Summary
Last Friday (10/28), the Commerce Department released its first ("advance") estimate of third-quarter gross domestic product. The report indicated real growth at a 3.8% annual rate during the period, versus the 3.3% rate reported for the second quarter. The news launched a major rally in stocks. Was it justified?
_____
General Observations Regarding
the Advance Third-Quarter Numbers
* Last Friday (10/28), the Commerce Department reported that real gross domestic product grew at a 3.8% annual rate during the third quarter, faster than the 3.3% rate during this year's June quarter. The third-quarter result was slightly better than a consensus forecast that was looking for something around 3.6% growth.
* Hurricanes Katrina and Rita made US landfall on August 29th and September 23rd, respectively. Chronologically speaking, therefore, third-quarter gross domestic product includes the early impact of those storms. Nevertheless, in its recent GDP release, the Commerce Department made no specific mention of the influence on the data from the two hurricanes.
* The three-month period ended September 2005 was the 16th consecutive quarter of reported real GDP expansion.
* The advance estimate of 3Q2005 real GDP exceeded the final estimate of 2Q2005 real GDP by $104.0 billion, or about 0.938%. Add one, then raise the result to the fourth power, and you get the rounded annual rate of change of 3.8%. This compares with respective 2Q2005 and 1Q2005 rates of 3.3% and 3.8%, and a 4Q2004 rate of 3.3%.
* The "better-than-expected" third-quarter strength helped launch a major rally in stocks (DJIA up 173 points, 1.7%). By itself, was a mere 0.2% difference in GDP growth worth that response? Certainly not, and here's why.
* While annualized real GDP is a huge number measured in the many trillions, relatively small changes from one quarter to the next have a sizable impact on annual rates of change. For instance, a $104.0 billion increase between the second and third quarters resulted in a change of 3.8%. But had real GDP expanded by $99 billion instead of the reported $104 billion, the rate of change would have come in at the expected 3.6%. How big a deal is $5 billion? Not very big, not when you consider the complexity and enormity of the various components, and that last week's reported data are subject to two more revisions over the next two months, then additional revisions in coming years.
Nominal (Pre-Inflation) Comparisons
* Versus 2005's second quarter, 3Q2005 nominal GDP rose $211.6 billion, or at an annual rate of 7.0%. The respective numbers: 3Q2005 = $12589.6; 2Q2005 = 12378.0 billion.
* Versus 2004's third quarter, 3Q2005 nominal GDP rose $770.8 billion, or 6.5%. The respective numbers: 3Q2005 = $12589.6 billion; 3Q2004 = $11818.8 billion.
Real (After-Inflation) Comparisons
* Versus 2005's second quarter, 3Q2005 real GDP rose $104.0 billion, or at an annual rate of 3.8%. The respective numbers: 3Q2005 = $11193.2 billion; 2Q2005 = $11089.2 billion.
* Versus 2004's third quarter, 3Q2005 real GDP rose $384.3 billion or 3.6%. The respective numbers: 3Q2005 = $11193.2; 3Q2004 = $11808.9 billion.
"Advance" Vs. "Final" Comparisons
* Five of the six primary GDP categories added to real growth in the "advance" 3Q2005 GDP estimate versus the "final" 2Q2005 estimate. One subtracted from it. The net result was an increase of $104.0 billion.
The categories adding to growth in order of their dollar contribution, these were:
(1) Personal consumption expenditures (+$75.2 billion),
(2) Nonresidential fixed investment (capital
spending, +$19.4 billion),
(3) Government spending (+$15.8 billion). Federal
spending contributed about $13.8 billion to the
total increase, of which $12.2 billion came from
an increase in national defense spending. State
and local government spending was up the remaining
$2.0 billion.
(4) Residential fixed investment (housing, +$7.0
billion),
(5) Net exports (+$2.4 billion), by virtue of a
narrowing in the trade deficit by that amount).
Inventory change was the category subtracting from growth. It registered a decline during the quarter of $14.9 billion.
The following table breaks out in greater detail many of the numbers discussed above. Note that the additional data in the far right-hand column represents a change in format from previous reports.
----------------------------------------------------------
ADVANCE ESTIMATE OF THIRD-QUARTER 2005
REAL GROSS DOMESTIC PRODUCT (Released
10/28 -- Billions of 2000 Chained Dollars
at Seasonally Adjusted Annual Rates)
----------------------------------------------------------
3Q2005 2Q2005 Change/ 2Q05F/
Advance Final Impact 1Q05F
--------------------------------
Real GDP 11193.2 11089.2 3.8% 3.3%
Inventory Change -16.6 -1.7 -$14.9 -$59.9
Real Final Sales 11208.5 11089.2 4.4% 5.6%
----------------------------------------------------------
Components of GDP
-----------------
Personal Consumption 7904.7 7829.5 3.9% 3.4%
Nonres. Fixed Investment* 1298.4 1279.0 6.2% 8.8%
Resid. Fixed Investment 606.3 599.3 4.8% 10.8%
Net Exports -611.8 -614.2 +$2.4 +$31.2
Government Purchases* 1999.9 1984.1 3.2% 2.5%
----------------------------------------------------------
Implicit Price Deflators:
Gross Domestic Product 3.1% 2.6% -- --
Gross Domestic Purchases 4.0% 3.3% -- --
----------------------------------------------------------
*MEMO ITEMS
-----------
Government Purchases
--------------------
Total 1999.9 1984.1 3.2% 2.5%
State & Local 1249.8 1247.8 0.6% 2.6%
Federal 749.9 736.1 7.7% 2.4%
National Defense 503.9 491.7 10.3% 3.7%
Nonresidential
Fixed Investment
----------------
Total 1298.4 1279.0 6.2% 8.8%
Structures 251.8 252.7 -1.4% 2.7%
Equipment & Software 1063.3 1040.9 8.9% 11.0%
Info. Processing
Equip. & Software 603.1 584.6 13.3% 14.5%
----------------------------------------------------------
MAJOR GDP COMPONENTS -- CHANGES BETWEEN
"ADVANCE" 3Q2005 AND "FINAL" 2Q2005 ESTIMATES
(Billions of 2000 Chained Dollars at
Seasonally Adjusted Annual Rates)
----------------------------------------------------------
3Q2005 2Q2005
Advance Final Change
----------------------------
Real GDP 11193.2 11089.2 104.0
Inventory Change -16.6 -1.7 -14.9
Real Final Sales 11208.5 11089.2 119.3
---------------------------------------------------
Personal Consumption 7904.7 7829.5 75.2
Nones. Fixed Invest. 1298.4 1279.0 19.4
Resid. Fixed Invest. 606.3 599.3 7.0
Net Exports -611.8 -614.2 2.4
Govt. Purchases 1999.9 1984.1 15.8
----------------------------------------------------------
REAL GROSS DOMESTIC PRODUCT (SEASONALLY
ADJUSTED ANNUAL RATES, 2000 CHAINED DOLLARS)
--------------------------------------------
Year Q1 Q2 Q3 Q4
----------------------------------------
2005 3.8% 3.3% 3.8% --
2004 4.3% 3.5% 4.0% 3.3%
2003 1.7% 3.7% 7.2% 3.6%
2002 2.7% 2.2% 2.4% 0.2%
2001 -0.5% 1.2% -1.4% 1.6%
2000 1.0% 6.4% -0.5% 2.1%
1999 3.4% 3.4% 4.7% 7.3%
1998 4.5% 2.7% 4.7% 6.2%
-----------------------------------------
MEMO ITEM: Annual change in real GDP
before and after the "comprehensive
revision" published by the Commerce
Department on 12/10/03.
-----------------------------------------
1929-2002 1959-1992 1992-2002
---------------------------------
After 3.4% 3.4% 3.2%
Before 3.4% 3.4% 3.2%
----------------------------------------------------------
Real Vs. Nominal: The Whiff of "Stagflation" Continues
* The recent third-quarter estimate showed increases in the primary GDP inflation measures, versus the second-quarter data -- to 3.1% from 2.6% for the overall GDP implicit price deflator, and to 4.0% from 3.3% for the implicit price deflator for personal consumption expenditures. The current numbers certainly keep in play "stagflation" concerns.
Here are how the key GDP inflation measures have performed over the last eleven quarters (% change at annual rates):
2003 2004 2005
------------------ ------------------ -------------
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
-------------------------------------------------------
[1] 3.1 1.1 1.9 1.8 3.7 3.9 1.3 2.7 3.0 2.6 3.1
[2] 4.1 0.4 2.1 1.6 4.3 4.1 1.9 3.2 2.9 3.3 4.0
-----------------------------------------------------------
Implicit price deflators for:
[1]GDP; [2]gross domestic purchases.
-----------------------------------------------------------
* On 7/29, the Commerce Department published benchmark GDP revisions from 2002 forward. Of the 13 quarters comprising the revision period, inflation as measured by the implicit price deflators for both overall GDP and for personal consumption expenditures was revised higher in 10 of them, lower in two of them, and left unchanged in one of them.
* Nothing in those benchmark revisions or in the latest numbers dispelled my warning of many months ago, to wit: At least a whiff of "stagflation" was returning to these numbers. And in this regard, it remains important to lay out the critical difference between relatives and absolutes.
* Many on Wall Street would have you believe that stagflation is a phenomenon only present with high inflation rates, which is not accurate. Three reasons I can quickly think of might account for this distortion:
(1) Perhaps many of today's very bright but very young and inexperienced analysts simply were not taught certain relationships during their formal education process.
(2) Stagflation of the past often was accompanied by very high inflation rates. For instance, the inflation accompanying the so-called "Carter Malaise" period of the late 1970s was among the highest in the nation's history, with the reported CPI and PPI rates well into double digits.
(3) Stagflation does not denote a positive environment. Therefore, inherently, it is not something Street bulls would want to talk about. Thus, since reported inflation rates of the last few years have been low, if you associate stagflation with high inflation rates, you automatically have found a way either to avoid or to spin the subject.
* I suspect that number three has a good deal of merit. But as to the way the phenomenon works in practice, high inflation rates are definitely not necessary to experience stagflation. Instead, it is present when inflation becomes a relatively large and growing portion of nominal or total growth.
* Stagflationary environments simply are not healthy ones. History unambiguously shows that they create stress and distortions that are injurious to the economy in both macro and micro terms.
The following table breaks out the relationship between nominal and real gross domestic product over the last 15 quarters.
----------------------------------------------------------
NOMINAL AND REAL GROSS DOMESTIC PRODUCT
(SAAR, 2000 Chained Dollars); RATIO OF REAL
TO NOMINAL; IMPLICIT PRICE DEFLATORS FOR
GDP AND FOR GROSS DOMESTIC PURCHASES
(Incorporates Benchmark Revisions of 7/29/05)
----------------------------------------------------------
Year Q1 Q2 Q3 Q4
------------------------------------------------
2005 Nominal 7.0% 6.0% 7.0% --
Real 3.8% 3.3% 3.8% --
R/N 0.54 0.55 0.54 --
================================================
GDP Def. 3.0% 2.5% -- --
PCE Def. 2.9% 3.2% -- --
------------------------------------------------
2004 Nominal 8.1% 7.5% 5.3% 6.1%
Real 4.3% 3.5% 4.0% 3.3%
R/N 0.53 0.47 0.75 0.54
===========================================
GDP Def. 3.7% 3.9% 1.3% 2.7%
PCE Def. 4.3% 4.1% 1.9% 3.2%
------------------------------------------------
2003 Nominal 4.8% 4.8% 9.3% 5.5%
Real 1.7% 3.7% 7.2% 3.6%
R/N 0.35 0.77 0.77 0.65
===========================================
GDP Def. 3.1% 1.1% 1.9% 1.8%
PCE Def. 4.1% 0.4% 2.1% 1.6%
------------------------------------------------
2002 Nominal 4.3% 3.7% 3.9% 2.4%
Real 2.7% 2.2% 2.4% 0.2%
R/N 0.63 0.59 0.62 0.08
===========================================
GDP Def. 1.5% 1.4% 1.5% 2.2%
PCE Def. 1.3% 2.4% 1.6% 2.2%
----------------------------------------------------------
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