Q3 GDP Strengthens to 2%, But Is Held Down by Weak Business Investment

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This piece was originally written for Encima Global.

We think most scenarios for the U.S. election and Europe crisis lead to a global recession in 2013, though there are still some escape valves. Current Fed policy is contractionary by hurting savers, damaging markets and rechanneling capital from job-creating parts of the economy to the government, big banks, big corporations, foreign investment, gold and commodities. As the Fed has dramatically expanded its purchases and future commitments, U.S. growth has slowed from 2.4% in 2010 (fourth-over-fourth) to 2% in 2011 and only 1.7% in the first three quarters of 2012.

In addition, a confluence of problems in Greece, Spain, the U.S. tax code, the U.S. deficit and earnings are coming together at year-end to reduce business investment. We expect U.S. GDP growth to remain slow in the fourth quarter, with business investment in both the U.S. and Europe waiting for government reforms.

• U.S. real GDP grew 2% in the third quarter, slightly above consensus and above the second quarter’s 1.3% growth rate. The contributors to third-quarter growth were consumption (2.0% Q3 growth, 1.4% contribution) and government (3.7% growth, 0.7% contribution) whereas forward-looking components were weak. Business investment (non-residential fixed investment) subtracted 0.1% from third quarter GDP and net trade subtracted 0.2% due to weaker exports.
• Residential investment contributed 0.3%. Housing is in a material recovery, but from such a low base that it can’t grow enough to lift other components much. Non-residential private structures subtracted 0.1%. The price index for residential investment rose to 2.6% in the third quarter from 1.2% in the second quarter, due in part to rising construction costs as housing starts accelerate.
• The overall GDP price deflator rose 2.9%, pushed up by energy prices. The core PCE deflator -- the Fed’s preferred measure which has been deeply lagging and heavily revised upward in past inflation cycles -- rose 1.3% (see WSJ How the Fed is Holding Back Recovery 10/19/10.)
• Equipment and software investment showed no growth in the third quarter from the second. Software contributed a positive 0.1%, while other components (computers, capital equipment) subtracted (see Business Investment Weak 10/25/12.)
• Defense spending grew at a 13% annual rate in the third quarter, contributing almost all (0.6%) of the 0.7% GDP contribution from federal, state and local government. This sharp third quarter growth in defense spending came after sharp declines in the fourth quarter of 2011 (-10.6%) and the first quarter of 2012 (-7.1%), leaving the level of inflation-adjusted defense spending still below year-ago levels.

Bottom line: We think the data is showing a relatively consistent picture of slow growth in GDP and weakness in business investment. We expect these and jobs to be affected by year-end policy decisions regarding U.S. tax increases and the attractiveness of the business climate for new investments and hiring.

David Malpass is President of Encima Global and Chairman of GrowPac.com’s Stop the Fed campaign.