President Joe Biden and the White House are working hard to claim the United States is not in a recession — but one key statistic in Thursday morning’s gross domestic product report spells particular trouble for the economy.
Growth in final sales to private domestic purchasers, adjusted for inflation, fell to zero.
Here’s why it matters:
In arguing that the U.S. is not in a recession, White House economists noted that the negative first quarter real GDP number was influenced by factors that don’t necessarily relate to future growth.
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They had a strong case. Specifically, declines in business inventories and imports, both of which subtract from the calculation of headline GDP, drove the overall growth rate into negative territory. Neither of those bear on the underlying strength of the economy.
And another measure of economic output, gross domestic income, was positive in the first quarter, showing a 1.8% annual rate.
Taking those caveats about the GDP numbers into consideration with the strong jobs growth through the first half of the year, it’s reasonable to think that the GDP statistics have seriously understated the strength of the economy.
But the story has changed with the second quarter number on final sales to private domestic purchasers:
The final sales to private domestic purchasers number strips out the noisy effects of net exports and inventories (which again detracted from the headline number in Thursday’s report for the second quarter, knocking it down by 2 full percentage points). It also strips out changes in government purchases and thus reflects the underlying strength of households and businesses. That is why the Biden Council of Economic Advisers specifically cited it in a now-controversial blog post making the case that two quarters of decline do not necessarily make a recession.
It slowed to a standstill in the second quarter.
Worse, it declined because consumer spending on goods fell and housing investment cratered at a massive 14% annual rate.
Those are signs that the Federal Reserve’s campaign to slow spending by raising interest rates is having an effect. If so, the slowdown will only worsen in the months ahead as the Fed hikes rates further.
“Both business and household fixed investment contracted quarter on quarter, with the biggest declines seen in household fixed investment; this most likely reflects the rising cost of assets like vehicles over the last year, as well as the more recent slowdown in the housing market as interest rates rise,” said Cailin Birch, global economist at the Economist Intelligence Unit.
In other words, the Fed raised interest rates, which led to higher rates on mortgages, which slowed the housing market, with trickle-down effects on the construction industry, home goods purchases, and everything else related. With inflation still far above the Fed’s 2% target, more rate hikes and pain are in store.
It’s important to keep in mind, though, that Thursday’s numbers will be revised and could easily end up showing GDP growing.
The bottom line:
There are many reasons to think the economy is stronger than the headline GDP numbers suggest — especially the hot labor market. But Thursday’s report shows that the trend is not favorable and that the economy is at serious risk as the Fed tries to bring down inflation.
