With the release of the Q3 US GDP report this week, we realized it had been a while since we’d looked at some of the underlying components of GDP to get a sense of the general economic trends at home. In this case, we’ll use the “expenditure” based approach; this methodology adds Consumption, Investment, Net Trade (negative subtracts, positive adds), and Government Expenditures to come to a total GDP number. This works for nominal (not adjusted for inflation) and real GDP (adjusted for inflation) numbers. As always, a quick, broad overview of these aggregates provides an interesting picture on recent trends in the US, perhaps gives us a picture of the future sources of US growth, and upends a few nuggets of conventional wisdom along the way.
Now, here are the charts for the four underlying categories. We used the real, inflation-adjusted numbers for all series, and begin in 1997, as there were a few data inconsistencies as we went beyond that point. These charts show each category as a percentage of overall real GDP.
Right off the bat, we’re struck by the sharp rise in real consumption as a percentage of GDP from the late-1990s, which coincided with a sharp deterioration in the trade balance. This makes sense as the sharp rise in personal consumption coincided with a sharp decline in the savings rate. A declining external trade balance is very much reflective of declining national savings. Since the crisis, consumer spending has leveled off relative to overall GDP since the beginning of the Great Recession. Still, it’s amazing how well the series has held up all things considered.
Investment, on the other hand, took the brunt of the pain prior to and during the Great Recession and Financial crisis, falling significantly relative to overall real GDP. From Q4:2006 through Q4:2009, real investment experienced unrelenting negative year over year prints—13 straight quarters of year over year declines! Q1, Q2, and Q3 2009, during the worst days of the recession, year over year real investment was down 23%, 26%, and 25%. Since then, investment has rebounded decently and is now getting closer to levels observed prior to the crisis in terms of its relationship to overall economic growth. Since Q1:2010, there have been six quarters out of 15 with double digit year over year investment gains. Combine the improvements in investment with the improvement in the trade balance, and we get a sense that the overall national savings rate has increased a decent amount.
Which brings us to what is perhaps the most interesting chart of the four, that of US government expenditures, which includes expenditures at all levels of government. This is where conventional wisdom gets turned on its head. Read the news and listen to the arguments among politicians, and one would assume that government spending run amok dominates the GDP aggregates. Not so. Actually, government expenditures are easily at the lowest point relative to overall real GDP observed in the past two decades. If we broaden out the data series to 1947, the current level of government expenditures relative to overall real GDP is at its lowest point in the post-war era. As you can see in the chart, the level of government expenditure relative to overall GDP spiked during the recession as automatic stabilizers and the stimulus kicked in. Since then, the US has experienced its own mini-version of European style fiscal austerity. Of course, we focus entirely on Federal government spending, but keep in mind that state and local government spending has been hit hard in many cases. Counterintuitively, this seems to explain a good bit of the improvement in national savings. Government at all levels has made the big adjustment on a relative basis, not the US consumer. Since Q1:2009, average year over year quarterly real government expenditures comes to -0.54%. The year over year print has been negative in 12 out of the last 13 quarters. In the most recent quarter (Q3:2013) real government expenditure was -2.77% year over year.
Keeping with the theme of upending conventional wisdom, here is the breakdown of average year over year real government spending prints for all presidential administrations going back to Eisenhower:
Obama: -0.54%
GW Bush: 2.30%
Clinton: 1.26%
GHW Bush: 1.95%
Reagan: 3.35%
Carter: 1.98%
Nixon/Ford: 0.06%
Kennedy/Johnson: 5.02%
Eisenhower: 1.07%
Again, government expenditure numbers account for total expenditures at all levels, but with the Federal government accounting for the bulk of the overall expenditures, it creates some interesting food for thought.
Wrapping up, there are several things to take note of. First, since 1947 average year over year real GDP has been 3.26%. The average since the beginning of 1990, however has only been 2.48% and since the beginning of 2000, it’s been a paltry 1.92%. Clearly the US capacity for growth has downshifted over time. Since Q1:2010, we’ve seen 7 out of 15 quarters with sub-2% year over year real GDP growth, including the last four quarters. It’s easy to see why many economist types and Federal Reserve officials are worried about slow growth, output gaps, deflationary potential, and other bugaboos. Second, while the old cliché posits that you should never bet against the American consumer, we’d guess that going forward consumption has reached a ceiling relative to overall GDP growth. At best, we’d expect mediocre real consumption growth going forward. Worst case, consumer oriented sectors could feel some pain, at least relative to other sectors like industrials, as there seems to be opportunity for investment to continue to increase. Interestingly, among the subsectors in the S&P 500, the Consumer Discretionary subcomponent is trading at the richest valuation among all sectors; normalized P/E is now approaching 30x, and it’s now at the highest level observed since early 2000. Finally, as the fiscal position of state and local governments improves gradually with the overall economy, we’d imagine that government expenditures will pick up and the overall series will stabilize relative to overall GDP. The Federal government remains a wild-card. Finally, we can use Investment + Net Exports as a quick proxy for national savings; this number was in steady decline from 1997 to and through the financial crisis. Since then the number has improved back to levels last seen at the beginning of the 2000s. We expect the trend to continue.
