A GDP Reality Check

The 4.1% growth rate in U.S. Gross Domestic Product in the 2nd quarter (announced today) was not a surprise to anyone looking at the monthly numbers. In fact, it came in a bit below the consensus prediction of 4.5%. But that won’t stop the accolades the current administration will be handing itself over the coming months. This number will surely be a centerpiece of political rhetoric as we move into the heat of the Midterm race. And as with most rhetoric, it is safe to say that the true context of these numbers will be lost. The recent report card on the economy is very good, but not in the way it will be touted.

One quarter of 4% growth is good, but hardly unique. The U.S. economy averaged 5% growth in the middle part of 2014. And the economy has expanded by 2.8% over the last year—in line with the typical pace since the Great Recession came to an end. In other words this is good—not great—news.

We also have to understand why the economy has accelerated recently. Back in 2014 the driver of high growth was a booming oil sector, which was expanding capacity at a frenetic pace. This time the driver is the fiscal stimulus package put into place by Congress at the end of last year. Taxes were cut, while government spending was increased. This accelerated the pace of consumer spending (disposable income jumped sharply because of the cuts) and businesses have responded to an increased rate of depreciation that allows them to defer taxes.

But of course the downside of this fiscal stimulus is that it can only be driven by a sharp increase in borrowing. In the 4th quarter of 2017 the U.S. government actually ran a small surplus. In the 1st quarter of this year, the U.S. hit one trillion in borrowing at an annualized pace—the worst reading since 2012. The second quarter figure is liable to look considerably worse when that figure is released in the next two months.

This kind of stimulus is borrowing from the future to help today. This is why it is typically used only in economic downturns, not during healthy economic expansions. Eventually this surge in growth will have to be met by higher taxes and a reduction in future spending, which will hurt growth. This isn’t a real acceleration, it’s a college kid running up the balance on his/her parents’ credit card. Putting the borrowing to one side, the economy is still running at the same 2% to 2.5% pace.

This isn’t to say the GDP release was bad news. Along with the 2nd quarter growth estimate, the Bureau of Economic Analysis (BEA) also revised its data for the last few years. Very little was substantively changed on the output side, but there was a big change in the income statistics. As it turns out, the BEA now suggests that growth in real personal income has been much stronger over the last few years than originally estimated. Growth in real incomes is now estimated to have been averaging slightly under 4% over the past two years.

This paints a much better outlook for consumer spending, and hence overall growth, for 2018 and 2019. And this may well be needed if the U.S. enters a major trade war with China and/or NAFTA.