see the same thing this year. Fading optimism and no hard signs of a revival just a slow down from a heart-attack type pullback in the economy to one where we still continue to worsen. Perhaps we will see positive GDP growth in Q3.  But do not be surprised to see a double dip by late 2009.