GDP Disappoints The Optimists

Recent news on the gross domestic product (GDP) has disappointed the optimists. Overall real GDP growth during the first quarter slowed to a 1.1% annual pace, better than a zero-to-negative figure that would have indicated recession but a poor showing, nonetheless. The detail behind this overall measure tells an even less encouraging story and makes recession in coming months and quarters more likely than not.

Worries about the economy’s underlying strength first emerged this time last year, when the Commerce Department reported an outright 1.6% decline in real GDP. When the second quarter report showed another, less severe decline of 0.6%, many in the business and financial communities declared that the economy was in recession. The White House objected to this assessment, arguing in terms of technical complexities. Debate raged for a time but died down when the third quarter showed a reasonably strong 3.2% real growth rate, and the fourth quarter showed a weak but nonetheless positive 2.6% annual rate of growth. Now the first quarter’s weakness will likely reignite debate. It should. The full picture is far from encouraging about the current state of the economy or the likely path going forward.

This latest Commerce Department report identified only two significant sources of strength, and even they are suspect. One is the American consumer. On the surface, it looks good. After a slow 1.0% annual rate of growth during last year’s fourth quarter, overall consumer spending accelerated to a 3.7% growth pace during the January-March period. Worries nonetheless attach to the picture, since the entire surge occurred in durable goods, particularly autos. Alone, sales of autos and parts accounted for almost half the overall GDP growth of the quarter. Because auto sales have trailed during the entire post-Covid recovery, surges of this kind are more likely a sign of a catchup than a basis for future gains. And there is an additional concern. In today’s inflationary environment, consumers often buy early, and ofter on credit to beat anticipated price increases, to enjoy the use of their car rather than save for a future purchase and lose real buying power of the money in the interim. For obvious reasons, such behavior, though rational, cannot repeat indefinatly.

Net exports were another seeming place of strength. Commerce reports that real exports of goods and services rose at a 4.8% annual rate during the quarter just passed, while imports rose at only a 2.9% rate. The difference added to measures of overall production and growth. The difference also suggests that the United States is growing at a less robust rate than the rest of the world. Many products sold – both to consumers and businesses – are imported or contain imported parts. Slack in the pace of imports growth betokens slow sales generally. It is noteworthy in this respect that the sales strength otherwise occurred in autos, since most cars sold in this country – whether an American or a foreign brand – are manufactured domestically and so tend not to raise measures of imports. In other words, the low import growth figure captures slow growth elsewhere.

Most worrisome are two sharp first quarter declines. Housing fell at a 4.2% annual rate during the quarter, and business purchases of productive equipment fell at a 7.3% rate. The first is hardly a surprise. Residential construction and sales figures have given evidence of the housing slump for months. Weakness in housing always translates in time to weak sales in appliances and household goods generally. The drop in sales of business equipment signals a fall in business confidence that can only slow the pace of economic activity going forward. What is more, slack equipment purchases point to slower productivity growth in coming months, since productivity-enhancing innovations are usually built into machinery. Also indicating slack future productivity growth is the deceleration in purchases of technology and systems, what the Commerce Department refers to as “intellectual property products.” These increased at only a 3.8% annual rate, barely over half the pace of earlier quarters.

To be sure, drawdowns in business inventories did disproportionately detract from growth during the first quarter. A rebuilding will no doubt improve the overall look of the current quarter when it is reported in July. But such gyrations are typical and say little about the underlying strength or weakness in the economy. If anything, the future will see only a muted catchup since high and rising interest rates have made retailers and wholesalers keen to keep inventory stocks lean.

On balance, this first quarter GDP report offers little to no encouragement. If for the time being there is reason to reject the recession designation, likelihoods – and the Federal Reserve’s continued rate hikes – point in a recessionary direction by the second half.