Tuesday, 8 September 2009

The worsening structure of US GDP

The immediate media focus on US GDP concerns whether its decline will halt in the third quarter of 2009. Given the huge scale of US government intervention since September 2008, and the growth recovery in China, which is on course to become the world’s largest visible trading economy, it would be extraordinarily serious if US GDP continued to decline. At least minimal US growth is likely. But examination of the detailed revised 2nd quarter US GDP figures shows that the underlying structure of the US economy is continuing to deteriorate with consequent negative cyclical and medium/long term consequences.

As noted previously both major global 'imbalances’, China’s balance of payments surplus and the US balance of payments deficit, have shrunk sharply during 2009. But they have done so for opposite reasons and with opposite results.

China’s balance of payments surplus has so far undergone a ‘benign’ correction. China’s investment level has moved up towards its savings level. As a balance of payments surplus is necessarily identical to the amount by which domestic investment falls short of domestic savings, the result of China’s rising investment has been simultaneously to maintain domestic growth and reduce its trade surplus – a beneficial combination both for China and the world economy.

For the US, however, a ‘malign’ reduction of the balance of payments deficit has occurred. The US balance of payments deficit is necessarily identical to the degree by which US domestic investment exceeds its domestic savings. But this deficit has not been cut in 2009 by US savings rising towards its investment level but US by investment collapsing downwards towards a saving level which has itself fallen further.These trends are confirmed by the revised 2nd quarter 2009 GDP data.

This decline in investment is shown in Figure 1, which charts US total fixed investment - private and government. As can be seen US fixed investment in the second quarter of 2009 declined to the lowest level since World War II - 14.7% of GDP.

Figure 1

09 09 02 Total GDFCF

The consequences of such a severe fall in investment will have short, medium, and long term negative consequences for the US economy. Cyclically the fall in investment is the major factor depressing GDP. In the medium term, unless growth in fixed investment is resumed, it is hard for the US to resume expansion. In the long term, as investment is the most important factor input into economic growth, such a severe decline in investment will reduce the US growth rate.

A consequence of the investment decline is that the proportion of US GDP devoted to consumption has actually risen under the impact of the financial crisis – as may be seen in Figure 2. As previously pointed out on this blog claims that US consumption has been falling, and saving rising, are erroneous because they confuse a rise in household saving, which has occurred, with total US savings - which have declined further under the impact of the growing budget deficit.

Figure 2

09 09 02 Total Consumption

A ‘perverse’ structural shift is thereby occurring whereby US consumption, which is already the highest of any major economy in the world, is actually rising further as a proportion of the economy and US investment declining sharply. It is for this reason that the internal reshaping of the US economy indicates a 'malign' closing of the gap between US savings and investment reflected in the declining trade deficit.

Such a decline of investment will further undermine the competitivity of the US economy at its present exchange rate. At present the deep recession is severely depressing US demand for imports. The last time the US balance of payments deficit contracted, in the early 1990s, it was by the same mechanism of a recession. As soon as the US economy began to expand again the balance of payments deficit widened very sharply again. Given the proven inability of the US economy to compete at its present exchange rate it is therefore extremely probable that as the recession slows down, and growth resumes, the US balance of payments deficit will expand again. It is notable, as a confirmation of this likelihood, that since February improvement in the US trade deficit has essentially ceased - the trade deficit was $26.1 billion in February and still $27.0 billion in June.

Structural trends in the US economy have therefore deteriorated. Investment has fallen sharply and so far there is no indication that the US can move out of recession without the balance of payments surplus widening again.

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