WHY FOURTH-QUARTER GDP MIGHT BE UP 4% / BARRON´S ( RECOMMENDED READING )

MONDAY, JANUARY 4, 2010

ECONOMIC BEAT

Why Fourth-Quarter GDP Might Be Up 4%

By GENE EPSTEIN

A sub-par recovery.


THE GREAT RECESSION OF 2008-'09 ENDED IN mid-'09. The recovery that began in the third quarter will likely be strong enough to bring real GDP back to its previous peak by 2010's third quarter.

Technically, the recovery will then be over, and the expansion of the U.S. economy will resume.

Meanwhile, the stock market -- still more than 25% below its Oct. 9, 2007, apex -- probably won't regain all that lost ground in the coming year. But with profits rebounding (see my Nov. 16 "Upwardly Mobile" article), stock prices have plenty of room to post respectable increases. A 10% rise in the S&P 500 from its current level would still leave that index more than 20% below its previous peak.

Now, as recoveries go, the one outlined here would still be subpar. But even this relatively modest outlook sounds overly rosy to critics of this column, attuned to the depredations of Obamanomics.
As one who considers himself similarly attuned, I'd rather be hectored by these folk than praised by the president's supporters. But as much as I agree with these critics that Obamanomics hurts far more than it helps, I think they give it undue credit for ruining the recovery.

America's "mixed economy" has always suffered from government drag. If the drag is worsening, the part of the economy that still consists of capitalism has a broad back -- broad enough to carry the economy ahead, even if at a subpar rate.

As an indication of how subpar, compare the current outlook for a recovery with previous recoveries from comparable recessions.

Real gross domestic product rose at an annual rate of 2.2% in the third quarter and probably climbed at 4% or more in the quarter just ended. In 2010, quarterly growth should run at an annualized 3% to 3.5%. As mentioned, that would bring real GDP back to its second-quarter 2008 peak by the third quarter of 2010. So the recovery phase will have lasted five calendar quarters before an economic expansion resumes.

Compare that outlook with the history of the two comparable post-World War II recessions -- those that occurred in 1973-75 and 1981-82. In the first case, the recovery was finished in just three quarters, during which real quarterly gross domestic product rose at an average annual rate of 5.1%. In the second, the recovery took just two quarters, during which GDP climbed at an average annual rate of 7.2%.

By the standards of the past, then, the current recovery should have ended in the fourth quarter, or should end in 2010's first three months. Instead, it's not likely to conclude until this year's third quarter -- one indication of how far the U.S. economy has fallen.

THE TECHNICAL DETAILS OF this decidedly nonrosy scenario include the most technical detail of all: inventories.

A revival in consumer spending is often thought to be the alpha and omega of a recovery. For sure, no recovery happens without a rise in consumer spending. Monthly data indicate that retail sales advanced in the fourth quarter, and fairly modest sustained increases in consumer spending are probably in the offing. But most of the heavy lifting will be done by the nonconsumer portions of private-sector GDP that crashed in the first place: housing investment, business investment, and inventories.

The shift from inventory liquidation to inventory rebuilding is a major unseen player in almost any economic turnaround, and this time probably more so than usual. Gross domestic product measures actual production. GDP takes a hit if final sales are satisfied from inventories, rather than production. In the third quarter, inventory liquidation continued, but at a slower rate. That meant that more final sales were satisfied from production than in the previous quarter. So inventories contributed 0.7% to GDP growth, a pretty large chunk of 2.2% overall growth.

There's great potential for that contribution to grow even larger in the quarter just ended and in subsequent ones. That's because the degree of inventory liquidation is so huge, if it came to a halt in a single quarter, its contribution to growth in that quarter could run an eye-popping 4%. A surprising Dec. 11 Census report indicated that business inventories actually increased in October, after 13 consecutive months of decline. If that trend were sustained, overall GDP growth in the fourth quarter could produce an upside shock, given the contributions to growth from other factors.

In any case, get ready for a reading of 4% or more when the advance report on fourth-quarter GDP growth is released on Jan. 29. But don't treat such good news as evidence that Obamanomics is helping more than hurting. Those of us with a sense of history know otherwise.

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