In the 3rd quarter, U.S. GDP grew by 2%, down from an almost 6% pace over the three preceding quarters. Weak growth in consumer spending, with a sharp drop in spending on durables, is the primary culprit. Business investment slowed as well.
Not surprisingly, the relatively weak number has led to an abundance of hang-wringing by pundits and many in the media – and almost assuredly will lead to calls for extending Federal stimulus efforts. Blame is falling on all sorts of things, from the Delta variant to inflation to supply chain problems to the policies of the Biden administration, and more.
Let’s start with one important point… the 3rd quarter numbers do not reflect a slowdown in the nation’s economic recovery since the U.S. economy has already fully recovered, at least from the standpoint of consumption. The graph below shows the trajectory of real economic output (GDP) and of real final demand, which is the gross combined spending of consumers, the government, and businesses in the form of investment. As you can see, aggregate demand has returned to its long run trend.
In a closed economy these numbers could vary from quarter to quarter based on movement in inventories. For example, we could consume more than we produce by using a stockpile of excess products saved from previous quarters. In the longer term, the United States regularly consumes more than it produces by importing the excess. In other words, as illustrated above, the long run gap between these two data series reveals the structural trade deficit the nation has been running for over two decades.
As Beacon Economics predicted, the pandemic recession was the shortest downturn in history—just two months according to the National Bureau of Economic Research, which dates economic cycles. The “V” shaped bounce in economic activity is clear in both the path of GDP and final demand, but the latter has recovered faster. From an aggregate final demand perspective, the United States was already back to the trend line it was on prior to the pandemic in the 2nd quarter. In other words, Americans were consuming just as much as we would have predicted in the 2nd quarter had there been no downturn. So, growth should be slowing down if we are to maintain spending at long run sustainable levels.
But while spending has returned, output is lagging substantially, still more than 2.5% below trend. The bounce in consumption has been supplied not by domestic producers but rather by foreign ones as reflected in the massive increase in the U.S. trade deficit. The pandemic created a different kind of recession in the United States—one that is better characterized as a supply shock rather than the far more typical demand-shock recession. In 2010, after the last downturn, many people stopped going to restaurants because they couldn’t afford it, they had to rebuild their savings after the collapse in asset prices. In 2020 most consumers stopped going to restaurants because they weren’t allowed to. They took some of the money they didn’t spend on restaurants and instead spent it where they could, mainly on buying goods.
Consumer goods in the United States are often purchased directly from foreign producers or are assembled in the United States from inputs that are sourced from foreign producers. So it isn’t surprising that the goods-heavy rebound in overall spending would lead to an increase in the trade deficit. In the 3rd quarter, consumer spending on services was still 5% below trend while spending on goods was 8% above trend. This explains the intensity of today’s supply chain problems. Just how much excess demand has exacerbated supply chain issues can be understood by considering two sectors of the economy, automobiles, and restaurants.
Auto sales dropped sharply in the 3rd quarter, by over one-third from their April peak. This sharp drop looks more like something seen in a recession, not in a recovery. But a quick look at record-low auto inventories and the skyrocketing price of used cars shows that the problem is the inability of auto companies to keep up with demand, not that they are suffering from a lack of it. Consumers are buying other goods in the meantime, and those products are competing with auto parts for scarce space in congested shipping lanes.
Restaurants are getting hit on both ends. At first, many had to close their doors because of the pandemic’s restrictions on activity. Now that demand is back, they are again struggling—this time with labor shortages. Spiking asset markets and short-term disruptions in the U.S. labor market were enough incentive to convince 2.5 million Americans to retire. The net result has been a massive labor shortage, with job openings crossing the 11 million mark in the United States, half as many as in the months prior to the pandemic. Hearing that there is an hour long wait at your favorite restaurant despite half the tables sitting empty, is becoming a frequent occurrence. Frustrated diners are likely to spend even more on goods, driving more of the gains into the trade deficit.
Bluntly speaking, slower growth in the 3rd quarter is irrelevant from an economic outlook perspective. As Beacon Economics has argued over the past year and a half, as tragic as the pandemic has been in human terms, the economy was always going to rebound quickly. Unfortunately, Congress and the Federal Reserve Board bought into nonsensical predictions by so many economists that a depression would result. They responded with a massive amount of largely unneeded stimulus: $5 trillion in fiscal stimulus, and another $4 trillion in quantitative easing—most of which passed directly to the financial markets since consumer spending has been constrained by the supply impact of the pandemic.
The excess cash has goosed asset markets, generating even more wealth. According to the Federal Reserve Flow of Funds data, in just two years, the net worth of U.S. households has increased by 25%—almost $30 trillion in new wealth created since 2019. This is what has pushed aggregate demand into the red-hot zone and has led to the primary problem with growth in output—the inability of suppliers to keep up with demand. Goods suppliers can’t get the parts and inputs they need, and services can’t hire workers. But they will keep trying and eventually, they will succeed—there is a lot of pent-up demand to meet.
But we should remember that all this prosperity is based on an illusion of wealth created by the $9 trillion in Federal stimulus tossed at the U.S. economy. Stimulus is not free. The gross Federal debt to GDP ratio is over 130%, in 2000 it was under 60%. The ratio of money to the size of the U.S. economy has never been higher than it is right now, even in the high inflation 1970’s. Beacon Economics sees no reason to believe that the current pace of price increases will slow anytime soon, and it may well accelerate. And we can’t pity consumers (ourselves) for paying higher prices—it is excess consumer demand that is driving prices up. In the end, what stimulus giveth, it must eventually take away, although the next two years look like they will be hot (it’s being labeled the new roaring 20’s). After that, however, the big question is how hard the stimulus sugar crash will be when it finally sets in.
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