In details and graphics.
By Wolf Richter for WOLF STREET.
There has been a lot of confusion about this 1.4% quarter-over-quarter drop in “real” GDP. So let me go over what didn’t cause it, then what did. What caused it was an abnormal event, and this abnormal event should begin to unfold in the second trimester. We are already seeing evidence of this.
What did not cause the drop in GDP:
Consumer spending rose 2.7% in Q1, annual rate adjusted for galloping inflation. It represented 70.5% of GDP. This growth was in the middle of the range prevailing after the Great Recession until the pandemic (from 0.4% in Q2 2011 to 4.5% in Q4 2014).
However, there has been a pronounced shift from spending on goods to spending on services, especially discretionary services, where spending had collapsed during the pandemic. These discretionary services include airline tickets, sports and entertainment venues, cruises, more or less discretionary health services (such as dentists, elective surgeries, routine medical visits, etc. I have discussed in detail this shift in consumer spending from goods to services here. This shift in spending from goods to services will be important in a moment. The chart shows total consumer spending in GDP data in adjusted dollars. ‘inflation :
Gross private domestic investment increased by 2.3% annualized, after the spectacular spike in Q4. This measure includes investment in residential and non-residential structures, equipment, intellectual property, etc., and it includes “change in private inventories” (more in a moment).
Private inventories increased by 5.7% in Q1, after the 7.1% jump in Q4, annualized and corrected for galloping inflation. There was a boom in sales of goods, especially durable goods in 2020 and 2021, which triggered all sorts of supply chain issues and shortages, and US businesses ran out of inventory in many categories of goods. They struggled to catch up and some of the supply chain issues improved later last year and earlier this year.
In addition, consumers have shifted their spending from goods, where spending has fallen, to services, where spending has increased. Goods require inventories. And lower demand for goods has eased pressure on inventories. But inventories remain well below the levels needed for the economy to function properly:
The Freak event that caused GDP to fall in the first quarter:
The trade deficit in goods and services has exploded of $192 billion in the first quarter, annualized and adjusted for inflation, the second-worst decline on record in dollars, behind only the third quarter of 2020.
Exports are added to GDP, imports are subtracted from GDP. With exports rising moderately but imports booming, “net exports” (exports minus imports) have been negative for GDP for decades. During the pandemic, stimulus-fueled consumers spent record amounts on goods, many of which were imported, and the trade deficit grew.
But what happened in the last quarter, the trade deficit super spike, was extraordinary. While supply chains have improved somewhat and businesses have been able to build up inventory, imports of goods have historically increased, causing the goods trade deficit to widen sharply.
And that sharply widening trade deficit reduced GDP by $192 billion annualized. But overall GDP only fell by $70 billion! A drop of half the size, which would still have been huge, would have produced a positive GDP reading:
Why this abnormal trade deficit figure will start to dissipate in the second quarter
For the next one or two quarters, the trade deficit will become smaller than the abnormal show in the first quarter, and it will be less of a drag on GDP. Why? Because…
Consumer spending has shifted on a large scale towards services, instead of goods (all adjusted for inflation).
Spending on non-durable goods fell again in March, seasonally and inflation-adjusted. It has been falling since November last year and was down 0.8% from a year ago. But it still remains very high, up 13% from 2019, and is expected to fall further in the second quarter. Non-durable goods are mainly food, fuel and household supplies.
Spending on durable goods has fallen sharply since March 2021 (-10.7%, adjusted for inflation). But it has remained very high, up 24% from March 2019, and will likely continue to fall, regressing towards the pre-pandemic average, as consumers shift their spending towards services:
Many of these goods are imported, and a decrease in spending on goods will reduce imports from the levels of the abnormal shows last year and the first quarter of this year. This doesn’t mean that the trade deficit will magically disappear, but it will go from abysmally horrible to just horrible, and the trade deficit will shrink and be much less of a drag on GDP.
Meanwhile, spending on services is increasing. Even adjusted for inflation, it jumped 0.6% in March and 6.3% year-on-year. But it remains below the pre-pandemic trend and still has a long way to go with above-normal growth to return to normal levels, and we will see more of that normalization in the second quarter:
The sudden drop in freight indicates a slowdown in demand for goods in the second quarter.
We are already seeing a slowdown in the volume of transport in the United States. And it is at all levels. The volume of shipments to the United States by all modes of transport, but excluding raw materials, fell 0.5% year over year in April and 1.8% from April. April 2019, and 5.0% from April 2018, according to the Cass Freight Index (my discussion: Signs of a slowdown in the freight cycle, trucking and demand). See the bold red line:
Government consumption also fell in the first quarter.
Expenditures by federal, state, and local government agencies on equipment, supplies, fuel, etc. (not wages and social spending) fell in the first quarter, which also led to a drop in GDP.
I’m not going to make predictions on government consumption, but governments at all levels are floating in a sea of money after the bill printing frenzy and high tax revenues for 2021. And these governments are going to spend that money early or later, which will then boost GDP.
First-quarter decline in GDP likely to reverse in second quarter.
Less catastrophic imports, therefore a less catastrophic trade deficit, will reduce the impact on GDP. Consumers are resisting for now. And there’s still an indescribably huge amount of money circulating among consumers, businesses and governments at the state and local levels, after the $11 trillion in stimulus in two years – $4.7 trillion in the Fed’s money printer and about $6 trillion. in deficit public spending. And some of that money will be spent over the next few quarters.
Yes, there will be a recession one day because sooner or later there always will be, because recessions are part of the economic cycle. But so far in the data no recession is depicted. Consumer spending on durable goods has retreated from insane highs during the pandemic, as spending shifts towards services, and overall spending growth is returning from the peak during the pandemic to pre-pandemic normal. This normalization is underway, and it is a good thing.
However, in terms of asset prices, there is a downward trend: the Fed has embarked on rate hikes and will soon embark on quantitative tightening, after the interest rate crackdown and QE have inflated almost all asset prices to often ridiculous levels. So that’s where the action will continue to be.
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