Last Friday (October 26, 2018), the US Bureau of Economic Analysis published their latest national accounts data – Gross Domestic Product, 3rd quarter 2018 (advance estimate) , which tells us that the annualised real GDP growth rate for the US remains strong at 3.5 per cent (down from 4.2 per cent in the June-quarter 2018). Note this is not the annual growth over the last four-quarters, which is a more modest 3 per cent (up from 2.9 per cent in the previous quarter). As this is only the “Advance estimate” (based on incomplete data) there is every likelihood that the figure will be revised when the “second estimate” is published on November 28, 2018. The US result was driven by a growing household consumption contribution (2.7 points) with the personal saving rate falling by 0.4 points. Further, the government spending contribution was also strong (0.6 points up from 0.4) with all levels of government recording positive contributions. Real disposable personal income increased 2.5 percent, the same increase as in the second quarter. While private investment was strong it was mostly due to unsold goods (inventories). Notwithstanding the strong growth, the problems for the US growth prospects are two-fold: (a) How long can consumption expenditure keep growing with slow wages growth and elevated personal debt levels? Most of the consumption growth is coming because more people are getting jobs even though wages growth is flat. (b) What will be the impacts of the current trade policy? It is a work in progress.
The Wall Street Journal article (October 26, 2018) – 3% Growth, If We Can Keep It – which responded to the BEA data release was a mixture of falsehoods and truths.
By way of falsehood, the WSJ said that:
It’s clear that the Republican policy mix of tax reform, deregulation and general encouragement for risk-taking rescued an expansion that was fading fast and almost fell into recession in the last six quarters of the Obama Administration. The nearby chart tells the story that Mr. Obama and his economists won’t admit. Soaring business and consumer confidence have been central to this rebound.
The ‘Chart’ in question was just the Quarterly percent change in GDP from Q3 in 2015 to Q3 this year (see below for my version of the graph).
As you will see below, the data does not support the claim that business has rebounded because of a “mix of tax reform, deregulation and general encouragement for risk-taking”.
Most of the growth came from household consumption expenditure with solid contributions from the government sector. While the contribution from private capital formation was strong, it was mostly due to unsold goods (inventories) with fixed investment and residential investment dragging down growth.
This is contrary to the narrative that the WSJ is trying to confect.
In assessing the WSJ’s claim that consumer and business confidence has risen due to Trump’s policy stance, we can consult the Conference Board Measures of Consumer and CEO confidence.
The Conference Board Measure of CEO Confidence showed a continued decline in this measure since the March-quarter and “is now at its lowest level in two years” falling by 0.8 points in the September-quarter.
In contrast, The Conference Board Consumer Confidence Index increased in the September-quarter by 3.7 points.
By way of truth, the WSJ said that:
All the more so because Mr. Trump may soon face an economic challenge from a Democratic House, if not Senate. A tax increase would be near the top of Speaker Nancy Pelosi’s policy list, and she might use the need to raise the federal debt limit in 2019 to force Mr. Trump’s hand.
The Democratic obsession with ‘sound finance’ and its continual railing against the fiscal deficit and public debt is a massive danger to US growth, especially when one considers the point I noted before that the growth is being driven by the rising debt in an environment of flat business investment.
Seriously, the Democrats need to really rethink their approach.
US economy – what is going on at the aggregate level?
The US Bureau of Economic Analysis said that:
Real gross domestic product (GDP) increased at an annual rate of 3.5 percent in the third quarter of 2018 … In the second quarter, real GDP increased 4.2 percent.
Note that the BEA is using the annualised quarterly figure here (multiplying the September-quarter growth by 4) rather than the actual annual (year-on-year) growth rate which is the percentage shift from the September-quarter 2017 to the September-quarter 2018.
That growth figure was 3.04 per cent, up from 2.87 per cent in the June-quarter although the quarter-on-quarter growth outcome of 0.86 per cent was down on the June-quarter result of 1.02 per cent.
The following sequence of graphs captures the story.
The first graph shows the annual real GDP growth rate (year-to-year) from the peak of the last cycle (December-quarter 2007) to the June-quarter 2018 (grey bars) and the quarterly growth rate (blue line). Note the date line starts at December-quarter 2007.
The year-to-year growth calculation smooths out the considerable volatility in the quarterly data to help us see the trend.
There is now growing momentum in US growth in terms of the annual growth rate (year-on-year).
The next graph shows the evolution of the Private Investment to GDP ratio from the December-quarter 2007 (real GDP peak prior to GFC downturn) to the September-quarter 2018. Note the date line starts at December-quarter 2007.
The decline in the investment ratio as a result of the crisis was substantial and endured for 2 years. As a result the potential productive capacity of the US contracted somewhat. There are various estimates available but the overall message is that potential GDP fell considerably as a result of the lack of productive investment in the period following the crisis.
The retreat in the Investment ratio after the June-quarter 2015, appears to have been arrested and while the ratio is trending upwards, it fell from 18.1 per cent in the June-quarter to 17.9 per cent in the September-quarter 2018.
In this blog post – Common elements linking US and UK economic slowdowns – I discuss estimates of potential GDP in the US and the shortcomings of traditional methods used by institutions such as the Congressional Budget Office.
So if you are interested please go back and review that discussion.
The latest CBO estimates, made available through – St Louis Federal Reserve Bank, show why we should be skeptical.
To get some idea of what has happened to potential real GDP growth in the US, the next graph shows the actual real GDP for the US (in $US billions) and two estimates of the potential GDP. There are many ways of estimating potential GDP given it is unobservable.
While I could have adopted a much more sophisticated technique to produce the red dotted series (potential GDP) in the graph, I decided to do some simple extrapolation instead to provide a base case.
The question is when to start the projection and at what rate. I chose to extrapolate from the most recent real GDP peak (December-quarter 2007). This is a fairly standard sort of exercise.
The projected rate of growth was the average quarterly growth rate between 2001Q4 and 2007Q4, which was a period (as you can see in the graph) where real GDP grew steadily (at 0.65 per cent per quarter) with no major shocks.
If the global financial crisis had not have occurred it would be reasonable to assume that the economy would have grown along the red dotted line (or thereabouts) for some period.
The gap between actual and potential GDP in the September-quarter 2018 is around $US2,186 billion or around 10.5 per cent.
That gap rose steadily since late 2014 but then stabilised and has been declining since the March-quarter 2018.
In the September-quarter 2018, it fell by 0.2 points as a result of the stronger growth.
The green dotted line is the estimate of potential output provided by the US Congressional Budget Office and made available through – St Louis Federal Reserve Bank.
In relation to the CBO estimate, the US economy is estimated to be operating at 6.2 per cent over its potential in the June-quarter 2018.
It is hard to believe the estimate!
As a hint, the BEA report for the National Accounts release notes that:
The price index for gross domestic purchases increased 1.7 percent in the third quarter, compared with an increase of 2.4 percent in the second quarter … The PCE price index increased 1.6 percent, compared with an increase of 2.0 percent. Excluding food and energy prices, the PCE price index increased 1.6 percent, compared with an increase of 2.1 percent.
That is, price pressures declined, hardly symptomatic of an economy that is operating at 6.2 per cent over its capacity.
Further, wages growth remains flat and broader measures of labour underutilisation indicate there is still considerable slack.
Which suggests that the CBO estimates are inaccurate – probably by several percentage points.
We know (and I explain this in more detail in the blog post mentioned above), the CBO base their estimate of Potential GDP on their estimate of the NAIRU – the (unobservable) Non-accelerating Inflation Rate of Unemployment.
This is a conceptual unemployment rate that is consistent with a stable rate of inflation.
The literature demonstrates that the history of NAIRU estimation is far from precise. Studies have provided estimates of this so-called ‘full employment’ unemployment rate as high as 8 per cent or as low as 3 per cent all at the same time, given how imprecise the methodology is.
The former estimate would hardly be considered ”high rate of resource use”. Similarly, underemployment is not factored into these estimates.
The continued slack in the labour market (bias towards low-pay and high underemployment) would lead to the conclusion that the output gap is likely to be somewhat closer to the extrapolated estimate than the CBO estimate.
The question to ask is this: How much lower would the unemployment rate and the broader underutilisation rate go if the US federal government offered a Job Guarantee on an unconditional basis?
I would bet the answer would be much lower without any inflation acceleration emerging.
Contributions to growth
The accompanying BEA Press Release said that:
The increase in real GDP in the third quarter reflected positive contributions from personal consumption expenditures (PCE), private inventory investment, state and local government spending, federal government spending, and nonresidential fixed investment that were partly offset by negative contributions from exports and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased (table 2).
The deceleration in real GDP growth in the third quarter reflected a downturn in exports and a deceleration in nonresidential fixed investment. Imports increased in the third quarter after decreasing in the second. These movements were partly offset by an upturn in private inventory investment.
The next graph compares the September-quarter 2018 (blue bars) contributions to real GDP growth at the level of the broad spending aggregates with the June-quarter 2018 (gray bars).
Household consumption expenditure continues to be the strongest positive contributor rising from 2.57 points to 2.69 points in the September-quarter 2018.
With household debt remaining high (see below) and real wages growth sluggish it remains to be seen how long household consumption can maintain this impetus.
Most of the consumption growth is coming because more people are getting jobs even though wages growth is flat. This cannot persist obviously.
Gross private domestic investment also contributed 2 points to growth but most of that was from the Change in Private inventories (unsold goods).
Household investment fell for the third straight quarter.
The Government sector added 0.6 points to the September-quarter 2018 growth up from 0.4 points in the previous quarter.
That contribution was spread between the Federal government (0.21 points down from 0.24 points) and State and Local government (0.35 points up from 0.24 points).
Net exports undermined growth (-1.78 points down from 1.22 points). This is almost certainly the impact of tariff increases with exports alone cutting 0.45 points from the current quarter’s growth.
The next graph decomposes the government sector and shows that all levels of government contributed significantly to growth in the current-quarter and increased the contribution relative to the previous-quarter.
The federal contribution was, however, dominated by the strong military expenditure while reducing the contribution of non-defense spending.
That has been a trend under the current Presidency – a worrying sign.
The next graph shows the contributions to real GDP growth of the various components of investment.
The inventory cycle dominated other positive investment contributions.
Household consumption and debt
total household debt reached a new peak in the second quarter of 2018, rising by $82 billion to reach $13.29 trillion. Mortgage balances, the largest component of household debt, rose to a total of $9 trillion during the second quarter. Auto loan balances increased by $9 billion to reach $1.24 trillion, continuing a six-year upward trend …
Aggregate household debt balances increased in the second quarter of 2018 for the 16th consecutive quarter, and are now $618 billion higher than the previous (2008Q3) peak of $12.68 trillion. As of June 30, 2018, total household indebtedness was $13.29 trillion, an $82 billion (0.6%) increase from the first quarter of 2018. Overall household debt is now 19.2% above the 2013Q2 trough.
The question that remains unanswered is whether US households will be able to maintain consumption spending growth given the rising household debt levels.
Is the significant slowdown in consumption spending growth a sign that a peak debt level is approaching?
The following graph is taken from the FRBNY publication. Clearly the gap between mortgage and non-mortgage debt is rising as total household indebtedness rises.
This looks to be an unsustainable situation and will require either significant non-government spending boosts in investment or net exports or government spending increases to offset the likely slowdown in household consumption spending.
The continued growth in the September-quarter 2018 was down to strengthening household consumption spending, largely the result of a slight rundown in savings and the fact that more people are getting jobs.
Even though wages growth is flat the fact that more people are working means that spending growth can be maintained.
But that source of growth is finite and eventually the record levels of household indebtedness combined with the flat wages profile will bring it to an end.
Whether the rise in inventories is a negative will be seen in the next few quarters.
The tariff war is probably impacting now on exports which detracted from growth.
Further, the government spending contribution was also strong (0.6 points up from 0.4) with all levels of government recording positive contributions.
That impetus is being challenged by the Democrat insistence that the Federal deficit be cut. Whether that happens will be influenced by the political events in the next few weeks.
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.