(WMT) First Quarter GDP Revised Up to 1.9% – Part 2

Part 1: http://www.stockbloghub.com/2011/06/24/pce-first-quarter-gdp-revised-up-to-1-9/77415

Second Quarter Projection

Second quarter growth looks like it will probably come in close to the 1.9% level of the first quarter. That means that second-half growth will have to average 3.7% to get the whole year to 2.8%. We will need a lot of strength from net exports in the second half to get us there.

However, if we can start to replace imported oil with domestically produced energy we could substantially boost the overall rate of economic growth. While ultimately we would want to do that with renewable sources, such as wind and solar, they mostly produce electricity, and oil is mostly used as a transportation fuel. We do, however, have very abundant supplies of natural gas, and the technology for using natural gas as a transportation fuel is already very well established.

We need to take steps NOW to transition to the use of more natural gas as a transportation fuel to replace oil.  Ethanol really is not that good of an answer since the production of corn to be made into ethanol for fuel requires using a lot of oil. The use of a huge portion of our corn crop to make fuel is a big part of the reason that food prices are rising so quickly. That is a bit of a problem here, it is a huge problem for the rest of the world.

However if we can move to ethanol made from things like saw grass, or the corn stalks that are left over from the corn harvests, that would be a major step forward. Bio-fuels based on algae are another promising area. However, commercialization of non-food based ethanol is several years away.

A weaker dollar would help significantly on the other half of the trade deficit, the part that is made up of all the stuff lining the shelves at Wal-Mart (WMT). King Dollar is a tyrant and needs to be deposed. It will help on reducing imports as foreign goods become relatively more expensive and producers fill demand from domestic production. That does not happen overnight, however.

The trade deficit is a far bigger economic problem than is the budget deficit, particularly over the short and intermediate term. The fact that we are making significant progress in bringing it down is extremely welcome news.

Mixed Results Overall

Overall this was a mixed report. An upward revision is nice, as is coming in better than expected. Unfortunately, the revision was due to low-quality inventory additions. The consumer is still doing his part, but not very energetically.

Construction, both residential and non-residential, should be playing a major positive role in driving the economy at this point in the cycle, but both remain drags. The increase in inventories was ameliorated as it was associated with a much smaller drag from imports. Exports, though, were a much smaller contributor than we thought. Overall, though, the news on the net export side was positive.

Spending cuts at all levels of government are slowing down the economy, and the amount of the drag was higher than we thought after the last look at the data. The slowdown from the defense side is not likely to be repeated in the second quarter, but we will probably see a drag from the non-defense side of Federal spending in the second quarter, and that drag will probably grow as the year progresses. The already substantial drag from state and local government cutbacks will probably increase as well as the year goes on.

The overall feel of this report is much more like that of the third quarter than of the fourth quarter. Just as in the third quarter inventories added more than half the growth and net exports, especially higher imports were a big drag on growth. I suspect that inventory growth will be sort of a non-factor in the second quarter. It is hard to say which direction net exports will go, but the higher price of oil is not going to help matters.

Growing at 1.9% (1.8%, 1.8%) is nothing to get excited about. Better than falling back into recession, but it is not the sort of growth that is going to seriously reduce unemployment. We need to see more of a positive contribution from residential investment if we are really going to get the economy back on track.

Eventually that is going to happen, but eventually can be a long time from now. The continued high contribution from business investment in equipment and software is encouraging, the downward revision to it is certainly not.

The Consumer, which represents the overwhelming bulk of the economy, is doing OK, but not great. While the 1.52 (1.53, 1.91) contribution is down from the fourth quarter, it is also at a level that looks very sustainable, and we will probably get a similar contribution in the second quarter. While over the long term I would like to see the consumer become a smaller share of the overall economy, at this point of the cycle it is imperative that the consumer play a big role.

Government spending is going to be an even bigger drag going forward, although it seems likely that in the second quarter, it will be the non-defense side that is the big drag, not the defense side as was the case this quarter. The anti-stimulus coming from the state and local level is likely to continue if not get worse, and that will be a significant anchor on the economy for at least the rest of the year.

The private sector is going to have to grow much faster to offset the drag from government. Overall private sector growth of 3.1% (backing out the drag from all levels of government) is not all that bad, although in the early stages of a recovery you would want to see it higher. It would be a very solid showing if averaged over a complete economic cycle. However, with the economy operating well below potential, we need to grow much faster than that to get back up to potential.

I am not thrilled with this report, but neither am I despondent about it. However, if growth does not start to rebound again in the second quarter it will be time to get worried. This sort of growth is not going to bring down unemployment and if it persists we may well start to see unemployment creep up again.

The final graph (again from this source) shows the historical relationship between growth of GDP and the change in the unemployment rate. If the 1.9% growth rate were to persist, we would be looking at rising (apx. 0.4% over a year) not falling unemployment rates. The data on this graph though is only through the third quarter of 2010.

 

Part 1: http://www.stockbloghub.com/2011/06/24/pce-first-quarter-gdp-revised-up-to-1-9/77415

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