Tuesday, 2 August 2011

US GDP Revisions - Well Below "Stall Speed"

It hasn't happened quite yet, but whilst I'm away on 'holiday' it's a very safe bet that the US Street will be cutting its GDP forecasts for 2011 quite savagely. Quite possibly, the more venturesome of them will alter not just the numbers in the tables, but their underlying view. The onset of these downgrades will come in response not to the debt deal, but rather to the blunderbuss of GDP revisions with which the Bureau of Economic Analysis blasted the accepted version of recent US economic history.

Before we get into details, one bottom line is this: the US economy is approximately US$140 billion smaller than we though it was.

The details matter, though, particularly since the revisions tell us that in 1Q11 the US economy grew only 0.4% annualized, rather than the 1.8% previously recognized, and grew only 1.3% in 2Q (and that's a preliminary reading,too).  This means that the US economy right now remains smaller in real terms than it was immediately prior to the crisis - 0.4% smaller, in fact. Worse, the series of 0.4% followed by 1.3% is ominous, because it means that the US has been growing much slower than 2% now for two consecutive quarters.

This means the US economy is bumping along well below the 2% 'stall speed' which the US Fed economist Jeremy Nalewaik tentatively identified with developing recessions. In a paper for the Fed this May (available here), he observed that statistically since 1947, when two-quarter annualized real GDP growth fell below 2%, recession followed within a year 48% of the time. We're there already.

The odds get worse, however, when YoY real GDP growth falls below 2% in two successive quarters:  recession then follows within a year 70% of the time. We're not yet there yet, but annualized 3Q GDP growth would have to come in around 4% to avoid that fate. I've just checked the Bloomberg consensus, and only three out of 64 surveyed economists expect that (step forward the brave economists of Pierpoint Securities, MFGlobal and First Trust Advisors).

(One possible reason 2% might be a "stall speed" is that that labour productivity growth in the US tends to  average around 2% a year. So if the economy cannot manage to grow at such a pace, employment markets will certainly be slack. As we observe today.)

So economists, who had a consensus forecast for US GDP growth of 2.9% as late as May, and still apparently expect 2.5% growth this year, followed by 2.9% next, are now very firmly on the on the wrong side of historical probabilities.  Unless they can provide convincing reasons why this time is different, the low-risk, high-probability default position should now be for renewed recession in the US, within a year.

A third detail is also worth noting: the toll the financial crisis has taken on the US's stock of capital is greater than previously expected, and the recovery has not yet begun.

Working on a 10yr straight line depreciation schedule, the previous data suggested that by March this year US capital stock had shrunk 0.9% from its 1Q09 peak, but was expected finally to have started growing in 2Q11.  The revised data tells us that the contraction of capital stock has been 1.3% since the peak, and is still contracting in both YoY and QoQ terms. Capital accumulation is a fundamental engine of economic growth - and in the US, it's still now happening.

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