Monday, January 31, 2011

GDP x3

Yep, back from hols. We had a great time. Thanks for asking.

Three important fourth-quarter-2010 GDP results were out while I was away: UK, China and the US.

In the United Kingdom, GDP contracted 0.5% in Q4. That was well below market expectations of a small rise. That makes three surprise results on the trot. Q2 and Q3 results were well above expectations. The statistical cynic in me thinks we were simply due a bad number.

The mid-year results were simply too strong given the underlying fundamentals of the UK. It led me to concede that this was the economy I was most wrong on (least right?) in 2010. The Q4 number therefore, somewhat perversely, gives me some comfort that economic fundamentals still matter! I know the theory: every country is supposed to have at least one comparative advantage. The UK’s escapes me for the moment.

Of course the bad UK weather copped most of the blame for the poor result, but also underscores fragile economic conditions in the UK, especially as fiscal austerity measures impact over the course of 2011.

In China, GDP posted an annual rise of 9.8% in Q4 (10.3% in year-on-year terms). Yes folks, it is still a world of two halves out there. Inflation fell back a bit in December to 4.6%, following November’s rise of 5.1%.

Despite this better inflation result, the control thereof remains the key challenge for China in the period ahead. Further tightening appears a near certainty. This will be on three fronts: further increases in benchmark interest rates, the required reserve ratio and further appreciation in the CNY.

Of course further CNY appreciation will also assist in global rebalancing by making China imports cheaper, thereby boosting consumption. Retail sales growth of 14% in the December year was good news, but ideally we want China consumption to be the strongest part of GDP growth for the foreseeable future.

Which brings me to the United States. Fourth quarter annualised growth of 3.2% was both good and not-so-good news. The good news first. 3.2% in the quarter is a good result for a country that is meant to be just “muddling through” (our words) the last half of 2010 and early 2011. It was only back in August that the “double-dipsters” were at their most apoplectic.

The make-up of the result was interesting. Business investment put in another increase in the quarter, although somewhat softer than previous quarters. Exports were strong and imports were weak which made for a positive contribution from net exports. Remember business investment and exports are the two areas we want to see perform well for a better balanced US economy.

Inventories made a big negative contribution in the quarter. That’s not so good for this quarter, but bodes well for production further down the track.

Personal consumption is the part we really need to think about for a minute. Private consumption rose 4.4% (annualised) in the quarter. On the one hand it’s good to see consumers spending a bit, but that is only a short-term consideration. We are more concerned about the medium to long-term outlook.

The first point is this. That growth in consumption was not driven by growth in jobs or incomes. That means it came out of savings. Indeed the personal savings rate dropped from 5.9% in Q3 to 5.4% in Q4.

Now let’s remind ourselves of the genesis of the Global Financial Crisis. A global “savings glut” (Ben Bernanke’s own words) led to low real interest rates which led to over-inflated asset prices. As the bubble inflated, consumers consumed on the back of perceptions of increased wealth. The US had become the world’s borrower and spender of last-resort.

That was never going to go on forever and indeed didn’t. In my view, the US has only just STARTED the deleveraging process. This leaves me wondering if the Q4 rise in consumption is just a “blip” borne out of deleveraging fatigue and a bit of a Christmas spend-up before refocussing on debt repayment again in the New Year. Only time will tell.

If that’s not the case and consumers are spending again, then the message to Timothy Geithner is to use the opportunity to put the accelerator pedal down on fiscal consolidation. It’s called “tough medicine”.