US GDP data shows Gross Distorted Position of the Country

The publication of the US 2nd quarter GDP figures highlighted several striking and interlinked structural trends in the US economy. These go considerably beyond the well publicized slowing of the US economic recovery. The data confirms the US recovery is weak. Unsurprisingly, because it was anticipated, and as has been widely reported, the data confirmed the slowdown in US economic recovery.

The advance estimate of second-quarter GDP growth came in at 2.4%, below the expectation going into the report of 2.7%, underlining a deceleration in growth. That deceleration was made starker still because first-quarter growth was revised up to 3.7%, from the previous 2.7% estimate. The report included revisions going back to 2007, and despite the upward revision to the first quarter, revisions overall reduced historical growth estimates.

Consumer spending – which accounts for two-thirds of US GDP and is seen as a lead indicator of economic recovery – slowed, rising by 1.6pc in the quarter, compared with 1.9pc in the prior three months. The savings rate rose to 6.2pc as consumers instead put money to one side. The biggest factor in the slowdown was the US's widening trade deficit, following a 28.8pc surge in imports – the sharpest rise in 26 years – against a 10.3pc rise in exports.

Historical revisions in GDP report, stretch back to 2007, and they have reduced growth by an average of 0.2 percentage point per year. The biggest shift is in 2008 growth (now zero instead of 0.4%). The peak-to-trough decline in GDP during the recession is now 4.1%, instead of 3.8%, further underlining the status of this recession as the worst in the postwar era. For those interested in the minutiae, the peak GDP quarter is now the fourth quarter of 2007 with GDP of -6.8%; the rise in GDP during the second quarter of 2008 is now insufficient to reverse its first-quarter drop. As a result, the peak GDP quarter now lines up with the official monthly cycle peak of December 2007, identified by the NBER's Business Cycle Dating Committee.

Such figures have essentially decided the debate between those who argued that because the US downturn was very severe its economy would spring back strongly from recession, and those, such as the present author, who pointed to the underlying structural situation of the US economy and therefore argued recovery would be weak compared to previous US post-war business cycles.

Chart below illustrates how much weaker the present US economic recovery is than in previous post-war business cycles. In the previous most serious post-war cyclical downturn, that following 1973, the US economy regained its previous peak level of production after eight quarters. In this recession after 10 quarters the US economy has still not recovered its peak GDP level.

Source: US Bureau of Economic Analysis

As also widely reported, the new GDP data now calculates the US recession was deeper, and started earlier, than previously estimated. Peak US GDP is now analysed as having occurred in the 4th quarter of 2007 rather than the 2nd quarter of 2008 as previously estimated. The trough of US GDP in the 2nd quarter of 2009 is now calculated to have been 4.1% below the cyclical peak level - the previous deepest fall in a US post-World War recession, that after 1973, was 3.2%.

These revisions help explain a few head scratchers that have irritated economists in recent months, but still don’t fully resolve them. First, the deeper recession will temper some of the unusually strong productivity gains that were reported over the recession. Second, that deeper recession also provides a little more rationale for the large degree of job losses that materialized over the period. Third, the resulting larger amount of economic slack provides a little more support for the persistently low rate of core inflation (with pressures still on the downside), as the recovery gets increasingly long in the tooth.

Some economists - Geithner, Summers etc - say that the US is recovering. Some others, such Marc Faber, say that the US is not recovering and it is headed into inflation. Still others agree that the US is not recovering, but they also believe it is headed into hard-core deflation. But Bill Bonner of Daily Reckoning, calls all of them wrong and instead believes the US is headed into soft-core, Japanese-style deflation. It remains to be seen who eventually turns out to be correct. Given the importance of the US economy, investors in India will also feel the impact.