Real Final Sales Drive GDP to Downside

by Rick Davis, Consumer Metrics Institute

In their second estimate of the US GDP for the first quarter of 2015, the Bureau of Economic Analysis (BEA) reported that the economy was contracting at a -0.75% annualized rate, down a full percent from the +0.25% estimated last month, and down sharply (-2.97%) from the +2.22% growth rate recorded for the prior quarter.

And according to the “real final sales of domestic product” (BEA’s very own “bottom line” for the economy), the economy shrank at more than a percent (-1.08%) during the quarter, down -3.40% from last quarter’s +2.32%.

A look at the details provides little comfort. The already anemic consumer spending on goods improved a smidgen to +0.10% annualized growth, and fixed commercial investment also improved — although only to a “less bad” contraction rate of -0.21% (from -0.40%). All other changes made the report awash with red: imports were revised downward significantly (a -0.58% decline), inventory growth was weaker by -0.41%, consumer spending on services dropped -0.13%, government spending was -0.05% lower and the contribution from exports declined -0.07%.

Real annualized per capita disposable income was also revised downward by -$25 (now reported to be $38,210 per annum). Meanwhile, the household savings rate was unchanged at 5.5% (the highest rate since the fourth quarter of 2012), which accounts to a large extent for the continued sluggish consumer spending.

For this report the BEA assumed a mild dis-inflationary annualized deflator of -0.12%. Interestingly, during the same quarter the far more responsive Billion Prices Project (BPP) recorded mild positive inflation. If the BPP inflation metric was used to deflate the nominal BEA data the economy could be shown to be contracting at a more than -2.69% annualized rate.

Among the notable items in the report :

• The headline contribution from consumer expenditures for goods was +0.10% (down -0.97% from the prior quarter).
• The contribution to the headline from consumer services spending decreased to +1.13% (down -0.78% from the previous quarter). Healthcare spending alone provided +0.60% to the headline number. The combined consumer contribution to the headline number was 1.23%, down -1.75% from the prior quarter.
• Contracting commercial private fixed investments removed -0.21% from the headline number — down nearly a full percent (-0.93%) from the fourth quarter of 2014. This drop occurred in spending for structures, industrial equipment and IT equipment. Some growth was reported in transportation equipment and intellectual property.
• Inventory growth added +0.33% to the headline number (up +0.43% from the previous quarter). Once again it is important to note that this number has logically and historically been nearly zero-sum over extended time periods, and future mean reversion to the zero sum should be expected.
• Governmental spending removed -0.20% from the headline (up +0.15% from the -0.35% for the previous quarter). The remaining contraction was largely the result of decreased state and local spending on infrastructure.
• Exports are suffering from the strong dollar, and are now reported to be subtracting -1.03% from the headline growth rate (down -1.62% from the previous quarter).
• Imports subtracted substantially less from the headline number (-0.87%) than during the prior quarter (-1.62%) — also an expected consequence of the stronger dollar.
• The “real final sales of domestic product” is now contracting at a -1.08% annualized rate. This is the BEA’s “bottom line” measurement of the economy and it excludes the reported inventory growth.
• And as mentioned above, real per-capita annual was revised downward in this report, but it is still up $432 per year quarter-to-quarter. The new number represents an annualized growth rate of +4.65%. But it is up only +4.18% in aggregate since the second quarter of 2008 — an annualized +0.61% growth over the past 26 quarters. The reported softening growth in consumer spending is a consequence of a significant increase in household savings — i.e., most of that $432 quarter-to-quarter growth went into savings.

The Numbers, As Revised

As a quick reminder, the classic definition of the GDP can be summarized with the following equation :

GDP = private consumption + gross private investment + government spending + (exports – imports)

or, as it is commonly expressed in algebraic shorthand :

GDP = C + I + G + (X-M)

In the new report the values for that equation (total dollars, percentage of the total GDP, and contribution to the final percentage growth number) are as follows :

The quarter-to-quarter changes in the contributions that various components make to the overall GDP can be best understood from the table below, which breaks out the component contributions in more detail and over time. In the table below we have split the “C” component into goods and services, split the “I” component into fixed investment and inventories, separated exports from imports, added a line for the BEA’s “Real Final Sales of Domestic Product” and listed the quarters in columns with the most current to the left :

Click for larger image.

Summary and Commentary

We had trouble writing the headline for this report. We ultimately chose the more politically neutral phrase “BEA Reveals that …” in lieu of the probably more accurate “BEA Admits that …” for the headline. Cynically minded observers have often claimed that the BEA manipulates the first estimate for any quarter to lead future expectations in the right direction — while not fully disclosing pending bad news. Although last month’s first estimate was just barely positive, it was far enough below the expectations of most economists to send a clear warning that even worse numbers will soon be forthcoming. It just seems that the full truth is too painful for full initial disclosure.

It reminds us of the Lucy Ricardo character never divulging the full extent of her latest disaster when first asked. It is only after Ricky inevitably says “Lucy, you have some ‘splaining to do” that the full truth is revealed.

We should expect (dare we say “demand“?) better transparency from a Federal agency that is tasked with tracking the state of the economy — an agency which, unlike Lucy, is not itself culpable for the bad news. The BEA explains that they are working with largely incomplete data some 30 days after the end of the quarter (a situation which may have been acceptable in 1936, but is arguably unacceptable in 2015 — an era of microsecond transactions and real-time settlements). But even in a state of incomplete data (for which they are culpable) they certainly know the tendencies in their sadly lagging data — and therefore they should be capable of better extrapolating where things actually were at the end of the quarter. Instead they seem to take the happiest assumptions available, knowing that they have months (and ultimately years) to finally get the view in the rear mirror correct. Unfortunately, economic decisions are often made from that badly distorted rear-view mirror.

Perhaps the most discouraging aspect of this report is the extent to which many economists were surprised. Perhaps it is they who have “some ‘splaining to do.”