Thursday, July 25th, was an exciting day: the U.S. Bureau of Economic Analysis released its advance estimate of how the economy performed in the second quarter. Given the turbulence in the presidential race, these numbers were more eagerly anticipated than usual.
So, what did the GDP numbers show? Is the U.S. economy still strong, as Biden-turned-Harris supporters claim? Or is there a recession opening up just in time for the election, as many Trump backers suggest?
As of today, there is no recession coming, so those who hope for doom and gloom to help Trump win in November will have to wait a bit longer. However, if I were a Democrat (which I am not) I would not exactly celebrate these GDP numbers. They remain robust for now, but there are two big red flags buried in them that suggest bad things to come in the third quarter—the numbers for which we will get about two weeks before the election.
Let us run through the key numbers before we get to the deeper, and meatier stuff. Adjusted for inflation, gross domestic product, GDP, grew by 3.0% year over year, i.e., from the second quarter of 2023. This is up from 2.9% in Q1 and just a hair above the 2.95% for Q4 last year. This means that the U.S. economy has reached that coveted 3% mark where there is actually some progress in the standard of living.
The BEA opens its press release by reporting an annual growth rate of 2.8%, but that is not the actual annual growth rate. They arrive at this number by looking at how much the economy grew from Q1 this year to Q2, and then multiplying that number by 4. They have used this technique for calculating annual growth since time immemorial, and it never makes any sense. It is an artificial growth number that serves no particular purpose—especially since we have the genuine annual growth rate I mentioned above.
The fact that the Biden economy has reached 3% is worth a thumbs up, but not more than that. Every relevant economic indicator says that the U.S. economy is currently operating at the very peak of its business cycle; to do that and only grow by 3% is not a sign of strength, but a sign of structural weakness.
During the Trump presidency, we reached 3.2% in Q4 of 2017, 4.1% in Q1 of 2018, and 3% in Q2 of that same year. These numbers are stronger than the three-quarter stretch of barely-3% growth that we have reached under the Biden administration, but the bigger problem here is that neither Trump nor Biden—and certainly not Obama before them—has been able to revitalize the U.S. economy to the point where it grows at 4% or more for the entire peak of the business cycle.
In short: while we can be happy that we are a full percentage point and more ahead of where Europe and Britain are, we have good reasons to criticize Biden for having taken absolutely no initiatives to meaningfully improve the structure of the American economy. Trump at least tried, with deregulations and decent tax reform; the infrastructure bill that Biden signed had so little infrastructure spending in it that it makes no difference from a structural viewpoint.
As I mentioned, if we dig beneath the GDP figures themselves, we find a couple of reasons to believe that the third quarter will be tough on the American economy.
First, there is the consumer spending number. The total, real annual growth in private consumption for Q2 was 2.4%, which means private consumption is growing more slowly than the economy as a whole. Since consumption accounts for almost $7 out of every $10 spent in the U.S., the fact that it is growing more slowly than GDP is worrisome. This is usually a sign of recession: households are losing confidence in the future, pulling back on spending, and trying to shore up liquidity for tougher times to come.
We see a clear sign of this shift in consumer sentiment in the decline of spending on consumer durables, i.e., appliances, home electronics, furniture and home improvement products, cars, etc. A year ago, this spending category was growing at 3.04%; in the third and fourth quarters of last year, its expansion exceeded 4.5% on an annual basis. Since then, it has slowly cooled off and is now at a level where it could easily drop into negative numbers next quarter.
Even more interesting are the numbers for business investments, or ‘gross fixed capital formation’ as we national accounts nerds prefer to call it. On the surface, this variable looks healthy, growing at almost 6.4% on an annual basis. However, not a single one of the ‘regular’ categories of capital formation lives up to this number:
- Construction of residential structures—homes—grew by 5.5%;
- Investments in nonresidential structures, i.e., offices, warehouses, manufacturing plans, garages, repair shops, etc., grew at 4.6%;
- Purchases of equipment, i.e., furniture, computers, manufacturing robots, vehicles, tools, etc., expanded at 1.6%;
- The normally strong category of intellectual property products—primarily computer software—reached 4.7%.
So where did the 6.4% growth in capital formation come from?
It comes from inventories. In the second quarter of last year, U.S. businesses reduced their inventories by an inflation-adjusted $22 billion; in the second quarter of this year, they built up inventories by $1.1 billion. This shift from a large negative number to a small positive one registers as a significant rise in investments.
In reality, it means that businesses reduced inventories in the spring of last year to keep up with sales and deliveries while this spring, they have put products in inventory instead of selling them.
Long story short: taken in isolation, the 6.4% real growth in business investments is a statistical mirage. However, when we put it in a broader macroeconomic context, including a small uptick in unemployment, this investment pattern suggests that businesses in general are growing more pessimistic about the future. Not only have they—again on a small scale—shifted from hiring to firing, but they have also shifted from reducing inventories to building them up.
All in all, the U.S. economy is more than likely going to show real signs of a recession in the third quarter. This means that Kamala Harris—the presumptive Democratic presidential nominee—will go into the election in November with rising unemployment.
It also means that the Federal Reserve will cut its federal funds rate in September, by at least 0.25 basis points, but possibly more than that.
