Friday, February 27, 2009

Can the GDP report be good news? 

The news this morning of a downward revision in GDP has been accepted calmly in the markets (remarkable given it's also digesting the government's conversion of its preferred shares from TARP into common stock ownership of Citi. �I'll wait to read more about that until the weekend.) �I think the reason for this is that the changes include some positive developments.

The Wall Street Journal has provided some balance to the report on a downward revision to inventories:

The inventory revision in Friday's report was good and bad. Bad, because the $19.9 billion drop meant inventories added a mere 0.16 of a percentage point to GDP in the fourth quarter, instead of adding 1.32 percentage points as reported originally. But the drop also suggests there is less of an inventory overhang, a bit of good news. Still, inventory-to-sales ratios have gone up, an unwelcome sign. Excess inventory will have to be worked off, and that signals production cuts, which, in turn, could mean layoffs and further impair the economy. Experts see a large drawdown of stockpiles during the first half of 2009 and expect a big drop in GDP during the current, first quarter.
January data on industrial production confirms that.

But the size of the drop is not nearly as large as we imagine from the headline. �We knew that real final sales of domestic product -- meaning you pull out the inventory changes -- fell from 5.1% in the advance report on January 30 to 6.4% in today's. �So that's a good portion of the revision from 3.8% to 6.2%. �Another half of a percent was from a downward revision to consumption, along with an increase in the savings rate from 2.9% to 3.2% (an extra $33 billion.) �The American consumer will only begin spending again when it feels its net worth is being rebuilt, and its rational reaction to this recession has been organic rebuilding via savings.

There are, to oversimplify, a set of adjustments that have to happen to balance sheets and to inventories, and if you have no choice but to do them better to get them over with. �The revisions are signs that it's happened quicker than previously thought. �I think that is good rather than bad news.