American Economy Growing Stronger

There is good news today from the Bureau of Economic Analysis, which reports that U.S. GDP…

increased at an annual rate of 4.0 percent in the second quarter of 2014, according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 2.1 percent (revised). The Bureau emphasized that the second-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency

This is good news, indeed, even with the caveat that there will be revisions to the number by the end of August when more complete data has been processed. As a reminder of how big those revisions can be, consider that the estimates for the first quarter of this year ranged from -2.1 to -2.9 percent. That was an unusually large margin of error. Early estimates, like this four-percent growth figure for the second quarter, are based on limited data and matched with forecasting models that “fill in the blanks”. Those models, in turn, are based on historic trends in industrial activity throughout the U.S. economy. When real economic activity deviates from long-term, historic trends – either because of a protracted recession or because of an ongoing structural change to the economy – the part of preliminary GDP estimates that comes from forecasting models is suddenly more uncertain.

In a nutshell, while there is an underlying trend of recovery, that trend is not strong and confident enough to yield highly accurate preliminary GDP estimates. But even if there is an unusually large downward adjustment of this figure, we are still going to have satisfactory growth going in this economy.

So what is behind this good GDP news? Back to the BEA news release:

This upturn in the percent change in real GDP primarily reflected upturns in private inventory investment and in exports, an acceleration in PCE [private consumption], an upturn in state and local government spending, an acceleration in nonresidential fixed investment, and an upturn in residential fixed investment that were partly offset by an acceleration in imports.

In other words, the BEA sees an across-the-board increase in economic activity. This is very good, even though we could have done without the rise in state and local government spending. However, once the more complete numbers are out in about a month, there will be opportunity for a detailed examination of the actual growth drivers. However, the BEA gives some hints:

Real personal consumption expenditures increased 2.5 percent in the second quarter, compared with an increase of 1.2 percent in the first. Durable goods increased 14.0 percent, compared with an increase of 3.2 percent. Nondurable goods increased 2.5 percent; it was unchanged in the first quarter.

The rise in durable-goods consumption is particularly notable, as it is often associated with long-term spending or financing commitments by consumers. This could actually indicate a deeper, more lasting trend of growth, driven by strengthening consumer confidence. If so, we will see much more of GDP in the 3-percent growth bracket. That would be highly welcome, especially since the average GDP growth for the U.S. economy in the 2000s barely exceeded an inflation-adjusted 1.5 percent per year.

But before we all jump up and down with joy, keep in mind again that growth in the first quarter was a solid negative 2.1 percent. I attribute that, at least in part, to the uncertainty around Obamacare. Businesses have now adjusted to it, consumers are absorbing the cost and accommodating to it. That does not mean Obamacare has not had negative effects on the economy; wait and see what happens to health care costs, employment in the health sector and spending on medical technology.

Another indicator that the economy may be on a reinforcing rebound is the 5.3-percent increase in non-residential construction, an indication that businesses expect activity to grow on a long-term basis. Business equipment investment corroborates this, with a solid seven-percent growth (it decreased in the first quarter). Residential construction growth was even stronger, at 7.5 percent.

All in all, what has been a tepid recovery looks better today. A couple of key variables indicate reinforced confidence among consumers as well as businesses. If the Obama administration sits still and does nothing, they will make the best contribution possible to this. No more big spending programs, please. (Let’s not forget that Obama has been more fiscally conservative than any recent Republican president, Reagan included.) If Republicans take the Senate in November, there will be even more reasons to believe in a sustained recovery.

In addition to continued growth in jobs and earnings, a solid trend of growing GDP will also reduce the risk of monetarily driven inflation in the United States. From this perspective it is particularly reassuring that consumer spending on durable goods is growing, as is spending on both residential and commercial construction. All these activities rely heavily on credit, and that includes, of course, the mortgages needed to buy new homes. Excess liquidity that has been slushing around in the U.S. banking system will now go to work where it is needed.

This particular aspect of the recovery is usually under-estimated by economists. Let’s briefly compare our situation to what is happening in Europe. There, too, business credit is growing, but not for the same reason as here. EUBusiness.com reports:

Banks in the eurozone eased credit standards for loans to businesses in the second quarter for the first time since 2007, the European Central Bank said Wednesday. Announcing the upbeat results of its quarterly euro area bank lending survey, the ECB said it had also become easier for private households to get loans as confidence returned to the sector.

This is nonsense. The EU economy may be breaking into positive growth numbers, but it is closer to one than two percent annually. The best evidence of this is a very slow growth rate in private consumption. This is not enough to shore up confidence and make people crowd to the banks, desperate for loans. The same is true for businesses, whose investment growth is nowhere near American levels.

Instead of a desperately needed real-sector recovery, the increase in lending in the euro zone is a direct effect of the negative interest rates that the European Central Bank has introduced on bank over-night deposits. This measure, which de facto marked Europe’s entry into the liquidity trap, penalizes banks if they deposit excess liquidity to accounts with the ECB. Faced with a penalty from the ECB, banks have apparently decided to aggressively market loans to businesses and households.

The fact that they decide to lower credit standards right away, right as they start their loan marketing campaign, is a good indicator of cause and effect in this: if households and businesses were recovering solidly from the Great Recession, they would qualify for loans at existing standards; the fact that banks have to lower credit standards in order to sell loans to customers means that the aggregate credit profile of the European bank customer has not changed recently. That in turn means that people and businesses make roughly the same amount of money, have approximately the same employment and sales outlook on the future, and that job prospects and markets are not growing.

In other words, without the ECB’s negative interest rate and without banks lowering credit standards, there would be no increase in bank lending in Europe.

Because there is no recovery, an increase in lending to the private sector could result in monetarily driven inflation. More on that some other time, though. For now, let’s celebrate yet another U.S. macroeconomic victory over Europe.