November 5, 2003
Does the GDP really mean as much as stock market investors
thought when they heard of the 7.2 percent annualized gain that occurred during
the summer? Yes it does.
GDP (Gross Domestic Product) is an estimate of the value in
current dollars of all goods and services produced domestically.
Those outsourced plants in Honduras do not count.
However, those profits earned by Nissan in Smyrna, Tennessee are in the
Another measure of economic activity (Gross National
Product) excludes the Smyrna profits and includes the profits earned by U.S.
owners of Coke bottling in Mexico. Because
GNP is based upon ownership of resources, it proved to be more confusing than
GDP. However, the two measures are
not far apart.
Actually, the 7.2 percent already is adjusted for
inflation. Excluding price changes,
GDP rose 9 percent at annual rates in the quarter.
This is well above sustainable rates of growth and will increase pressure
upon corporations to increase their capacity to grow through investment and new
Of course, GDP is a measure of what already happened, not
what will happen. Therefore,
forecasters first must determine how much of the change was caused by special
Because of the $400 child credit and the reduction in
withholding rates, consumers received a windfall of $100 billion in reduced tax
liabilities. As the savings rate
only jumped from 3.2 percent to 3.3 percent of after tax household income,
households spent their tax reductions.
Some further reductions will occur when lower capital gains
and reduced taxes on dividends are reflected in the annual returns filed between
January and April of next year. Therefore,
a little further boost to consumption from tax changes is likely, but it should
not be large.
Therefore, the 6.6 percent growth in consumer spending
after inflation during the summer should slow to slightly less than sustainable
growth in the next few quarters (somewhere in the 3.0 to 3.5 percent range).
The surge in housing and especially home remodeling also
will slow sharply as finance charges rise.
The fence sitters jumped into housing activity during the summer enough
to add almost a full percentage point to GDP.
That will not happen again any time soon.
One big surprise was the continued heavy spending on
defense. After the largest
quarterly gain since the Korean conflict, I assumed that some slowing would
occur in the summer. That did not
Computer and software spending was amazing, adding half a
percentage point to GDP growth. By
contrast, spending on structures subsided after only a one quarter spurt.
Computers can make workers more efficient but structures are not needed
until we have more workers.
While most of the one time events were positive, the
liquidation of inventories was a drag upon summer activity.
Clearly, corporations do not believe current sales are sustainable (or
they believe the prices of goods will fall further), so they are meeting sales
from their warehouses. This process of inventory liquidation must end soon.
When all the exceptional factors are extracted, I still see
4 percent growth for the next few quarters.
That is not as good as the summer, but that certainly is better than most
people expected as recently as this spring.
The other part of GDP is that every dollar spent means a
dollar earned. In the summer, that
$168 billion of increased value went somewhere.
An estimated $6 billion went to replace capital used up to produce that
value. Another $10 billion went
directly to government through sales taxes, property taxes, earnings by
government enterprises, etc.
Of the remaining more than $150 billion, less than $40
billion went to or for the benefit of workers.
Rents and interest grew, but their total was less than $10 billion.
By contrast, almost $30 billion went to private companies and
partnerships. The remaining $70
billion probably will wind up in the column of
corporate profits after adjustment for changes in the values of existing
inventory and capital, although not enough information is yet available to make
In short, operating profits before taxes probably increased almost 25 percent in the past year. With analysts only now realizing that gains of more than 20 percent are possible, should we be surprised that stock market investors are pleased with these results.