Monday, August 30, 2010

The Recovery and the Post

The GDP numbers released last week were disappointing.   Yet, the numbers for the Postal Service and advertising in general were not that bad.  Why is that?    It is simply that sales to domestic purchasers -- which include consumers, businesses and the government -- rose 4.3%.    An an industry that depends on its ability to grow the sales of firms that sell products and services to consumers and business, having customers whose business is growing faster than the economy is good news.

So why does the economy seem to be slowing down?   The reason is four fold. 

First, Americans are not purchasing domestically made goods.   Nearly every sale in the shopping mall is either imported directly or includes significant amount of their components imported.  From apparel to electronics, nearly every item is shipped directly from factories overseas to stores and sometimes directly to consumers.   Larger items that are manufactured in the the United States like appliances have key parts like electric motors that are shipped from overseas manufacturers for assembly in factories in the United States. 

Second, companies had cut both retail and production inventory so sharply in 2009 that the increase in business and consumer demand in the first half of 2010 resulted a major inventory rebuilding effort, much of which required purchasing goods from overseas.  Given that no company wants to rely on expensive air shipping of component parts or retail inventory, companies built up inventory to levels required to permit slower ocean transport for forecasted demand levels. 

Third, forecasting consumer demand is difficult.  Even a slight over-estimation of consumer demand results in build-ups in inventory of foreign purchased goods.  So if a company assumes more sales than actually occurred then they will have inventory levels of imported goods greater than their ability to sell at full retail price.  This reduces the GDP as GDP represents the difference between the price paid for the imported goods and the sale price to consumers.

Fourth, during a recovery it is likely that inventory build-ups of both seasonal and non-seasonal goods may occur in quarters prior to the sale.   For example, imported holiday decorations and themed products may arrive in the United States and added to inventory a quarter or more before they are actually sold so the public.   In this case, the import of inventory  reduces GDP in the quarter that it is imported and will increase GDP in the quarter that it is sold.   The effect of the temporal difference between inventory build-up and actual sales has the impact of lowering reported GDP in quarters experiencing the inventory build-up and raising it when it is sold.   So it would not be surprising to see much faster growth later on when there is a small adjustment for imported inventories.   The build-up in inventories may have worsened this effect over normal seasonal patterns.

So trying to estimate the real change in GDP is a lot more difficult than before.   It is unlikely that this will be picked up by the nightly news, political commentators, or politicians as it is difficult to explain in a soundbite.   The only place where this might be understood is among investors, and the market's positive reaction to the GDP revision  suggests that large investors clearly saw that the decline in the GDP numbers may have exaggerated the economies slowdown.

This is not to say that the economy is strong.    Unemployment remains quite high, the value of the assets of most consumers are down, and their need to save and not spend is greater than at any time since the 1930's. In addition, both residential and consumer real estate has significant excess inventory that will put a major damper on construction spending for a number of years to come.

In the next few months both Republicans and Democrats will be making proposal for fixing the economy, grow jobs and improve GDP growth.    The problems that imports create in measuring GDP growth suggest that businesses, like those that use the mail for advertising, should start asking serious questions to these politicians and their advisers about how their proposals increase net domestic spending (domestic spending minus imports) as opposed to that of their opponents.   They should not accept arguments that said that one approach or another worked in the past as these approaches were applied in an economy where imported goods represented a smaller share of domestic spending.  They should instead ask:  How does this approach when a significant share of all domestic spending involved imported goods and services?

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