Latest data – largest quarterly output decline in recorded US history – but Europe is worse

The US Bureau of Economic Analysis (BEA) released the – Gross Domestic Product, Second Quarter 2020 (Advance Estimate) – data last week (July 30, 2020). It shows that the US economy has declined by 9.49 per cent between the March- and June-quarters. On an annual basis the decline was 9.54 per cent. This is the largest quarterly contraction in recorded history. Consumption expenditure declined by 10.1 per cent in real terms and business investment by 17.4 per cent. The collapse in consumer expenditure was mostly concentrated in services (-22.6%), which reflected lockdowns and the unwillingness of consumers to continue normal practices. Personal saving as a percentage of disposable personal income jumped dramatically from 9.5 per cent in the March-quarter to 25.7 percent in the second quarter. That is a testament to the endemic uncertainty that the pandemic has created. The contribution of net exports actually rose, not because exports rose (their individual contribution was -9.38 points), but because of the slump in imports – a smaller leakage from the expenditure system (adding 10.1 points t growth!). Overall, there is no trend – just a massive mess. How the second wave of the virus impacts is anybody’s guess but lots more deaths and more disruption is certain.

The global context and overview

The latest Eurostat data shows the European Union contracted by 11.9 per cent in the second quarter 2020, while the euro area was down 12.1 per cent. Italy shrank by 12.4 per cent and is now the same size as it was in 1993. The Spanish economy contracted by 18.5 per cent, France by 13.8 per cent, Portugal by 14.1 per cent and Germany, the largest European economy contracted by 10.1 per cent. Unemployment rates are rising as output shrinks.

Similarly, the US economy contracted by 9.5 per cent in the June quarter, the largest quarterly contraction in recorded history. Consumption expenditure declined by 10.1 per cent in real terms and business investment by 17.4 per cent.

The collapse in consumer expenditure was mostly concentrated in services (-22.6 per cent), which reflected lockdowns and the unwillingness of consumers to continue normal practices.

Durable goods consumption actually rose (0.7 per cent), reflecting purchases of vehicles and white goods brought forward on the back of cash payments associated with government stimulus.

The consumer outlook is bleak. The Conference Board Consumer Confidence Index rose in June, but as the infection rate has accelerated, the July figure declined from 98.3 to 92.6.

This was accompanied by a massive decline in the Expectations Index, which signals short-term consumer estimates of income and labour market prospects – down to 91.5 from 106.1.

The future is not looking optimistic.

Several major US companies are laying off thousands (for example, Boeing, AT&T, Hilton, HSBC, Linked-In, etc and many companies have disappeared forever.

Conversely, Amazon, Apple and Facebook have boomed with shifts to home office setups and on-line shopping. These shifts will not be temporary. Firms will start rationalising expensive office space and the decline in bricks-and-mortar retailing will accelerate. Both trends have serious implications for the viability of commercial real estate, which was already in trouble before the pandemic.

The human tragedy is exemplified by the 54 odd million people that have filed for unemployment insurance since early March. While the weekly claims started to decline as the lockdowns eased, they have risen again with 1.4 million filing in the last week of July. The insured unemployment rate has also risen (11.6 per cent).

The socio-economic crisis is global and will worsen as nations around the world endure the emerging second wave of the virus. Renewed lockdowns are certain as hospital systems face being overwhelmed and death rates remain high.

The politicians started with the V-shaped (hibernation) presumption, while they ‘flattened the curve’. The reality is different. This will be a long-drawn out crisis and many companies will fail to ‘get to the other side’, leaving a residual of high unemployment.

Capitalism is now on state life support. The ‘market’ will not provide the cure.

The age of irrational worry about fiscal deficits and public debt ratios will have to give way to a new era of large, continuous deficits supported by the monetary capacity of the Federal Reserve.

The problem for most nations is that governments ‘penny pinched’ on the fiscal support that accompanied the lockdowns. This not only exacerbated the economic losses, but, created the vicious cycle where political pressure led to premature easing of the lockdowns, which then fuelled the infection rate, and magnified the economic losses.

The only reasonable conclusion, as evidenced by the substantial increase in official unemployment and the rise in the BLS U6 broader measure of labour underutilisation is that the fiscal support has been grossly inadequate and poorly targeted.

The benefits of the US government’s fiscal package flowed disproportionately to corporations and left millions of workers exposed to income loss and financial disaster.

The main action has come from the Federal Reserve’s decisions to purchase government bonds in large quantities and to provide other liquidity support.

The following graphs provide some comparative analysis, given that Eurostat released some June-quarter national accounts data last week.

The first shows the GDP indexes for selected European nations (and the EU and Eurozone) and the US from the March-quarter 2008. This graph lets us see the different recovery profiles after the GFC and the dives as a result of the pandemic.

The US recovered more strongly than any of the European nation, the best of them being Germany, which, because of its size drives the overall EU and Eurozone result.

Italy, by way of contrast, never really recovered and is now 21.2 per cent smaller in economic size than it was before the GFC. That is unsustainable.

The next graph shifts the benchmark for the index to December 2019 (=100) to better show how the extent of the pandemic slumps in the respective economies.

Three big European nations – Spain, France and Italy – have contracted by 22.8 per cent, 18.9 per cent and 17 per cent, respectively – since the end of last year.

The US has contracted so far over the same period by 10.6 per cent.

The aggregate level

The US Bureau of Economic Analysis said that:

Real gross domestic product (GDP) decreased at an annual rate of 32.9 percent in the second quarter of 2020, according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter of 2020, real GDP decreased 5.0 percent.

Note that the BEA is using the annualised quarterly figure here (multiplying the June-quarter growth by 4) rather than the actual annual (year-on-year) growth rate which is the percentage shift from the June-quarter 2019 to the June-quarter 2020.

That contraction was 9.54 per cent, after the annual figure for the March-quarter was a lowly 0.32 per cent.

The quarter-on-quarter growth outcome for the June-quarter was 9.49 per cent after a 1.26 per cent contraction in the March-quarter.

The BEA figure is somewhat misleading in this type of crisis. It is good for headlines but the economy is likely to rebound more quickly than usual once the lockdowns ease, although note my caution above.

The following sequence of graphs captures the story.

The first graph shows the annual real GDP growth rate (year-to-year) from the peak of the last cycle (December-quarter 2007) to the June-quarter 2020 (grey bars) and the quarterly growth rate (blue line). Note the date line starts at March-quarter 2008.

The next graph shows the evolution of the Private Investment to GDP ratio from the December-quarter 2007 (real GDP peak prior to GFC downturn) to the June-quarter 2020. Note the date line starts at March-quarter 2008.

The decline in the investment ratio as a result of the crisis was substantial and endured for 2 years. As a result the potential productive capacity of the US contracted somewhat. There are various estimates available but the overall message is that potential GDP fell considerably as a result of the lack of productive investment in the period following the crisis.

In more recent times, the investment ratio has stalled and is now at 17.5 per cent of GDP, down from 18.4 per cent in the June-quarter 2019, which was the highest levels since the current BEA data series began in the June-quarter 1947.

In this blog post – Common elements linking US and UK economic slowdowns (May 1, 2017) – I discussed estimates of potential GDP in the US and the shortcomings of traditional methods used by institutions such as the Congressional Budget Office.

So if you are interested please go back and review that discussion.

The latest CBO estimates, made available through – St Louis Federal Reserve Bank, show why we should be skeptical.

To get some idea of what has happened to potential real GDP growth in the US, the next graph shows the actual real GDP for the US (in $US billions) and two estimates of the potential GDP. There are many ways of estimating potential GDP given it is unobservable.

While I could have adopted a much more sophisticated technique to produce the red dotted series (potential GDP) in the graph, I decided to do some simple extrapolation instead to provide a base case.

The question is when to start the projection and at what rate. I chose to extrapolate from the most recent real GDP peak (December-quarter 2007). This is a fairly standard sort of exercise.

The projected rate of growth was the average quarterly growth rate between 2001Q4 and 2007Q4, which was a period (as you can see in the graph) where real GDP grew steadily (at 0.65 per cent per quarter) with no major shocks.

If the global financial crisis had not have occurred it would be reasonable to assume that the economy would have grown along the red dotted line (or thereabouts) for some period.

The gap between actual and potential GDP (red dotted version) in the June-quarter 2020 is around $US4,625.4 billion or around 21.2 per cent.

The green dotted line is the estimate of potential output provided by the US Congressional Budget Office and suggests that the US economy was estimated to be operating at 0.8 per cent over its potential in the December-quarter 2019.

It is hard to believe the estimate given the suppressed inflationary environment leading into the pandemic.

The CBO is now estimating a 10.8 per cent output gap – so the reality is somewhere between the two estimates – probably closer to the read line than the green line.

Contributions to growth

The accompanying BEA Press Release said that:

The decrease in real GDP reflected decreases in personal consumption expenditures (PCE), exports, private inventory investment, nonresidential fixed investment, residential fixed investment, and state and local government spending that were partly offset by an increase in federal government spending. Imports, which are a subtraction in the calculation of GDP, decreased …

The decrease in PCE reflected decreases in services (led by health care) and goods (led by clothing and footwear). The decrease in exports primarily reflected a decrease in goods (led by capital goods). The decrease in private inventory investment primarily reflected a decrease in retail (led by motor vehicle dealers). The decrease in nonresidential fixed investment primarily reflected a decrease in equipment (led by transportation equipment), while the decrease in residential investment primarily reflected a decrease in new single-family housing.

The next graph compares the June-quarter 2020 (blue bars) contributions to real GDP growth at the level of the broad spending aggregates with the March-quarter 2020 (gray bars).

The major driver of the GDP collapse has been the decline in personal consumption spending with private capital formation the second largest driver.

It is clear that the contribution of the government sector has been weak compared to the contraction in the private sector.

We conclude that the fiscal stimulus has been totally inadequate relative to the scale of the crisis.

Further state and local government spending contracted.

The next graph decomposes the government sector and shows that all levels of government contributed significantly to growth in the current-quarter but decreased their contributions relative to the previous-quarter.

The next graph breaks down the contributions to real GDP growth of the various components of investment.

The decline in most categories of investment is a worrying sign.

Household consumption and debt

The Federal Reserve Bank of New York publication – Household Debt and Credit Report – was last updated for the March-quarter 2019 (published May 2020) – (PDF Download).

It shows:

… total household debt increased by $155 billion, or 1.1 percent, to reach $14.3 trillion in the first quarter of 2020. Mortgage balances rose by $156 billion, while nonhousing debt balances remained relatively flat. Credit card balances declined by a larger-than-expected degree, based on seasonal patterns, but it is too soon to confidently assess any connection between this decline and the coronavirus outbreak.

The rise in non-housing debt (for example, credit card balances) is particularly worrying. It is a sign that household income growth is not sufficient to finance basic needs.

The Data shows that:

About 189,000 consumers had a bankruptcy notation added to their credit reports in 2020Q1, a small decrease from the 192,000 seen in 2019Q1.

The following graph is taken from the FRBNY publication. Clearly the gap between mortgage and non-mortgage debt is rising as total household indebtedness rises.

Part of any stimulus/recovery program should be targetted on increasing real wages growth and household disposable income growth to allow these debt levels to be reduced.

Conclusion

The pandemic has created the largest quarterly contraction in recorded US history.

The US economy has declined by 9.49 per cent between the March- and June-quarters.

On an annual basis the decline was 9.54 per cent.

Consumption expenditure declined by 10.1 per cent in real terms and business investment by 17.4 per cent.

The collapse in consumer expenditure was mostly concentrated in services (-22.6%), which reflected lockdowns and the unwillingness of consumers to continue normal practices.

Personal saving as a percentage of disposable personal income jumped dramatically from 9.5 per cent in the March-quarter to 25.7 percent in the second quarter.

The contribution of net exports actually rose, not because exports rose (their individual contribution was -9.38 points), but because of the slump in imports – a smaller leakage from the expenditure system (adding 10.1 points t growth!).

Overall, there is no trend – just a massive mess. How the second wave of the virus impacts is anybody’s guess but lots more deaths and more disruption is certain.

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.