New Quarterly GDP Number Not as Big as it Appears

GDP

The first thing people may have thought when they saw the U.S. first quarter GDP come in so much higher than expected is that this may be alarming. We need not worry.

There are some smaller creatures that, when faced with a threat, will puff themselves up to appear bigger than they actually are. This is exactly what this latest quarterly GDP number is doing, and when we look more closely at what is behind it, the false puffiness does stand out.

This is actually a good thing for the stock market at least, if not for the economy as a whole, as we really don’t want to be seeing this number grow too large, if it’s doing so in a valid way that is, one that suggests higher inflation.

It has taken all these lower projections to finally placate the Federal Reserve and get them to keep their feet well away from the interest rate hike pedal, and we really don’t want to see this messed up. The next move, based upon what we do know right now, should be an interest rate cut, but it doesn’t take that much to take us off this course and we should be rooting for these forecasts to come true if we want to stay out of trouble.

The first thing that we need to take into account is how this number rose due to the expansion of inventories. When we see inventories go up, this alone may tell us that supply is exceeding demand, which means that demand may be waning here. Companies don’t like to hold a lot of inventory because this reduces their efficiency, and this looks like their demand projections have come in lower than they expected.

This excess inventory will also need to be sold, in upcoming quarters, and this will restrain the amount of production necessary to satisfy demand later. This will have a downward effect on upcoming GDP numbers, including the next one, and we’ll have to keep a close eye on how inventories are impacted.

We could understand these two numbers together, this quarter and next, and it would make sense to, taking into account the limitations of these calculations and average the two together to get a better idea. The actual number of 3.2% may also end up getting revised downward, as the number announced is always subject to revision.

It’s the Potential Effect on Inflation That Matters Most Here

Seeing a number like this is not really such a bad thing anyway, provided that inflation is kept within acceptable parameters. There is nothing behind this number to suggest it has deviated upward from our projections by an amount that should concern us or the Fed.

What we really want here is the economies of other countries to grow while inflation in the U.S. is kept in check. GDP and inflation are different measures, and the country can be doing better without inflation rising if more goods are sold elsewhere. GDP therefore is more globally focused, where other measures of our economy such as inflation are domestically determined, in this case by the price of a basket of goods and services.

The Fed looks at GDP pretty closely though, but only to project inflation rates, and inflation is really the only thing that the Fed cares about. GDP is more of a supply side measure, where inflation is determined by price. Domestic production only really matters to them due to this influencing domestic inflation, but this is far from a direct relationship as production is also shaped by foreign demand.

This number was also inflated by what we could call more of a return to normalcy as far as trade is concerned. Both domestic and foreign consumption of U.S. products and services promote GDP growth, which is limited by imports, because GDP does stand for gross domestic product, which means things produced domestically. When we buy imports, we actually contribute to the GDP of other countries, not ours.

Our trade balance took a hit in the final quarter of 2018, and while things have returned more to normal this quarter, this balancing of things did cause an artificial growth in net trade this quarter, more than we would have seen if things stayed stable.

Inventories going up end up doing the opposite, overstating things now to have them balanced more later when inventory levels return to normal. These extra goods are therefore produced in one quarter and consumed in later quarters, and this leads to a cut in production later to compensate, which brings GDP down.

The Actual Number Is Pretty Small

When we calculate out the effects of both larger inventories and the artificial increase in net trade, we end up with what we could call a baseline growth rate of just 1.5%. This is not a number that those concerned that the economy is heating up enough would be concerned with, and if anything, it’s on the lower end.

We were in the same spot during the fourth quarter of 2015, when it had appeared that the Fed needed to rein things in when it turned out that the underlying economy wasn’t growing as fast as they had thought. There were plans on jacking up rates back then and cooler heads ended up prevailing when it became plainer that we would not need such a thing, and in fact, it would not have been wise.

While the average person often just looks at the raw number, economists aren’t being fooled here and are lining up to proclaim this increase as being due to just puffiness. Economists look beyond just the top line number though, and so do the economists at the Federal Reserve, so they very likely will not be fooled either.

If we had to grade this number overall, it might be a little on the low side if anything, but not by enough to really worry about. The real concern is that we’ll end up coming in significantly lower than projected, which this net number at least hints at. This could cause enough of an earnings recession, which we’re on the brink of now already, to scare a lot of money out of the stock market and put us in a true bear market, for a while at least.

The Fed is not there to play sidekick to the stock market and they actually don’t care about this all that much, but if the economy does end up slowing down more than we think it will, this is where they come in, and will look to at least nudge things back up.

When it comes to determining the impact of any market news, it’s really all about surprises, but this one wasn’t really all that big of a surprise once we get past the 3.2 and look deeper into the matter.

Robert

Editor, MarketReview.com

Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.

Contact Robert: [email protected]

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