JOHN WILLIAMS’ SHADOW GOVERNMENT STATISTICS

COMMENTARY NUMBER 261
Third-Quarter GDP Revision

November 24, 2009

__________

Lower GDP Growth Still Heavily Overstated

3rd-Quarter GDP at 2.8%, GDI at 2.0%

"Reduced" Inflation Bloated Reported Activity

Revised Salaries and Wages Soared as
Employment Collapsed?

__________

PLEASE NOTE: The next regularly scheduled Commentary is planned for Friday (December 4th), following release of the November employment and unemployment data. An intervening Commentary, however, will be published early next week to address the outlook for the employment/unemployment  report, as well as to assess reporting results on new orders for durable goods (October), on both new and existing home sales (October) and on both consumer confidence and sentiment (November) .

– Happy Thanksgiving! Best wishes to all, John Williams

 

GDP Data Quality Remains Seriously Impaired. Though formally followed by the media and analysts as the government’s broadest measure of economic activity, the GDP remains absolutely the worst-quality and most-heavily-politicized major economic report. Over the near-term, GDP reporting largely is based on government guesses, not on hard data. Accordingly, as seen today, major revisions to the previously published data are not unusual. Over the long-term, the GDP is structured with seriously-flawed concepts. One issue involves chain-weighted inflation used in deflation, with the effect that the subsidiary series never add up to the aggregate series. Another includes imputations such as what homeowners would pay to rent from themselves the homes that they otherwise own. Absurdities such as the imputations may be theoretical necessities to make the national income accounting work, but they have little, if any, relationship to the real world, and they face extreme distortions in extreme economic circumstances such as the current depression.

In contrast, despite all the reporting issues I have with the employment and unemployment data, those series are the best, broadest measures of economic activity published by the government. While those data suffer seasonal-factor distortions for both series and short-term surveying problems for the payroll data, the numbers are based on actual surveys, and, at least after revisions, give a much more realistic picture than the GDP of what is happening in domestic economic activity. As will be discussed early next week, the employment environment continued to deteriorate in November.

 

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. 


GDP.  The "second" guesstimate of, and first revision to third-quarter 2009 Gross Domestic Product (GDP) released this morning (November 24th) by the Bureau of Economic Analysis (BEA) showed a downwardly-revised annualized real growth rate for the quarter of 2.78% +/- 3% (95% confidence interval), reduced from an initial estimate of 3.53%. Such followed a 0.74% decline reported for second-quarter GDP.

The largest adjustments to the first estimate of third-quarter GDP were deteriorations in the net export account and in personal consumption expenditure, the latter category reflecting a less-robust boost than previously estimated from the cash-for-clunkers automobile rebate program.  

Net of the impact of a downward revision to the third-quarter GDP implicit price deflator, from an annualized quarterly inflation pace of 0.76% to 0.50%, the quarterly GDP growth rate would have revised to 2.52% instead of to 2.78%. Inflation estimation is central to real GDP reporting and gimmicking. The weaker the inflation rate used for deflating the GDP, the stronger will be the inflation-adjusted growth rate. The revised 0.50% annualized third-quarter GDP inflation was up from an annualized contraction of 0.02% in the second quarter. In contrast, reported 3.60% annualized third-quarter CPI-U inflation was up from an annualized positive inflation rate of 1.33% in the second quarter. If the reported GDP inflator moved in tandem with CPI, which is not too farfetched a concept, the bulk of the reported real growth in third-quarter GDP would disappear.

The year-to-year contraction in real third-quarter GDP widened to 2.51% from an initial reporting of 2.33%. That still was a smaller annual contraction than the record 3.83% decline reported for the second-quarter. As shown in the above graph, the latest year-to-year decline generally is in line with annual-growth troughs of the major post-World War II recessions.

The SGS Alternate-GDP estimate for third-quarter 2009 remains an annual contraction of 5.7% versus the 2.5% official estimate, narrowed from an annual 5.9% (3.8% official estimate) contraction in the second quarter. While annualized real quarterly growth is not formally estimated on an alternative basis, a flat quarter-to-quarter circumstance, plus or minus, likely was realistic. I look for a renewed quarter-to-quarter contraction in the GDP as of fourth-quarter 2009.  

GNP. The initial estimate of gross national product for third-quarter 2009 showed annualized real growth of 3.76%, up from a 0.96% contraction in the second-quarter. Year-to-year change narrowed to a 2.70% contraction in the third-quarter from a 4.04% contraction in the second-quarter. 

This number indicates a fair trade surplus in third-quarter factor income (interest and dividend payments), which likely is heavily distorted by the systemic solvency crisis and extremely poor-quality reporting of payment flows in the current extraordinary circumstances. I would expect to see significant revision to this series in the year ahead.

GDP. The initial estimate of gross domestic income for third-quarter 2009 showed annualized real growth of 1.98%, up from a revised 0.07% (previously 2.57%) contraction in the second-quarter. Year-to-year change narrowed to a still historically severe 3.36% contraction in the third-quarter from a 4.09% contraction in the second-quarter.

The GDI reporting included an extraordinary upside revision to second-quarter wages and salaries of 1.32%. While there likely will be some more detail in tomorrow’s (November 25th) reporting of October personal income, this change is extraordinary in that it runs completely opposite to the massive downward revision pending in nonfarm payrolls — due for release in February 2010 — based on the May 2009 (second quarter) downside benchmark revision estimated by the Bureau of Labor Statistics at 824,000 jobs. The GDI salaries and wages are calculated based on employment levels.

Week Ahead. Given the underlying reality of a weaker economy and a more serious inflation problem than generally is expected by the financial markets, risks to reporting will favor higher-than-expected inflation and weaker-than-expected economic reporting in the month ahead. Such is true especially for economic reporting net of prior-period revisions.

New Orders for Durable Goods (October 2009). Due for release tomorrow on Wednesday, November 25th, October’s new orders for durable goods likely will continue recent patterns, with the randomly volatile series showing a statistically insignificant month-to-month change, with orders holding at a low-level plateau of activity. Year-to-year change will remain sharply negative, although the pace of annual contraction will turn less negative, against year-ago comparisons that were entering something close to freefall at the time.

  

_________