THE FOURTH QUARTER LOOKS GLOOMY DESPITE THOSE GDP NUMBERS
The question is inescapable: Did the Bush Administration cook the numbers for gross domestic product? The answer: highly unlikely. Still, you wonder. The Commerce Dept. reported on Oct. 27 that real GDP grew at an annual rate of 2.7% in the third quarter--nearly twice the pace widely expected by most analysts. Market forecasters rarely miss GDP by that much.
Talk of number chicanery in order to help Bush's reelection bid swirled through the financial markets immediately following the report. The quarterly GDP numbers on the trade deficit and on business investment in new equipment seemed at odds with the monthly data on foreign trade and shipments of capital goods, respectively. Also, defense spending, which had declined for five consecutive quarters, suddenly popped up last quarter. What gives?
Probably nothing. When Commerce reports its first estimate of GDP, it does so without an entire quarter's worth of monthly data. In many cases, it has to make some sophisticated guesses. But ultimately, the monthly source data and the GDP data have to match. So the test of any tomfoolery will lie in future revisions. If the souffl falls unusually flat after the first revision in late November, then you can blame the cook.
There are two things that the White House can legitimately claim: GDP has now made a full recovery following its recession losses, and the inflation outlook is the best in decades.
Real GDP regained its prerecession peak last quarter. But compared with past rebounds, that's a small feat. If the recovery had proceeded at the average pace of the past four recoveries--excluding the short-lived 1980 upturn--real GDP would be 4.9% higher than it is now (chart). Typically, the economy regains its prerecession level in three quarters. This time, it took twice as long.
That explains the great outlook for inflation. An economy can generate price pressures only if demand outstrips production capabilities. With growth so far below where it should be, the economy has so many underutilized resources that inflation is likely to keep falling through 1993, even if growth picks up.
The more immediate focus of the GDP report, though, is what the numbers say about the fourth quarter. The news is not good. In addition to the strange jump in defense outlays, a big gain in consumer spending and an acceleration in the growth of business inventories were sizable contributors to third-quarter growth. But none of those advances will be repeated this quarter.
Defense spending rose at an annual rate of 6.9% last quarter. There are two possible explanations. Military outlays during the cleanups after Hurricanes Andrew and Iniki may have boosted the numbers. Or, some defense spending may have been brought into the third quarter from future quarters. In either case, military outlays will probably fall back in the fourth quarter.
Consumer spending is also on shaky ground. Real consumer outlays rose at an annual rate of 3.4% last quarter, but the monthly data show that all of the gain occurred in July, while spending in both August and September was essentially flat.
A peppier pace of spending on durable goods and services led the quarterly advance. However, service outlays rose far above their recent trend, suggesting that service spending will slow down this quarter.
Sales of home furnishings and appliances accounted for nearly all of the quarter's gain in durable-goods spending by consumers. That was driven by the jump in home sales early in the quarter as mortgage rates fell.
However, housing will not provide that kind of support in the current quarter. Through October, mortgage rates are up, and mortgage applications are down. Sales of existing homes fell 0.9% in September to an annual rate of 3.28 million--the slowest pace since January.
The overriding reason why consumers cannot keep up their third-quarter pace of spending is that they don't have either the will or the wallet. Households began the fourth quarter in an unusually downbeat mood. The Conference Board's index of consumer confidence dropped for the fourth consecutive month (chart). The index now stands at its gloomiest reading since February, when it had fallen to a 17-year low.
Jobs, or the lack of them, continue to top household worry lists. More than 35% of the nation's consumers say that their families are being adversely affected by the weak economy, reports the Conference Board. Nearly 25% say that someone in their household has been unemployed during the past year. And of those who found another job, well over 50% say they now earn less than they did in their previous position.
As testimony to that, one of the most telling numbers in the third-quarter GDP report was the one for consumers' real aftertax income. It posted no growth. That means households had to dig deeply into their savings in order to finance their purchases. Savings as a percentage of aftertax income dropped to 4.5% from 5.3% in the second quarter. Low savings, weak income growth, and heavy debts will surely restrain fourth-quarter spending.
A faster pace of inventory-building, from $7.8 billion to $14.7 billion, also added to third-quarter growth in real GDP, but again, inventories may be a drag this quarter. True, a big gain in farm inventories accounted for some of that acceleration, but it was the largest increase in more than three years--a good reason to expect a dropoff in the fourth quarter.
In addition, stock levels in manufacturing swung from a $6.5 billion liquidation in the second quarter to a $4.3 billion accumulation in the third. Since factories were cutting production in both August and September, the inventory rise appears to be unintended. That means weakness in the factory sector will probably continue in the fourth quarter, as companies wrestle their stockpiles into better shape relative to demand.
And demand remains tepid. Manufacturers' new orders for durable goods slipped by 0.4% in September--the third decline in a row. For the quarter, orders dropped sharply, and shipments slowed (chart).
Also in September, the backlog of unfilled orders dropped for the 13th consecutive month. That means production already in the pipeline continues to dwindle. A shrinking backlog, combined with weak new orders and heavy inventories is a deadly mix for future gains in factory output and employment.
The GDP report told a much brighter tale about inflation. The so-called fixed-weight price index for GDP--the broadest gauge of inflation--rose at an annual rate of only 2% in the third quarter. Hurricane distortions made the number look about one-half percentage point lower than it would have otherwise, but still, the annual inflation rate by this measure is running well below 3%.
One reason that inflation will stay down is the sharply slower pace of labor costs. The Labor Dept.'s index of employment costs--including both wages and benefits--continued that trend in the third quarter. In fact, wages posted the smallest quarterly advance in the 10-year history of the index.
During the past year, employment costs are up only 3.3%. That's the slowest annual pace in more than five years. Businesses have made especially steep cuts in the labor costs of their white-collar work forces (chart). Add in recent productivity gains, and unit labor costs are rising even slower than prices. That has helped to widen profit margins, even in a weak economy.
But households have paid the price for better corporate profits. Cost-cutting has become a euphemism for job elimination. That's the main reason why this recovery has been the weakest in the postwar era. And no matter how you cook the data, the economy will not be truly healthy until job prospects begin to brighten.JAMES C. COOPER AND KATHLEEN MADIGAN