JOHN WILLIAMS’ SHADOW GOVERNMENT STATISTICS

COMMENTARY NUMBER 319
Second-Quarter GDP Revision

August 27, 2010

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Second-Quarter GDP Revised to 1.6% from 2.4%

Deteriorating Economic Data Eventually
Should Disrupt
U.S. Financial Markets

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PLEASE NOTE: The next regular Commentary is scheduled for Friday, September 3rd, following release of the August employment and unemployment release. An interim Commentary will update the labor situation outlook.

– Best wishes to all, John Williams 

Economic Data Will Get Much Worse. The kindest thing I can say about a stock market that rallies on the "stronger than expected" news that annualized growth in second-quarter GDP was revised from 2.4% to just 1.6%, instead of to the expected 1.4% (keep in mind those numbers are quarterly growth rates raised to the fourth power), or that gyrates over meaningless swings in seasonally-distorted weekly new unemployment claims, is that it is irrational, unstable and terribly dangerous. 

As the renewed tumbling in the U.S. economy throws off statistics suggestive of a continuing collapse in business activity, as a looming contraction in third-quarter GDP becomes increasingly evident to all except Wall Street and Administration hypesters, who professionally never admit to such news, it would be quite surprising if the financial markets did not react violently, with a massive sell-off in the U.S. dollar contributing to and coincident with massive sell-declines in both the U.S. equity and credit markets. 

Recognition is growing rapidly of the re-intensifying economic downturn. Yet, little analysis so far has been put forth to public as to some of the unfortunate systemic implications of this circumstance. The problems range from extreme growth in the federal government’s operating deficit, tied to reduced tax revenues and to bailout expenditures for the unemployed, bankrupt states and continuing banking industry solvency issues, to U.S. Treasury funding needs to pay for same. The latter issue promises eventual heavy Federal Reserve monetization of Treasury debt, with resulting inflation problems and eventual hyperinflation (see the Hyperinflation Special Report).

Accordingly, the general outlook is unchanged, but it will be reviewed and updated in next Friday’s Commentary along with the analysis of August’s labor conditions. An update on systemic liquidity conditions also will be included. The month-to-month hemorrhaging of the M3 money supply (SGS-Ongoing M3 Estimate) appears to have been contained — at least temporarily — with major M3 components having flattened out or turned positive in weekly reporting of the last month, although annual change remains deep in negative territory. 

GDP-Related Definitions. For purposes of clarity and the use of simplified language in the following text, here are definitions of key terms used related to GDP reporting:

"Gross Domestic Product (GDP)" is the headline number and the most widely followed broad measure of U.S. economic activity. It is published quarterly by the Bureau of Economic Analysis (BEA), with two successive monthly revisions and with an annual revision the following July.

"Gross Domestic Income (GDI)" is the theoretical equivalent to the GDP, but it is not followed by the popular press. Where GDP reflects the consumption side of the economy and GDI reflects the offsetting income side. When the series estimates do not equal each other, which almost always is the case, the difference is added to or subtracted from the GDI as a "statistical discrepancy." Although the BEA touts the GDP as the more accurate measure, the GDI is relatively free of the monthly political targeting the GDP goes through.

"Gross National Product (GNP)" is the broadest measure of the U.S. economy published by the BEA. Once the headline number, now it rarely is followed by the popular media. GDP is the GNP net of trade in factor income (interest and dividend payments). GNP growth usually is weaker than GDP growth for net-debtor nations. Games played with money flows between the United States and the rest of the world tend to mute that impact on the reporting of U.S. GDP growth.

"Real" means growth has been adjusted for inflation.

"Nominal" means growth or level has not been adjusted for inflation. This is the way a business normally records revenues or an individual views day-to-day income and expenses.

" GDP Implicit Price Deflator (IPD)" is the inflation measure used to convert GDP data from nominal to real. The adjusted numbers are based on "Chained 2005 Dollars," at present, where the 2005 is the base year for inflation, and "chained" refers to the methodology which gimmicks the reported numbers so much that the total of the deflated GDP sub-series misses the total of the deflated total GDP series by nearly $40 billion in "residual" as of second-quarter 2010.

"Quarterly growth," unless otherwise stated, is in terms of seasonally-adjusted, annualized quarter-to-quarter growth, i.e., the growth rate of one quarter over the prior quarter, raised to the fourth power, a compounded annual rate of growth. While some might annualize a quarterly growth rate by multiplying it by four, the BEA uses the compounding method, raising the quarterly growth rate to the fourth power. So a one percent quarterly growth rate annualizes to 1.01 x 1.01 x 1.01 x 1.01 = 1.0406 or 4.1%, instead of 4 x 1% = 4%.

"Annual growth" refers to the year-to-year change of the referenced period versus the same period the year before. 

Widened Trade Deficit Accounted for Bulk of Negative GDP Revision. The revision to second-quarter 2010 GDP had annualized real (inflation-adjusted) growth dropping from an initial estimate of 2.4% to 1.6%. Eighty-percent of the downside revision came from June’s reported trade deficit deterioration, where the "advance" estimate of second-quarter GDP had been guesstimated by the Bureau of Economic Analysis (BEA) based on only the available April and May trade data (see Commentary No. 316). The remaining portion of the downside revision was a reduction in reported inventory build-up that mostly was offset by an upside revision to reported personal consumption. GDP inventory revisions commonly are offset by consumption revisions.

 GDP.  Published today (April 27th) by the BEA, the first revision, or second estimate, of second-quarter 2010 Gross Domestic Product (GDP) was a statistically-insignificant annualized real growth rate of 1.61% +/- 3% (95% confidence interval), down from the "advance" estimate of 2.39%, and down from an estimated growth rate of 3.73% in the first-quarter. The year-to-year change in real second-quarter GDP revised to 2.98%, from initial reporting of 3.17%, but it still was higher than the year-to-year 2.39% growth estimated for the first-quarter.

The GDP implicit price deflator — inflation measure — showed a revised annualized pace of inflation in second-quarter 2010 of 1.96% (previously 1.83%), which was up from 1.05% in the first-quarter. In an unusual divergence, annualized inflation for the CPI-U in the second-quarter was a contraction of 0.72% versus a positive 1.53% in the first-quarter. The higher the inflation rate used in deflating the GDP, the weaker is the inflation-adjusted number and vice versa. In this case, lower prices for imported oil spiked the implicit price deflator, because imports are subtracted from the GDP, which reverses the impact of the oil price changes in the aggregate number.

The SGS Alternate-GDP estimate for second-quarter 2010 remains an approximate annual contraction of 1.3% versus the official estimate of a 3.0% gain, less-negative than the annual 1.5% contraction (2.4% official gain) estimated in the first-quarter. While annualized real quarterly growth is not formally estimated on an alternative basis, a flat-to-minus quarter-to-quarter gain likely would have been realistic for the second-quarter. The relative upturn in annual change reflects the bottom-bouncing at low levels of activity seen for much of the last year in key underlying economic series, not an economic recovery. As discussed in the opening comments, an intensified downturn continues to unfold (see the Alternate Data tab).

GNP and GDI (see Sidebar). Initial estimates of Gross National Product (GNP) and Gross Domestic Income (GDI) for second-quarter 2010 GDP were published with today’s release. Neither series had a second-quarter growth estimate that was heavily divergent from the GDP’s growth estimate.

Annualized second-quarter 2010 real GNP growth was estimated at 1.65%, down from 4.41% in the first-quarter. Year-to-year change in the second-quarter was reported at 3.39%, up from 2.84% in the first-quarter.

Annualized second-quarter 2010 real GDI growth was estimated at 2.31% (1.93% before prior-period revisions), down from 4.11% (previously 4.50%) in the first-quarter. Year-to-year change in the second-quarter was reported at 3.25%, up from a revised 2.24% (was 2.34%) in the first-quarter.

The following graph shows the annual percent change in quarterly GDP for the history of the series. The record annual contraction for the series was 4.11%, seen in last year’s (2009’s) second-quarter.

 

Week Ahead. Given the unfolding reality of a weaker economy (or re-intensifying downturn) and more serious inflation problems than generally are expected by the financial markets, risks to reporting will tend towards higher-than-expected inflation and weaker-than-expected economic reporting in the months ahead. Increasingly, such is being seen in economic reporting net of prior-period revisions.

Employment and Unemployment (August 2010). Due for release on Friday, September 3rd, reporting of both the August payroll employment change and unemployment rate likely will disappoint market expectations. 

The Census Bureau has reported that its temporary and intermittent hires for the 2010 census were reduced by roughly 116,000 in August, based on the payroll-survey weeks. Consequently, the current consensus estimate (Briefing.com) of a total 120,000 jobs loss — which includes jobs gains other than census — likely will narrow to about a 90,000 jobs loss, in the week ahead. I look for an outright payroll contraction in August, net of census impact, with the total jobs loss likely to exceed 135,000. 

Briefing.com shows a consensus for the August headline U.3 unemployment rate at 9.6%, up from 9.5% in July. The jump in unemployment should be more severe, particularly when short-term (U.6) and long-term (SGS) discouraged workers are counted.

The outlook for the labor report will be updated next week, as detail comes in from related series. The Conference Board’s July help-wanted advertising index (newspapers), which leads August employment reporting, was reported, again, at 10 — unchanged for a number of months — and one point above its historic low.

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