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5/29/2014: First Quarter GDP Revised To Negative 1% - Pending home sales up just 0.4% in April, missing expectations


 

 

Short-term incentives and misguided fears are a major reason that this economic recovery, which started in 2009, has been so lousy.

The economic expansion following the 2008 recession has been the weakest of the post World War II era.  Four years into it, GDP has risen about half as much as the average post WW II recovery.[i]

For an economy (GDP) to grow it needs to increase consumption, investment, government spending, or exports.  It does not need all four to increase but together they must.

From 2001 to 2010, 70% of economic growth came from consumption, 15.9% from government spending, 18.6% from investment, and minus 4.5% from exports. (The U.S. imports more than it exports).[ii]

 

Short-Term Incentives

Beginning in late 2008, the Federal Reserves (Fed) tried to stimulate consumption and investment with QE.  QE consists of the Fed trying to lower already low interest rates by buying longer-term bonds, mainly from banks; in exchange for the bonds, banks get reserves.

Homebuyers took advantage of the lower rates, but as home prices increased and with high debt levels and little income growth home affordability became an issue and by late 2013 the housing market began slowing.

On April 22, 2014, the National Association of Realtors reported the sales of existing homes had decreased in seven of the last eight months.[iii]

Public companies also took advantage of lower rates but instead of borrowing to invest many borrowed to buyback their own stock. 

With most of the compensation of executives at public companies now coming from stock options, this creates a powerful incentive to use company resources to increase the stock price by buying back stock instead of investing in equipment, buildings, software, etc.

In 2013, the 30 companies listed on the Dow Jones Industrial Average authorized $211 billion in stock buybacks.[iv]

 

Misguided Fears

The collapse of the banking system and the subsequent recession resulted in an increase, in U.S. government debt.  Increasing deficits leads to cries of money printing, inflation, and default.

The government finances its deficit through the sale of bonds, and the money to purchase those bonds already exists in the economy.[v]  No new money is created; the buyers get a safe asset that pays them interest. 

Also, the U.S. has a fiat money system; its currency is not convertible into gold or anything else, and unlike some European countries all of the money must remain in it, this makes any talk of default ludicrous.

The U.S. does have legislation that limits the amount of government debt, but this is a self-imposed limit created in 1917 when it was on the gold standard.

During this recovery, the Fed had hoped to get inflation up to 2%; however, inflation is currently running at only 1.1%.[vi]

Fears of inflation and default are one reason the deficit has dropped from 9% of GDP at the start of the recovery down to 4% of GDP in June of 2013.[vii]

 

Investing is our future

Remember, there are four ways to grow the economy: investment, consumption, government spending, and exports.

Increasing investment leads to higher worker productivity, which leads to rising incomes and consumption.

Additional investment by companies would be the best way to increase growth, but until the incentives are changed many companies will continue to prefer buying back their own stock to investment.

In 1980, household debt was 47% of GDP.  In 2009, it got as high as 96%, and now it is about 75%;[viii] this correlates to 12 trillion dollars of current household debt, and until consumers stop reducing their debt any policy betting on consumer spending driving a recovery will be disappointed.  

That leaves additional government spending and hopefully if the U.S. decides to spend more they do it in a way that increases future productivity by rebuilding our crumbling infrastructure.

Housing is slowing; companies are more interested in buybacks, government spending is flat, and exports are decreasing it is not surprising that 2014 first quarter GDP was negative and unless someone increases their spending a slow recovery is going to turn into a recession.

 

Tim Hayes, AIF®, CRPS®, AWMA®, CFS®, is a financial advisor with over twenty years experience.  The views in this report are his own and not those of his Broker/Dealer or Investment Advisor.



[i]  Council on Foreign Relations, Dinah Walker, August 22, 2013

[ii] Federal Reserve Bank of St Louis, William Emmons, January 2102

[iii] National Association of Realtors, Walter Molony, April 22, 2014

[iv] Washington Post, Jia Lynn Yang, Dec 15, 2013

[v] The Six Myths That Hold America Back, Frank Newman

[vi]  The Wall Street Journal, Ben Leubsdorf, May 1, 2014

[vii] Council on Foreign Relations, Dinah Walker, August 22, 2013

[viii]FRED-Household Debt as Percent of GDP-Retrieved September 2013

 

 

Securities offered through Cambridge Investment Research, Inc., a broker/dealer, member FINRA/SIPC. Investment advisory services offered through Cambridge Investment Research Advisors, Inc., a Federally registered investment advisor. Tim Hayes, Investment Advisor Representative / Registered Representative, 39 Braddock Park Boston, MA 02116.

 

 

 

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