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It's All About Context

Written by Briton Ryle
Posted October 30, 2019

Just this morning, U.S. GDP growth for the third quarter came out: 1.9%. 

My first thoughts were: Well, we should be used to that number. It seems like we've seen 1.9% growth pretty regularly over the last decade...

Back in 2012, first quarter GDP came in at 1.9%. Donald Trump tweeted that the U.S. economy was in "deep trouble"...

trump 1.9

Two things strike me about this.

One: Only 140 likes? It's amazing what being president will do for your Twitter engagement stats. 

Two: Why does ~2% growth continue to get billed as weakness? 

It takes around $760 billion in consumer spending to push GDP growth up by 1%. Where would that additional money come from? It's not like the government just sent everybody checks like those tax rebates we got back in 2001 and again in 2008. 

It's pretty amazing that any president was able to pull this off. I mean, tax cuts (or hikes) are usually contentious enough without making them retroactive. But I guess once you say, "Everybody is getting a check," it gets kind of hard to oppose. Nobody wants to be the stick in the mud saying, "Nope, sorry, no check for you!"

Anyway, those tax rebate checks certainly worked. U.S. GDP rose 3.8% in the second quarter of 2008. Of course, you could certainly say that money was wasted — GDP fell an amazing 8% in the fourth quarter of 2008...

Spending and Debt 

There should always be a nice balance between rising wages, price inflation, spending, and personal debt. 

The whole purpose of the credit made available by fractional reserve banking is to make the purchase of big-ticket items like houses and cars possible. It makes sense to trade your future earnings for a house you can live in now. But when you start trading your future earnings for clothes and gasoline, well, there will clearly be problems down the road...

Because you already can't afford your life. That tends to not suddenly change without a major regrouping effort. In the wake of the financial crisis, the word "deleveraging" was used a lot. This basically meant paying down debt and realigning spending and income. No surprise that GDP growth in those years was on the weak side. 

And really, I think we should all be pretty happy with that 2% growth number. It's reliable, sustainable. After all, prosperity is a marathon, not a sprint. I'd be perfectly happy if Americans truly learned the core lesson that our grandparents (children of the Great Depression) knew, but it was somehow totally upended by the boomer generation that brought us Hummers and McMansions...

So within that context, I see the 2.9% gain in the Personal Consumption category of the GDP report as a pretty good number. We (the U.S. consumer) are doing our part. It's CAPEX (capital expenditure) spending at the corporate level that's an issue right now...

Is CAPEX Signaling a Recession?

It's a funny thing for an economy that is 70% driven by consumer spending, but when recession does hit, the consumer is the last to know.

But the reason is pretty simple: Most costs are pretty fixed. Month to month, we tend to spend the same amount of money on food, gas, entertainment, and so on...

It usually takes a pretty good shock to the overall household system to pull back on spending and create a recession. Like a job loss...

When corporations cut back on spending, well, that's a good time to start paying attention. Right now, companies say they are cutting spending due to uncertainty surrounding the trade discussions with China. Seems reasonable given the amount of business U.S. companies do with China...

Two outcomes to consider here. The first is bad. That's where the talks get contentious as the U.S. realizes China is basically predatory, happy to lie and steal for as long as it can to gain whatever economic advantage it can...

In this scenario, expect to see more blacklisting, like how U.S. tech companies are not allowed to do business with China's Huawei. Imagine that expanding to include Apple, Starbucks, and GM. I can tell you that if these companies suddenly can't do business in China, it's a virtual guarantee that Americans start losing jobs and the U.S. economy shrinks. 

This outcome is a lot scarier than it might seem. Global growth has been weak for a decade because there is too much production capacity in the world. Too much oil, too much steel, too much corn, too many soybeans...

Take China's economy offline, and it's like an instant loss of 10–20% of the global economy. How long would it take for the global economy to adjust to that? We're talking years. Crisis years, as jobs are lost and there is no QE that brings them back.

Now, let's say the powers that be have game-planned that outcome and think it might just be a negative for the president's reelection chances...

That brings us to option #2: The U.S. signs whatever BS deal with China we can, so we can avoid blowing a permanent 20% hole in the global economy. 

In this scenario, most U.S. supply chains are out of China by the end of calendar 2019. CAPEX spending picks up in the New Year. And earnings estimates start to move higher. 

Suddenly 2% GDP growth sounds pretty good, right? 

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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