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Economic Insights

Amid optimistic projections of an acceleration in growth, the factors that have restrained GDP remain firmly in place. 

A relatively strong end to 2013 seems to have generated talk of a generalized and sustained economic acceleration going forward. Journalists, tired of writing about slow growth, have embraced the new story line. The Federal Reserve and the International Monetary Fund (IMF) have raised their growth estimates for the U.S. economy in 2014 and 2015. Though a recovery doubtless will continue, the acceleration of which so many discuss will likely remain elusive. Never mind that these organizations have persistently shown overly optimistic projections—all that has kept growth slow to date remains in place.

No doubt the flow of statistics as the year progresses will change consensus opinion. It always does. In the final tally, a technical debate will ensue as to whether the forecasted acceleration was right or wrong. The pro and con of that dispute will, as always with economists, resemble the modern equivalent of medieval concerns over how many angels can dance on the head of a pin. To render the argument even sillier, it will revolve around statistics that will remain subject to revision for a long time to come. But as the following discussion of recent trends and their sustainability will show, the underlying picture, whatever the precise statistics that debaters reference, will remain one of continued, subpar economic recovery.

The root of all this recent enthusiasm is evident in the overall real gross domestic product (GDP) figures for the past year. The opening quarter of 2013 came in at a disappointing 1.1% real annualized growth rate, slow even by the standards of this disappointing recovery. At the time, the usual threats about a second recessionary dip gained currency and began to take over consensus thinking. The second quarter blunted some of this pessimism. It showed real growth up at a 2.5% annualized real rate, hardly good by the standards of past cyclical recoveries, but at least back on track with the rest of this disappointing recovery and enough to scotch talk of recession. The third quarter showed more strength, a 4.1% annualized rate of real growth. The preliminary 3.2% real growth figure for the fourth quarter seemed to confirm, at least for some, that something good was happening.1 Though even these figures look slow by the standards of past recoveries, they were enough to change the tone of consensus chatter. Recent weaker numbers already have taken some of the bloom of the rose of growth enthusiasm.

A Question of Inventories
Inventory patterns always presented a reason to doubt expectations of robust growth. A remarkable amount of the second half acceleration reflected an accumulation of goods on shop shelves and in warehouses across the country. According to the current state of statistics offered by the Commerce Department, this accumulation alone accounted for a little less than a third of the second half growth and almost two-thirds of the acceleration over the first half of the year. But though the Commerce Department reasonably counts inventories in the GDP because the economy produced them, they remain unsold. Actual final sales to final users in the second half grew much less robustly, at a 2.6% average annualized rate, up, admittedly, from the 2.3% annualized rate of the first half, but hardly the picture of a marked pick up that emerges when inventory accumulations are included, as they are in the headline figures.2

There is something else about this inventory buildup. Going forward, business is likely to meet future sales with these accumulated stocks of goods instead of with new production, or at least it will meet some of those sales in this way. Because a depletion of inventories would count against the gross growth figure, that measure would then trail the pace of final sales. To be sure, inventory sales ratios are up only slightly, and so invite only a small adjustment. Auto inventories today, for instance, stand at almost 2.2 months' sales, up from just over 2.0 a year ago. Overall retail inventories, presently at almost 1.5 months of sales, are less than 3.0% higher than they were a year ago. It is, however, far from a huge overhang. But it could convince management to trim inventory stocks a bit and certainly not to add much more to them. Either way, the figures going forward would miss the inventory fillip they got during 2013's second half. At best, the overall real GDP record would just about track the ongoing slow pace of final sales, at about a 2.5% annualized rate.3

The Household Sector
Consumer spending did accelerate in the fourth quarter, at least according to the Commerce Department's preliminary figures. Its overall annual rate of real growth registered 3.3%, compared with an average annual growth rate of 2.0% for the first three quarters of the year. Spending on housing buoyed the third quarter especially, expanding in real terms at a 10.3% annualized growth rate.4 But three factors call into question the sustainability of both those contributions to overall real GDP growth, at least at the pace of last year's second half. One is still weak labor markets and the implications that they have for income growth. The second is the already evident slowdown in home sales and construction. And the third is the mix of the recent spending surge.

Hiring remains lackluster. Some months show better payroll growth than others, contributing to alternating bouts of optimism and pessimism, but the underlying trend can at best be described as sluggish. During the past 18 months, payrolls averaged a monthly rise of 181,000, far slower than in past recoveries. During the last six months, the average actually slowed to 170,000 a month. At the same time, the average weekly wage has increased at a paltry 1.5% annual rate. This wage figure would have shown even slower growth were it not that industry turned to overtime in place of hiring. The resulting combination of employment and wage growth is sufficient to propel modest growth in consumption, but not enough to sustain the strong pace registered during fourth quarter 2013 especially. As it is, households, to support that expansion in consumption, had to slow their pace of savings, from 4.9% of their aftertax income last summer to 4.3%.5 Even if households are willing to renounce the embrace of thrift they made after the 2008–09 recession and financial crisis, there are limits to how far this can go.

Meanwhile, the housing recovery, which had gained such striking momentum earlier in 2013, has begun to slow. Its earlier powerful pace was never sustainable. Lenders have remained reluctant to extend credit, and besides, the recorded surge was more a typical statistical bounce from a very low trough than anything fundamental. It is noteworthy in this regard that the power of the initial surge occurred almost exclusively in those regions of the country where the previous downdrafts were most severe—Southern California, Nevada, Arizona, and Florida. The rise in mortgage rates during summer, after the Fed announced its decision to taper its rate of quantitative easing, reinforced a slowdown that was otherwise built into the fundamentals. Actually, sales and construction fell some during the later months of 2013. The sector will likely return to growth. Residential real estate remains historically affordable, even with the rise in home prices earlier in the year and the more recent rise in mortgage rates. And lenders are becoming a little easier about extending credit for home purchases. But the sector will not likely return to the rapid growth pace of earlier in 2013.6

And then there is the mix of spending during the surge. Three areas showed the greatest sales growth—autos, home furnishings and appliances, and recreational goods and vehicles, each expanding in real terms at annualized rates of, respectively, 3.0%, 9.6%, and 10%. Certainly, the slowdown in housing sales and construction should slow the pace of spending on home furnishings and appliances going forward. But more than that, all these sorts of purchases are durable goods. For most people, they constitute a one-time purchase that is not repeated for years. This recent surge reflected a measure of confidence that allowed consumers to catch up with long-deferred purchases. The average age of the country's auto fleet had reached the point where some large measure of replacement was all but inevitable. Perhaps that effect will carry on a little longer, but, by its nature, it cannot persist for long. As with other sources of this surge, its strength will likely fade, even as some moderate growth continues. The seemingly sudden 0.4% decline in retail sales recorded for January7 would seem to confirm this slowing picture, but, of course, the weather-induced severity of the adjustment overstates the degree of weakness.

Capital Investment and Trade
Capital investment by business and industry was only a small part of the second half GDP surge. There was only a slight acceleration in real spending on equipment, from a 2.5% real annualized rate of gain in the first half to a 3.1% rate in the second half. Real spending on what the Commerce Department calls "intellectual property" accelerated more, from a real 1.1% annualized rate of advance in the first half to a 4.5% rate in the second half. Meanwhile, real spending on structures and other fixed facilities followed its typical lumpy pattern, falling in real terms at a 25.7% annual rate in the first quarter, rising at a 17.6% rate in the second and at a 13.4% rate in the third, only to fall at almost a 10.0% annualized rate in the last quarter, at least according to preliminary figures. All this spending on average contributed a bit over half a percentage point to overall real GDP growth.8 Though there is every reason to expect this to continue, the caution continuously shown by business for years now, in its expansion plans, its hiring, even in its acquisitions, makes it doubtful that such spending will surge at all, much less enough to change the overall economic picture.

Trade is very different. Both a rise in exports and a fall in imports contributed greatly to the GDP acceleration during 2013's second half. Real exports accelerated from a 3.4% real annualized rate of growth during the year's first half to a 7.6% rate during the second half. Real imports, which count as a negative in the Commerce Department's GDP calculation, slowed from a 3.8% annualized rate of real growth in the first half to only a 1.7% rate in the second half. Combined, the contribution of net trade to real GDP growth swung from a 0.2 percentage-point detraction in the first half to more than a 0.7 percentage-point contribution in the second, a swing of almost a full percentage point.9 Because so much of this improvement reflects the fracking revolution in the energy industry, which is still gaining momentum, there is reason to expect the positive effects to persist into 2014 and 2015 and beyond, if not quite at the recent pace, at a significant pace nonetheless.

Government
This area, which detracted from growth all last year, should offer a modest contribution over the next 12–24 months. Actually, state and local government spending had begun to pick up a small measure of momentum last spring. Tax revenues have at last begun to pick up—not enough, of course, to put state and local government finances in good shape, but enough to turn the picture from one of cutbacks to one of modest re-hiring and modest increases in spending on other obligations. It was not a big deal. Such outlays in real terms went from declines of about 1.0% at an annual rate in 2012's last quarter and 1.3% in 2013's first quarter to a growth of about 1.3% in 2013's second half.10 Hardly the stuff of a boom, but an improvement nonetheless and one that shows every indication of persisting.

The federal picture should turn around more dramatically. Spending on goods and services, for defense and non-defense purposes, the only part that counts in the GDP, fell consistently throughout 2013, at a 5.0% annual rate in real terms during the first half of the year and at a 7.1% rate on the second half. But as the recent budget deal has postponed any sequester effects for a couple of years, the declines of last year should turn to modest increases this year, perhaps as much as 2.0–2.5% in real terms. So whereas federal cutbacks detracted some 0.4 percentage points from overall real GDP growth last year, they may add slightly, perhaps 0.2 percentage points, to growth during 2014.11 That change constitutes a swing of more than half a percentage point—not enough to drive a substantive acceleration, but a contribution to the overall growth picture, nonetheless.

Pulling the Threads Together
Though the picture in trade and government would suggest some real growth acceleration, these are hardly enough to overwhelm the larger areas expected to slow. Capital spending, after all, will likely track a still modest growth path and consumer spending going forward will, as explained, likely grow at a slower pace than in last year's second half. Since the consumer constitutes some 70% of the economy, even a modest slowdown in the sector can offset the aggregate effect of modest accelerations elsewhere. Meanwhile, housing, though it will likely resume its recovery in 2014, will expand at nowhere near the speed of 2013. The inventory effect will almost surely slow the aggregate growth pace. The balance is a continued slow recovery along the lines to which all have grown accustomed over these last few years, even if the exact contours of the mix clearly will change.

 

 

1 All data from the Department of Commerce.
2 Ibid.
3 Ibid.
4 Ibid.
5 Ibid.
6 S&P/Case-Shiller data.
7 All data from the Department of Commerce.
8 Ibid.
9 Ibid.
10 Ibid.
11 Ibid.

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ABOUT THE AUTHOR

CRITICAL RELEASES IN THE WEEK AHEAD

Milton Ezrati examines the key economic and financial releases scheduled for the coming week. 

KEY MOVER:

Durable Goods Orders for January*
Thu., February 27, at 8:30 a.m. ET
Previous: -4.3% • Prospect: +0.5%

The sudden drop recorded for December centered on one-time events in aircraft and autos. The January report should return to a moderate recovery path.
*Source: Department of Commerce.

OTHERS TO WATCH:

S&P/Case-Shiller HPI for November*
Tue., February 25 at 9:00 a.m. ET
Previous: -0.6% • Prospect: +0.2%

December's drop was a surprise after so many months recording unsustainably strong rates of price appreciation. This strength mostly reflected a bounce off a deep trough in very depressed regions of the country. The unsustainability of that trend and the rise in mortgage rates combined to halt this bounce. The still attractive affordability of housing should allow modest increases to resume with the November report.
*Source: Standard & Poor's.

New Home Sales for January*
Wed., February 26, at 10:00 a.m. ET
Previous: -7.0% • Prospect: -1.5%

In October and November, sales had gotten way ahead of the sustainable trend. Even the sharp downward adjustment recorded for December failed to bring these figures back to trend, inviting a further downward adjustment in the January release.
*Source: Department of Commerce.

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