SERIOUS MONEY:THE ECONOMIC and financial turbulence that originated in the US has spread far beyond its borders to major economies across the globe, including Canada, France, Germany, Italy, Japan and Britain.
Recent data shows that economic growth is dropping fast as the credit squeeze magnifies housing downturns in some countries, while inflationary concerns have left monetary conditions relatively tight in others. The euro zone registered its first quarterly contraction since the inception of the common currency area during the second quarter; Japan experienced negative growth over the same period; and both the Canadian and British economies are struggling to remain in positive territory. A recession in the developed world seems assured.
Perhaps surprisingly against this background, data released by the Bureau of Economic Analysis (BEA) on the performance of the ailing US economy during the second quarter showed real GDP growth of 3.3 per cent, which was sharply higher than an advance estimate of 1.9 per cent and exceeded consensus expectations by a wide margin. The favourable trend in relative growth rates allowed the dollar to stage a strong recovery in recent weeks, but is the US really out of the woods? Perhaps not.
The surprising GDP growth brought the data released by the BEA much closer to the consensus forecasts that prevailed prior to the release of the advance estimate towards the end of July.
The composition, however, differed in a number of important respects from market opinion.
Economic commentators had initially expected consumer spending to exhibit solid growth in the three months to June 30th due to the large fiscal stimulus.
This expectation failed to materialise, and although the BEA's latest estimate for personal consumption expenditures was raised to 1.7 per cent, the upward revision was modest and consumer spending failed to exceed 2 per cent growth for the third consecutive quarter.
Furthermore, recently released consumer spending data for July showed a 0.4 per cent drop in real terms, which suggests the first quarterly decline in personal consumption spend since the final three months of 1991 is almost certain in this quarter, a prospect that cannot be dismissed easily, given this area captures a more than 70 per cent share of GDP.
The large upside surprise arose primarily from an improved trade deficit, which added 3.1 percentage points to GDP growth as against an advance estimate of 2.4 percentage points. This represented the largest foreign trade addition since the third quarter of 1980. But the double-digit growth in exports is unlikely to persist given the rapid deterioration in economic conditions throughout the developed world.
Additionally, imports registered the largest quarterly rate of decline since the economic downturn of 2001 and this, alongside negligible growth in gross domestic purchases, suggests that the economy has become increasingly dependent on the export sector to avoid contraction. The liquidation of business inventories was originally estimated to have subtracted 1.9 percentage points from growth, but this has been revised downwards to 1.4 percentage points.
The outlook for consumer spending, however, combined with slowing export growth, means that inventory liquidation should continue to subtract from growth during the current quarter.
Furthermore, the outlook for non-residential investment, which grew by 2.2 per cent in the second quarter, is also deteriorating rapidly. Corporate profits have dropped year-on-year for six consecutive quarters and the rate of decline is accelerating, while foreign profits have begun to fall quarter-on- quarter.
It should also be noted that the price index used to deflate real GDP was estimated at 1.2 per cent in the second quarter as compared with 4.2 per cent for personal consumption expenditures, and 4.4 per cent for gross domestic purchases. The large difference arises because the GDP price index includes an estimate of both import and export prices. GDP includes exports net of imports such that a surge in import prices can result in a GDP deflator that bears no relation to what consumers actually pay for goods or services.
This is exactly what happened during the second quarter where the rising cost of imported oil contributed to a more than 30 per cent rise in the import price index. Simply put, Americans are paying more for what they consume than what they receive for what they produce, and this has contributed to a low GDP deflator. This effect should not be repeated in the current quarter and a higher deflator will act as a further depressant to growth in the third quarter.
The US has become increasingly dependent on external trade to buoy growth in recent quarters and the gap between the growth in GDP and gross domestic purchases grew to three percentage points in the three months to June 30th, a level typically associated with a domestic recession.
Unfortunately, the rapid deterioration in economic fundamentals elsewhere in the developed world means that this support should soon disappear. It's far too early to believe that the US is out of the woods.
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