Rate Watch #760 That GDP Report

February 4, 2011
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com

Fundamentals

The BLS Employment Situation Report reads like something from Lewis Carroll. The Unemployment Rate dropped to 9.0%. This was accomplished by adding 36,000 jobs and having 600,000 people exit the work force. If adding 36,000 jobs and having 600,000 people leave the work force is good news for the economy then I am starting in Sunday's Super Bowl. Credit for the low unemployment rate should go to the UFOs which alien abducted those 600,000 people.

Media commentary (or as much as I have read) is comic. The theme is that job growth was under what was forecast because of the weather. Help me out here. I do not doubt that snow decreased the number of jobs added but it does not explain why the number missed the forecast. Was everyone who did the forecasting in Miami and unaware of the snow? And just how did the snow cause the 600,000 folks who left the labor force to leave? Are there that many people stuck in snow drifts?

BLS Nonfarm Payrolls: Actual 36K, consensus 148K, previous 103K
Nonfarm Payrolls Private: Actual 50K, consensus 163K, previous 113K
Unemployment Rate: Actual 9.0%, consensus 9.5%, previous 9.4%
Average Workweek: Actual 34.2, consensus 34.3, previous 34.3
Hourly Earnings: Actual 0.4%, consensus 0.2%, previous 0.1%

The SurePayroll Small Business Scorecard shows hiring by small businesses down in every part of the country.

Worker Productivity: Actual 2.6%, consensus 2.2%, previous 2.3%
Unit Labor Costs: Actual -0.6%, consensus 0.1%, previous -0.1%.
The two statistics above reflect the continuing propensity of employers to get more done with the same number of employees.

Initial Jobless Claims: Actual 415K, consensus 425K, previous 454K.
The Initial Jobless Claims data from last week (as well as next week's data for this week) was affected by snowstorms.
ISM Services: Actual 59.4, consensus 57.0, previous 57.1.
Construction Spending: Actual -2.5%, consensus -0.4%, previous 0.4%.
ISM Factory Index: Actual 60.8, consensus 58.4, previous 57.0.

World food prices rose to an all-time high in January, according to the UN's Food and Agriculture Organization. Sharply increasing food prices, as Marie Antoinette learned the hard way, can lead to political instability.

That GDP Report

I want to start by saying that this piece is based on the work of Rick Davis of Consumer Metrics Institute. The ideas presented here are Rick's as paraphrased by myself. The Consumer Metrics Institute measures online shopping and the metric which they have created was an excellent leading indicator of GDP. Lately the correlation between Consumer Metrics and the BEA (Bureau of Economic Analysis - part of the U.S. Commerce Department) GDP data has weakened. The Consumer Metrics indicator shows a weaker recovery than the BEA.

Rick's newsletter of last week, which can be found on this page, makes some observations about the data and these are what I would like to discuss.

Almost every day there is some economic fundamental released which moves the equity and fixed income security markets. There are three fundamentals which, in my opinion, are the most important in regard to their potential effect on the markets. These are: the monthly CPI and PPI reports, the monthly BLS Employment Situation report and the quarterly GDP report. For the present I want only to look at the GDP report. Let's look at the most recent report. The complete BEA 4th Q 2010 GDP (advance) report is here.

Bottom line is that GDP in 4th Q 2010 was +3.2% (annualized). Simple enough, right? OK. Maybe not. What makes up GDP (Gross Domestic Product)?

GDP = C+G+I+(X-M) where "C" = consumer spending, "G" = government spending, "I" = investments (comprised of fixed investments and inventories), "X" = eXports and "M" = iMports. We can possibly gain some insight as to how the +3.2% resulted by looking at the changes in the 5 components of GDP for 4thQ2010.

GDP Components Table

	Total GDP	C	I	G	(X-M)
Annual $ (trillions)	$14.90	$10.60	$1.80	$3.00	-0.5
% of GDP	100.00%	71.10%	12.10%	20.10%	-3.40%
Contribution to GDP growth (%)	3.17%	3.04%	-3.20%	-0.11%	3.44%

 

The top row is the annualized GDP (dollar total and by component). The second row is the percentage which each component is of total GDP. Consumer Spending, for example, was 71.1% of GDP. The bottom row shows each component's contribution to quarterly GDP change and this is where things get interesting.

This report says many things including: 1) GDP went up 2) investments went down 3) exports went up or imports went down so that the contribution of (X-M) was larger (+3.44%) than total GDP growth (3.17%). It is not difficult to accept that investments (which includes business inventories) went down because inventory buildups stopped. This almost always occurs in recovery. Businesses were optimistic and were building inventory then stopped and in fact reversed in the 4thQ.

The really hard part to swallow is that if this CliffNotes version of the report is to be taken at face value then you would have to believe that essentially all of the increase in consumer spending was of domestic goods. This defies what we know about consumer spending. It looks as if something may be wrong.

What needs to be addressed is that lurking behind the data above is a large set of "deflators." A deflator is an attempt to translate total dollar expense into quantity of stuff to adjust for changes in prices (inflation.) Put simply, the deflators replace the number of dollars spent on widgets by dividing by the current price of widgets in order to calculate the number of widgets purchased. The most obvious item is crude oil imports. Since the price of crude oil increased substantially in 4thQ2010, BEA determined a deflator for oil and everything else and calculates a deflator for iMports. Here's where things get interesting. For 3rdQ2010 the deflator for imports was -9.2% (imports were 9.2% cheaper that quarter than in the previous quarter). For 4thQ2010 the deflator for imports was +21.8%. Thus, the import deflator changed by 31% quarter-to-quarter. In addition, the trade data (exports and imports) and investment data for the quarter always consists of 2 months of data and one month of guesstimate. This is why we see rather large revisions in the 2nd and 3rd GDP reports each quarter. That 3rd month of guesstimate when things are volatile is a lot more dangerous than when prices are flat.

The tiny table of GDP presented above comes from this much larger table. This table is in "real" (inflation adjusted) dollars. There is a corresponding table of "nominal" (not adjusted for inflation) GDP components here. So where does this table come from? This is Rick's explanation:

"Instead of tallying up commerce, the BEA runs the "mother of all spreadsheets" -- containing complex formulas that try to model the interactions within the whole economy. Picture in your mind the most elaborate, convoluted and opaque spreadsheet known to man. Increase that by an order of magnitude and have it maintained by hundreds of clerks -- none of whom have purview to the entire thing. Now assume that some of the inputs to this spreadsheet are dollar values of transactions, while other inputs are actually quantities of goods counted as they get transported or warehoused -- i.e., no prices/valuations are simultaneously collected, and somehow those goods have to get converted into dollars within the model."

Getting back to what makes up the change in GDP from one quarter to another you can also see a BEA breakdown by percent contribution of each component in this table.

One enormous point at present is this: if this report is accurate then the real (i.e., inflation adjusted) annualized growth rate of 3.17% assumes that in that quarter annualized inflation was only 0.3%. This is defied by almost all other inflation data.

So What?

To me, the BEA GDP report as headlined in the media is laughable. This reflects the nature of the media as much as it does the BEA. No one on TV wants to do anything other that pop a few numbers from this report and say things such as "Good news: GDP is up" or "GDP is up despite investments being down." Drilling into this report (which I have not even tried to do) would defy the simplistic approach which the media has to practically everything.

My sole point is this: the real picture of GDP is not contained in the brief report. BEA's system for collecting and analyzing data may reflect bureaucracy as much as it does the real economy. We should be better using the resources of real-time data collection. If we judge the state of the U.S. economy by a report with so many opaque adjustments then we could be running the economy the way we did the mortgage business when we were doing stated income. The adjustments (deflators) are so large that inaccurate assessments of their values obfuscate the data they are trying to correct. When the adjustment are large the bottom line is much less reliable. It is not good if the GDP estimate is less reliable at a time such as the present when we need accurate data in order to devise fiscal and monetary policy.

We may well need a more accurate methodology of measuring GDP - one which is more transparent, based of no guesstimates and involves fewer corrective formulations to the raw data. It also needs to be comprehensible so that neither the media not politicians stand between the data and the public. To me the GDP report is too much like the GPS in my iPhone. When I am at home in the San Francisco it tells me where I am accurate to about 100 yards but when I go to a race at Infineon Raceway in Sonoma County and park in a gigantic parking lot and really, really would like to know where my freaking car is there are too few cell sites nearby and just when I need it the most the GPS is useless.

 

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Dick Lepre
RPM - SF
1400 Van Ness Avenue
San Francisco, CA 94109
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dicklepre@rpm-mtg.com
Web site: www.loanmine.com
Blog: economy.typepad.com
(415) 244-9383
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California Department of Real Estate - real estate broker license #01201643

Comments

[Matt Penning]

I believe that there are a whole bunch of folks, media and government, who are saying that the emporer is fully clothed.

I like the idea of real-time data and transparency in what makes up the indicators.

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