The 2nd quarter (2007) GDP report published on July 27, 2007 shows a +3.4% growth rate of the real GDP for the quarter. Financial media have immediately hailed the surprisingly strong economic growth, and US government officials have come out enmasse to paint a rosy picture for the US economy. However, a detailed study of the GDP report reveals that a massive downward revision of GDP numbers has taken place for many past quarters. The first quarter (2007) real GDP number has been revised down more than 100 billion dollars, representing about 1% reduction from the figure in the “final report” published on June 28, 2007. The advanced GDP report of the first quarter of 2007 was published on April 27, 2007, and the preliminary report published on May 31, 2007. The growth rate of the real GDP from the 4-th quarter of 2005 to the 4-th quarter of 2006 is revised down to +2.6% from +3.1%, and the growth rate from the 4-th quarter of 2004 to the 4-th quarter of 2005 is revised down to +2.9% from +3.2%. If not for this massive downward revision of GDP for the past quarters, the growth rate of the real GDP of the 2nd quarter of 2007 would be -0.9%, a first negative growth rate since the start of this economic recovery in 2002. Thus the current economic recovery has become much weaker than we have perceived before this July 27, 2007 GDP report. The revision on the nominal GDP is a little less than the real GDP. For example, the nominal GDP of the first quarter of 2007 is revised down by 68 billion dollars, representing a 0.5% reduction. This means that the inflation picture through out this recovery is somewhat worse than we originally thought based on the GDP reports before this massive revision. We do not know whether somewhat calmer inflation picture of the second quarter of 2007 is a genuine improvement or is just the result of revising up the inflation indexes of the past quarters.
Even ignoring the massive downward revision of GDP numbers of past quarters, the reported +3.4% growth rate of the second quarter of 2007 does not portrait a rosy picture of the US economy ahead. The consumer spending has cooled down in the quarter substantially, and has contributed only +0.89% to the +3.4% growth rate of the real GDP. This should be compared with the +2.56% contribution in the first quarter of 2007 and the +2.68% contribution in the 4-th quarter of 2006 to the real GDP growth respectively. The real government spending has grown by +4.8% in the second quarter, contributing +0.82% to the GDP growth. Half of the growth of the government spending is from the national defense and another half is from the spendings by state and local governments. Such a robust increase of government spending will crowd out private consumer spending if allowed to continue into the future quarters. If this +0.82% contribution from the increased government spending is subtracted, the second quarter real GDP would have grown only by +2.6%.
The real consumer spending of the second quarter of 2007 has grown only by +1.3%. Its weakness is partly due to the reduced consumption of gasoline reflecting higher gasoline prices. The higher prices of gasoline is the result of prolonged disruption at the refineries. However, this disruption of gasoline supply has reduced the imports of crude oil, and that has, in turn, boosted the contribution of reduced imports to the GDP growth by +0.34%. Thus the combined contribution of the real consumer spending plus the reduced imports to the GDP growth is like 0.82 + 0.34 = 1.16%. When the gasoline supply returns to normal, the real consumer spending will rise, but so is the import of the crude oil. The combined contribution of the consumer spending and imports to the real GDP growth can only be expected to stay steady around +1.2% level, and will be still far short of the normal level as discussed before. The effect of mortgage woes are definitely starting to hurt the consumer spending. Even worse, the woes are spreading from the sub-prime mortgages to the prime mortgages and home equity loans since the spread between the 30 year fixed rate mortgage and the yield of 10 year treasury note is widening quite rapidly. This negative cycle will cast a spell on the consumer spending for quite a while. In conjunction with the sharply revised down GDP numbers, the reduced consumer spending will make the growth rate of the real GDP languish at a level lower than we originally anticipated. Such a low average level of GDP growth will produce some negative-growth quarters as the GDP numbers gyrate from quarter to quarter, and may fit the official definition of an economic recession in near future. We should note that the US trade deficit has been stagnating for more than a year, and this stagnation of the trade deficit is the source of the current economic slow down. Readers interested in this topic should consult with article 2 and article 2A. As this dismal picture of US GDP unfolds, FED will face a real challenge. If it lowers interest rates to combat the slow economic growth, the dollar will collapse big against Japanese Yen by inducing a massive unwinding of yen carry trades as discussed in Comment 42. It is also not clear that inflation is really under control to the level that FED can start to lower interest rates (see Comment 43 for this topic). It seems prudent to issue a “recession watch” at this juncture of the economic development.