Well, if you have been asleep all last Friday, or willfully and maliciously avoiding economic news, you probably missed the 4Q GDP numbers that came out last week.
Big mistake but your repentance is here.
4Q GDP blew through projections with a 5.7% annualized increase over the 3rd quarter numbers. In Q3, it was a 2.2% increase over Q2. So it seems that things are getting better at an increasing rate.
While you laziness may be forgiven in that these numbers are likely subject to further revisions and your precious time cannot be wasted on the incomplete speculation of some government bureaucracy, you are wrong.
Most of the increase in GDP (3.4%) came from inventory adjustments with the remainder (2.3%) coming from an increase in consumption, or what we like to call an actual increase in GDP. The 2.3% increase is over and above the change seen from Q2 to Q3, so things were already getting better, but what is with this 3.4% kicker, this bonus that hardly anybody saw coming?
Is this other 3.4% number mere voodoo magic, an accounting abstraction and nothing more?
Well, yes and no. Let me explain how it works.
In Q4, businesses sold $8.5 billion in goods over what was produced, meaning that they drew down inventories. How does this calculate into GDP? GDP = C + I + G + X. The inventory adjustment count as negative investment (-I), -8.5 billion or - 34 billion at an annual rate.
In Q3, inventory drawdowns were $34 billion, meaning that in Q3 we sold 34 billion more than we made, -139 on an annual rate.
This also counts as -I.
Here is where the magic happens.
Last quarter, inventory drawdowns were -139 I, this quarter they were - 34 I.
So the difference between -139 and -34 is +105 billion a change that is reported as positive.
We thought we were losing 139 billion dollars but we only really lost 34 billion, which is counted as positive GDP growth.
Econobrowser does a much better job of explaining it:
If consumers, businesses, foreigners, and the government had all purchased exactly the same quantity of real goods and services in 2009:Q4 as they had in 2009:Q3, more of those sales would have come out of inventory drawdown in Q3 than in Q4, so even without any gain in final sales we would have had to produce more stuff in Q4 than Q3, specifically, 3.4% more stuff at an annual rate. In fact real final sales to consumers, businesses, foreigners, and the government were not stagnant, but grew at a 2.3% annual rate during the fourth quarter, and the two effects combined give us the 5.7% reported GDP growth.
So we sold more stuff in Q4 over Q3, but this stuff came from the inventory adjustment that occurred in Q3. We didn’t see that huge inventory adjustment this quarter, meaning 2 things.
1. we are producing more to make up for the increase in stuff sold.
2. We are not producing more and this was a 1 time occurrence and GDP is likely to be less in the upcoming quarter.
I am inclined to believe #1, since the the ISM came out today as I am sure you are aware of, with inventories contracting at a slower pace in January, with production and new orders remaining on the rise.
This leads me to believe that we are producing more to replace the low inventory levels that we have seen since the recession started.
Hopefully, manufacturers inventories will rise and then customers inventories will rise, but it appears that lean times remain upon us. Eventually the increased production will lead to increased inventories, and these two components are the only ones still remaining underwater on the ISM.
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