Mish's Global Economic Trend Analysis

Double Dip Delayed, Not Derailed; Understanding Consumer Spending

Posted: 29 Oct 2010 11:47 AM PDT

The BEA Advance GDP for Third Quarter 2010 came in at +2.0%. However, Table 2. Contributions to Percent Change in Real Gross Domestic Product shows that Change in private inventories contributed +1.44 while real final sales contributed a mere .6.

How sustainable is that?

The answer is not very. This is likely the last hurrah for inventory replenishment even without factoring in upcoming cutbacks at the state level.

Not a V-Shaped Recovery

In terms of real final sales, this "recovery", is the weakest on record. Dave Rosenberg has some thoughts on that in Lunch with Dave.

U.S. REAL FINAL SALES 60 BASIS POINTS SHY OF DOUBLE-DIPPING

The major problem in the third quarter report was the split between inventories and real final sales. Nonfarm business inventories soared to a $115.5 billion at an annual rate from the already strong $68.8 billion build in the second quarter — this alone contributed 70% to the headline growth rate last quarter. If we do get a slowdown in inventory investment in Q4, as we anticipate, it would really not take much to get GDP into negative terrain. We estimate that if the change in inventories slowed to about $94.0 billion in Q4 (about $22 billion below Q3 levels), GDP would contract fractionally. In other words, it won't take much for GDP to slip into negative terrain.

The recession may have technically ended, but outside of inventories, and the best days of the re-stocking process look to be behind us, this has been a listless recovery. At 60 basis points above zero, real final sales are just a shock away from double-dipping — a shock like looming tax hikes, accelerating fiscal cutbacks at the state/local government level or the millions of "99ers" about to fall off the extended jobless benefit rolls at the end of November.

In terms of components, the good news was that consumer spending did accelerate to a 2.6% annual rate from 2.2% in the second quarter — the best performance since Q4 2006. Non-residential construction eked out a 3.8% annualized gain, the first advance since Q2 2008. But the good news pretty well stopped there.

It is also no surprise to see imports bulge when inventories did the same, but what caught our eye in the external trade portion of the GDP report was the sharp slowing in export growth, to a 5% annual rate trend — half the pace we saw in the first half of the year. Weren't the overseas economies supposed to be providing a big lift to the U.S. economy?

Finally, state and local government spending dipped 0.2% — the fourth decline in the past five quarters. At a 12% share of the economy, this sector is nearly twice as large as business spending, and can be expected to be a dead-weight drag on the economy as far as the eye can see.

Here is the bottom line: the double-dip has been delayed but not derailed; despite widespread cries from the economic elite to the opposite. The economic recovery is extremely fragile and unless we get an improvement in real final sales, all it would take would be a modest inventory drawdown to pull real GDP back into contraction mode.

Consumer Spending up 2.6 Percent? - No Not Really

Rosenberg mentioned the one bright spot was consumer spending was up 2.6%. Indeed Table 2 in the BEA report shows Personal Consumption Expenditures were +2.6%.

However, it is important to understand what components make up PCE.

I talked about PCE on August 3, 2010 in Personal Income Flat, Private Wages and Salaries Decline in June; Is Consumer Spending 70% of GDP? Checkmark Recovery Revisited

Understanding PCE and Consumer Spending

To understand the discrepancy, we have to know what goes into PCE in comparison vs. retail sales. Here is an interesting article written in August of 2009 that addresses the issue.

Is Consumer Spending is 70% of GDP?

Economist Michael Mandel's article Consumer Spending is *Not* 70% of GDP not only addresses the above question, he also explains the apparent discrepancy between retail sales and consumer spending. Let's take a look.
I opened up this morning's NYT and see the big headline "Retailers See Slowing Sales in a Key Season." And I just know that we are about to have another round of "consumer spending is 70% of gross domestic product, so blah blah blah blah of course we can't recover unless consumers start spending again." (Not in the NYT story, to their credit, but you can find similar quotes everywhere you look).

Blah blah indeed. As a textbook author, there are few things that frost me more than hearing "consumer spending is 70% of gross domestic product," because it perpetuates two very large and very misleading untruths.

First, the category of "personal consumption expenditures" includes pretty much all of the $2.5 trillion healthcare spending, including the roughly half which comes via government. When Medicare writes a check for your mom's knee replacement, that gets counted as consumer spending in the GDP stats.

At a time when we are wrangling over health care reform, it's misleading to say that "consumer spending is 70% of GDP", when what we really mean is that "consumer spending plus government health care spending is 70% of GDP."

Second, an awful lot of those back-to-school dollars are going to imported clothing and school supplies (how many of those laptops and iPods do you think are made in the U.S.?). A dollar of consumer spending does not translate into a dollar of domestic production.

In fact, the whole way that the BEA presents the GDP statistics points the public debate in the wrong direction. GDP stands for "gross domestic product"—that is, domestic production. But the breakdown of GDP is into expenditures categories—personal consumption expenditures, government consumption expenditures, etc.

I think we need to move towards presenting GDP in terms of production, rather than spending. We need a shift from the consumer to the producer as our main unit of analysis.

But for now, we need to stop being so darned obsessed with consumer spending.
Why Consumer Spending Is Important

I disagree with Mandel's last statement because sales tax revenues are extremely important to state budgets.

However, Mandel's excellent article helps explain many things even alleged "productivity" issues of the US vs. Europe.

Personal Consumption Expenditures

The above chart courtesy of the St. Louis Fed, shows one of the biggest distortions of reality you will ever see. Someone looking at the chart might actually get the idea that "consumer spending" has recovered above pre-recession levels.

However, state sales tax revenue (the only valid measure of consumer sales), is still far below 2007 levels and states are in serious trouble over it.

So no, consumer spending (in the real sense) is not soaring, and given the need for consumers to deleverage, it would not be a good thing if it were. For more on consumer spending and sales tax collections, please see Retail Sales Rise More Than Forecast; Once Again I Ask "Really?"

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Misguided Love Affair with China; China's Massive Monetary Expansion and Crackup Boom

Posted: 29 Oct 2010 01:39 AM PDT

China is pointing the finger at the US, complaining about "Out of Control" US dollar Printing by the Fed.

Dollar issuance by the United States is "out of control", leading to an inflation assault on China, the Chinese commerce minister said in comments reported on Tuesday.

"Because the United States' issuance of dollars is out of control and international commodity prices are continuing to rise, China is being attacked by imported inflation. The uncertainties of this are causing firms big problems," Chen was quoted as saying by the official Xinhua news agency.

Chinese officials have criticised U.S. monetary policy as being too loose before, but rarely in such explicit language.

Decoupling Theories Renewed

I will get to loose monetary policy in just a bit, but first consider More than decoupled, China is in league of its own

Two years on from the global financial crisis, the contrast with the rich world is striking. In the United States and Europe, growth is sluggish, a slump into outright deflation is a real risk and central banks look set to loosen policy further.

So the evidence is in: China is decoupled, influenced by, but ultimately independent from other major economies.

"The crisis was a test and China passed the test. Decoupling has become a much more solid thesis now than three years ago when we only talked about it hypothetically," said Qing Wang, Morgan Stanley's chief economist for greater China.

Chinese Money Supply Numbers from People's Bank of China

Money and Quasi Money Jan 2009 - 496135.31
Money and Quasi Money Sep 2010 - 696384.86

"Out Of Control" Monetary Expansion Irony

I am certainly not about to defend the Fed's misguided policies, but the complaint from Chinese commerce minister that US monetary printing is "out of control" is the ultimate in "pot calling the kettle black" irony.

Over the past few weeks I have exchanged quite a few Emails regarding China with my friend "BC" who writes ...

Total Chinese money supply is up over 4 times since '03, a 17%/yr. rate at a doubling time of just 4 years; up 66% since Jan. '08, a 19%/yr. rate at a doubling time of 43 months; and up 40% since Jan. '09, a 20%/yr. rate at a doubling time of 40 months.

Knowingly or otherwise, China has experienced a textbook faster-than-exponential money and debt/asset blow off or crack-up bubble that mathematically cannot continue. All faster-than-exponential bubbles burst and collapse, with prices falling back to the levels at which the differential rate of GDP and money began to diverge at an order of exponential magnitude, which was around early '02.

Ironically, Bubble Ben bashers claim the Fed is going off the rails with debt-money reserve growth?! Imagine what would happen to the Renminbi were the currency to be floated/convertible with money growing at arguably near hyper-inflationary rates in China!

Do Schiff, Faber, or Rogers ever talk about China's reckless, hyper-inflationary money supply growth? This kind of money supply growth is banana republic-like, making our feeble efforts appear benign by comparison.

This situation is INSANE, and the crash coming in China-Asia will be unprecedented in world history.

Credit Expansion in US vs. China

One might think that a country whose money supply is doubling every 40 months and growing exponentially since 2003 would not be pointing the finger elsewhere, complaining that others are "out of control".

One might also think those screaming about hyperinflation would scream about happenings in China, not just the US.

One would be wrong on both counts.

Moreover, unlike US monetary expansion that sits as excess reserves, China's money supply growth has spawned massive lending sprees, property bubbles, and asset bubbles in general.

I spoke briefly of this in Massive Inflation in China, US Inflation Nonexistent

In a fiat credit-based society, credit-expansion not reserve-expansion is the key to understanding inflation. Credit is contracting in the US but running rampant in China. It should be no wonder China shows signs of an inflationary crackup boom and the US is mired in deflation.

Peak Oil and the Demand for Resources

In my recent interview with Chris Martensen (see "Straight Talk" with Economic Bloggers) a pertinent question came up regarding energy.

2. Many of our readers have subscribed to Chris' position that the economy must be increasingly interpreted through two other lenses; energy and other environmental resources. Can you comment on the Three E's?

Mish: I am a firm believer in peak oil. I don't know how anyone can deny it. Given peak oil, and given the demand from China for oil and other commodities, the world is on a crash course of demand that cannot be filled.

China is growing at 8-10% a year (assuming you believe the stats). Can China keep growing at that rate forever? For even 10 more years? What about India? Brazil?

Either we get some serious energy breakthroughs, China slows, or the standard of living drops in the US, UK, and Europe. Well China does not want to slow, and the US and Europe are fighting hard to maintain a standard of living that is not sustainable.

Historically these situations end up with war. That is an observation, not a prediction.

Something has to give, perhaps many things, but all of the people who think China will soon be the number one economy in the world and that China's growth is sustainable, better start thinking about the implications of what I just typed above.

Preparation For War?

My friend "BC" writes ...

China's behavior since 9/11 and the invasion and occupation of Afghanistan and Iraq by the US is reminiscent of nations' war preparations of the past.

Then again, given Peak Oil, China's increasing dependency on imports of oil and other mineral resources, and the extent to which the US imperial military is arming the Middle East, encircling Iran and Pakistan, and encroaching deeper into Central Asia and towards China's western frontier, why would the Chinese not be preparing for war (or at least war-like conflict in regards to trade and resources)?

Runaway Printing Fuels Crackup Boom

It is important to understand the drivers behind China's growth.

1. Rampant monetary expansion
2. Property bubbles including completely vacant cities
3. US and European outsourcing
4. Malinvestment in infrastructure

Those who claim China's growth is internal fail to factor in points 2 and 4.

"BC" writes ...

China's runaway growth is derivative of US firms' massive investment in China-Asia, which has occurred recently coincident with Peak Oil, peak US Boomer and EU demographics, and now China reaching terminal velocity of investment, production, and credit growth.

That the US and EU economies (60-65% of world GDP) can no longer grow because of demographics and Peak Oil, and China is heavily dependent upon global markets for continuing US firms' investment and derivative growth of Chinese domestic investment, production, and exports, Peak Oil and China's terminal velocity occurring for the largest credit bubble per GDP in history implies that China faces an unprecedented contraction, with the risk that GDP per capita will fall at least 50% in the coming decade.

China bank profits defy loan problems

Much the same way the US housing bubble did not matter until it did, China bank profits defy loan problems

Bank of China and Agricultural Bank of China both reported rises in net profit of nearly 30 per cent in the third quarter in spite of government attempts to slow new lending and rein in asset prices.

The banks are the first of China's state-controlled lenders to report profits for what is expected to have been a bumper quarter for most of their competitors as well.

However, the banks face problems involving bad loans resulting from a government-directed lending binge launched to combat the financial crisis.

Analysts, regulators and even the banks warn that the big expansion in lending, with the volume of new loans doubling from a year earlier to Rmb9,600bn in 2009, will almost certainly lead to a large rise in non-performing loans as many borrowers eventually default.

With credit still relatively easy to obtain and with economic growth still above 9 per cent, many of those asset problems are yet to materialise.

Love Affair Will End Badly

Parabolic expansion of housing prices, credit, or asset prices never ends well. Yet because the US bubble has burst while the various Chinese bubbles have not, various economic pundits are chanting nonsense once again about decoupling scenarios, even in the midst of currency wars and competitive currency debasement.

This love affair with China will not end well for the US, for China, and especially for the commodity producers like Australia and Canada, each in huge denial about their own property bubbles.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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