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The American Economy…Getting Stronger!

Good news!  The U.S. economy is now showing more signs of self-sustaining growth.  Such growth is opposed to the somewhat artificial growth during late 2009 and in early 2010 tied in part to massive government stimulus.

The American economy (GDP) grew at a 3.2% real (after inflation) annual rate during 2010’s final quarter, the best performance since January-March 2010.  GDP, or gross domestic product, is the most all-inclusive measure of goods produced and services provided on U.S. soil.  While the growth pace was slightly less than the 3.5% consensus view of forecasting economists, the 3.2% growth pace came up short for the right reason.

Please note that the 3.2% fourth quarter growth estimate will be revised on February 25.  It will also be revised again on March 25 and, yes, any other time that U.S. Commerce Department bean-counters feel the urge.

Big Turnaround

U.S. economic growth during 2010 came in at a 2.9% rate after inflation, the strongest performance of the past five years.  Such growth compares to a 2.6% real rate of decline during 2009, the depths of the recession.  The swing in performance from 2009 to 2010 was the widest since 1983, a period of 27 years.

Better fourth quarter economic growth was led by stronger consumer spending.  Consumer spending, which accounts for roughly 70% of the overall economy, rose at a 4.4% real annual rate during 2010’s final quarter, the strongest performance in four years.  One component of that spending was during the Holiday season, where spending rose 5.5% versus the prior year, the largest gain in five years.

The U.S. economy also received a modest boost from investment into non-residential buildings and into equipment and software.  Housing investment actually rose slightly as well.  Strength in U.S. exports, when compared to declining U.S. imports, also added to the growth measure.  Overall government spending declined slightly during the quarter, reflecting severe budget pressures at the state and local level.

Fewer Goods on the Shelves

The most surprising detail within the report was the plunge in the accumulation of business inventories.  Note that GDP is a measure of what is produced, not what is sold.  Businesses added to their inventories of goods at a $7.2 billion annual rate, down sharply from the $121.4 billion annual rate in the prior quarter.

What does this mean?  The swing in inventories subtracted 3.7 points from growth, the largest impact since 1988.  Had inventories of manufactured goods accumulated during the fourth quarter at the same pace as in the July-September period, the U.S. economy would have grown at a red hot 7.1% pace in the fourth quarter, the strongest in 26 years!

Moreover, the sharp decline in inventory building during the fourth quarter creates a need for greater manufacturing output during the current and subsequent quarters.  In fact, many economists have increased their GDP forecast for the current quarter to near 4.0%, or even higher, as a result of the inventory data.  Various growth estimates for the second quarter have also been raised slightly.  (Yes, this stuff is primarily of interest only to economists!)

Inflation Stripping

The U.S. Commerce Department, like most government agencies, reports inflation-adjusted data when possible, in order to—obviously—compare apples to apples.  The Commerce Department noted that the annualized value of all goods produced and services provided was $13.38 trillion during the fourth quarter, when converted to 2005 dollars (don’t ask).

The Commerce Department also noted, and this is meaningful, that U.S. economic output in the fourth quarter finally surpassed the pre-recession peak reached during 2007’s fourth quarter.  When measured on a per capita (per person) basis, we are not there quite yet.

When measuring U.S. overall economic output in current dollars (the world we actually live in), the U.S. economy in the fourth quarter equated to a $14.9 trillion annual behemoth.  By way of comparison, the world’s second largest economy, China, is one-third the size of the U.S.  When measuring roughly 309 million people in the U.S., and at least four times as many in China, U.S. per capita output is 12 times that of Chinese per capita output!

Inflation Low

One primary measure of inflation, and a favorite of the Federal Reserve, is the personal consumption expenditures (PCE) index.  This measure of consumer inflation rose at a 1.8% annual rate during the fourth quarter, reflecting the recent rise in food and gasoline prices.

The core PCE, which excludes food and energy costs, rose at only a 0.4% annual rate, the smallest rise on record.  Such a modest increase gives the Federal Reserve more “cover” to maintain its key interest rate at essentially zero for most, if not all, of 2011.

From Here?

Why has U.S. economic growth improved recently?  And why is growth during 2011 and 2012 expected at a reasonably solid rate, even as much of the government stimulus concludes?

The simple answer is less uncertainty…and rising expectations.  Less uncertainty by businesses and investors as to tax policy this year and next.  Less uncertainty by the consumer as to the same.  Rising expectations that split government in Washington will slow the explosion in government spending.

Rising expectations that Republicans will follow through with campaign promises and create a framework (with bi-partisan cooperation) to get government spending under control.  Rising expectations that the President will continue his presumed move to the middle.

Rising expectations that the President’s health care bill…identified by The Wall Street Journal as “the worst bill ever”…will be derailed by the courts and ultimately modified by the Congress into something that is actually workable, affordable, and of real value to the American people.

Rising expectations that broken budgets and unaffordable pension programs at the state and local level will be addressed.  Rising expectations that the accumulation of changes noted above will soon lead to rising confidence in the business sector to boost payrolls.

Rising expectations that we have collectively peeked over the financial precipice and, just maybe, common sense will return to Washington.  Rising expectations that tough decisions must, and will, be made to move away from insane and destructive trillion dollar deficits for as far as the eye can see.  Rising expectations that America can get back on the right track before it is too late.