Remember those standardised multiple-choice tests from grade school with questions like: If it takes...
Remember those standardised multiple-choice tests from grade school with questions like: If it takes two men six hours to mow a lawn, with each man taking a half-hour break every two hours, how long does it take one man with a broken leg to mow the same lawn using only one hand?
So here's the question for the day: If the US economy grew 2% in the first quarter and final domestic demand rose 3% with the federal funds rate at 6.5% declining to 5%, how fast will it grow in the second quarter with the funds rate at 4.5% and headed lower?
Last week's report on first-quarter gross domestic product, old news that it is, should accomplish a couple of objectives.
First, it should dispel the notion that the US economy is in recession or headed for one. Even with inventories posting their first outright decline in a decade, subtracting 2.5% points from growth, the US economy still managed to expand at twice the fourth quarter's 1% pace.
"It is remarkable that this economy can absorb the body blow of a $63bn inventory swing and a drop in capital spending and yet manage to grow by 2%," wrote Bear Stearns economists in their data analysis.
Real final sales, which is GDP less inventories, rose 4.6% compared with 1.7% in the first quarter and the fastest pace in a year. The drivers were consumer spending (up 3.1%), investment in non-residential (up 11%) and residential (up 3.3%) structures, and government spending (up 4%). Investment in equipment and software fell 2.1% after a 3.3% decline in the fourth quarter, the first declines since the 1990-1991 recession.
Second, the report should put to rest the idea that the US is suffering from deflation. Take a price index, any price index, in the GDP report, and it shows price increases accelerating. Even Federal Reserve Chairman Alan Greenspan's preferred (read: lowest) inflation measure, the core PCE price index (that's the price index for personal consumption expenditures excluding food and energy), rose 2.7%, the fastest pace in the five-year history of the series.
Consider the other inflation measures in the report: The GDP price index rose 3.2%; the price index for gross domestic purchases, which measures prices paid by US residents, rose 2.8% and 2.4% excluding food and energy (the fourth quarter increases were 1.9% and 1.6%, respectively); the PCE price index rose 3.3% compared with 1.9% in the fourth quarter. In short, there is not one price index that could lead Greenspan to conclude inflation is well contained. Granted, it's not out of control. But it's disingenuous to maintain that prices, which lag the business cycle, aren't rising at a time when the Fed is stoking future inflation with the fastest money supply growth since the mid-1980s. (In the last three weeks, M2 rose an annualised 13%.)
Which brings us to our next point about the report. It should dispel the notion that Greenspan knew something we didn't when he orchestrated a surprise 50 basis-point inter-meeting rate cut last week.
"What did Greenspan know?" asks Jim Bianco, president of Bianco Research in Barrington, Illinois. "Certainly not the economic numbers. Whatever happened to 'near-0% growth?'" 2% growth is clearly close enough to 0% for government work. The GDP report, the first of three guesstimates from the Commerce Department, provided clues as to why Greenspan is lowering rates at the most aggressive pace since 1981, when the US was in the midst of back-to-back recessions.
"It's Cisco," says Henry Willmore, senior economist at Barclays Capital Group.
"Greenspan talks to CEOs of technology companies, and they tell him business is terrible. He oversold that idea."
Cisco Systems, the No 1 maker of computer networking equipment and a new economy benchmark, issued a dour warning about the current quarter's sales just two days before the Fed cut rates. Cisco said it expects revenue in the quarter that ends 28 April to fall 30% from the previous quarter.
Businesses operate in a nominal world. They get orders, make sales and earn profits in nominal dollars. Real is for statisticians.
In today's GDP report, investment in computers and other peripheral equipment fell an annualised 30.6% in the first quarter, mimicking Cisco's company forecast. These companies "are used to growth of 20 to 30%," Willmore says. "These are recession numbers for these industries."
In real terms, however, investment in computers fell 2.5%. No big deal, in other words. And the rest of the economy is doing OK. To ensure that it remains that way, the Fed is likely to lower interest rates again on May 15 to counter the effects of rising unemployment, lagging indicator that it is.
First-quarter growth may be revised away when the Commerce Department gets more complete data, especially on inventories and trade in March. Still, the composition of the report, with strong final sales and a big decline in inventories, is a positive for the second quarter.
If this week's reading on manufacturing from the National Association of Purchasing Management shows what would be a third consecutive rise in April, why it just might be time for Fed officials to dust off the recently ditched script on a second-half recovery.
Caroline Baum in the Bloomberg New York newsroom
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