USA Outlook Update (Sept. 7, 2006): Personal Consumption Expenditure and GDP from 2005 to 2006; a recession is not in sight.

Addendum (November 12, 2010):
The content of the main article was based on the government data released before July 27, 2007. However, in the annual revision issued at the end of July, 2007, both GDP and consumer spending data were revised downward by substantial amounts, dating back for several years. The new data have portrayed a steadily weakening economy and have prompted us to issue a "recession watch" on July 28, 2010 in USA_Update2007_07_28. In a long-term projection dated as Oct. 18, 2005, near the end of Comment 25 it is stated, "..., so if a recession should come, it will be in 2008, not within next 12 months." Also diascussed in article 10 was the inevitability of the most recent recession.

The growth rate of second quarter Real GDP has been revised to +2.9% from +2.5%. Since the first quarter growth rate was the sizzling +5.6%, sizable drop of the growth rate in the second quarter is unavoidable. Whether this +2.9% growth rate of the second quarter GDP is the natural slump from a sizzling first quarter or is reflecting a weakening economy becomes the concern of financial and equity markets. There are two camps of opinions. The first is the "soft landing" camp that argues for a gradual slow down of US economy in couple with a benign inflation environment. This camp thinks that interest rate will be held steady at the current level and thus equity markets will rally up strongly. The second is the "recession" camp that believes a recession is coming and FED will be forced to lower short-term interest rate very soon. The soft-landing camp points to the resilient equity markets as the support of their argument, but the recession camp brings up the sharply inverted yield curve as the evidence of an upcoming recession.

Both the soft-landing camp and the recession camp are assuming that consumer spending has slowed down substantially due to higher mortgage rates that discourages the consumer habit of borrowing against private residences to spend. Both camps only differ in assessing the scale of the slowdown of consumer spending. Real GDP data have been very volatile for the past 4 quarters; the third quarter of 2005 saw a Real GDP growth rate of +4.2%, the fourth quarter of 2005 was +1.8%, the first quarter of 2006 was +5.6% and the second quarter of 2006 was +2.9%. From those jumping and sporadic data we cannot derive the future direction of Real GDP growth rate at all. The implicit assumption of both soft-landing and recession camps that US consumer spending is slowing down is only based on speculation, not any hard evidence from data. What we need to do is to look at the monthly personal consumption expenditure data objectively and establish a feeling about the actual status of present consumer spending level. Monthly percentage changes of real personal consumption expenditure are first calculated, and a factor 12 is multiplied to obtain the annualized percentage changes. Three month moving averages of the annualized monthly percentage changes are plotted in the graph at the right from March of 2005 to July of 2006; three-month moving averages are used in order to smooth out the volatility of the monthly data. The sharp fall in the fall of 2005 and the subsequent bounce back are the effects of Hurricane Katrina. Before the hurricane the growth of consumer spending was very strong and was reflected in the strong performance of real GDP growth of +4.2% of the third quarter of 2005. The sharp drop of consumer spending after the hurricane caused real GDP of the fourth quarter to grow only +1.8%. The sizzling growth rate of the first quarter of 2006 was substantially aided by the natural rebound of spending after the sharp drop following the hurricane. If there had been no hurricane, the consumer spending would have fall gradually from the peak of the middle of 2005, bottomed out around +2.5% in the early summer of 2006 and then have turned up to plus 4% range by the end of the summer of 2006. This picture of consumer spending is very different from the imagination of financial analysts that US consumer spending is steadily eroding. There is no sign that US economy is imminently sliding into a recession. If we want to talk about a soft-landing, such a soft-landing then has already occurred in the late spring to early summer of 2006, and the consumer spending is now heading upward. The +4.0% growth rate of personal spending implies that real GDP is growing around +3.0% to +3.5% during the summer, a rate only slightly below the growth rate of real GDP from the middle of 2004 to the middle of 2005.

Since the onset of globalization process in the early part of 1980's, real GDP has grown with a rate similar to that before the globalization process, that is from 1955 to 1980, as can be seen from a logarithmic-scale graph in Section 4 of Article 2A. However, the dynamics driving the expanding real consumer spending is very different in the globalization era from the pre-globalization period. Before the globalization, US consumer spending expanded due to the expanding domestic production. In the globalization era, US consumer spending has expanded by borrowing from foreigners in the form of run away trade deficit. The current account deficit, that is, the broadest measure of trade deficit, has reached the rate of 800 billion dollars a year in the first quarter of 2006. In other words 800 billion dollars are paid to foreigners in a year. Since US Dollar is the legal tender only in USA, foreigners must recycle this 800 billion dollars a year back to US financial market to be borrowed by US entities, including consumers. Economics 101 says that lending generates more and more lending. Thus this 800 billion dollar pool of loans generates trillion dollars of borrowings and is fueling US consumer borrowing as well as public sector borrowings. As long as this huge influx of trade deficit money continues to flow, consumer spending will hold up strong. When borrowings against private residences become disadvantageous, consumers simply switch back to credit card borrowing and continue the spending spree. That is why consumer spending in US is not collapsing as mistakenly predicted by many analysts. In recent years the pattern of US trade deficit has undergone a significant change. The major source of US trade deficit is now from China, replacing the old deficit sources like Japan and Taiwan. Chinese Yuan has under gone substantial devaluation against US Dollar in the early part of 1990's, and then pegged to US Dollar closely until the middle of 2005. Since the middle of 2005, Chinese Yuan has been allowed to appreciate against Dollar only by a small amount. Thus US trade deficit with China is expanding steadily, compensating declining trade deficits with Taiwan and Japan that are influenced heavily by the movement of the value of Dollar against those currencies. At present US trade deficit does not seem to be going to shrink any time soon, so the danger of a consumer spending slowdown is not in sight, and nor is a recession.