Pondering the stellar growth rate of the US economy in the third quarter

Tyler Cowen says…

The housing sector is down twenty percent and the price of oil is flirting with $90 a barrel, maybe $100 to come. Yet the quarterly growth rate was just reported at 3.9%, led by surges in consumer spending and exports. It is wrong to think we have turned the corner, but it is also wrong to think the doomsayers have been giving accurate predictions.

I personally believe that part of the explanation for the high growth rate is that the government’s inflation statistics are flawed. Some of the shenanigans that go on with the inflation numbers are described here. If you don’t make the proper allowance for inflation, your real GDP figure is going to be artificially high.

But even by my reckoning, this can only be a small part of the story. At best, I can see it knocking the .9% off the growth rate. So I have to admit that the growth rate for last quarter was way higher than I ever would have expected.

Before I go any further, I should share another quote with you. This one comes from the Federal Reserve….

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.

As was predictable, oil hit a new high as a result of this cut. At this rate we will see oil being priced at 100 dollars a barrel before the end of November.

So tell me; if the economy is doing so well, why are we cutting rates? The Fed’s explanation just won’t wash. Given the strength in the economy last quarter, you should hope that the economic expansion would slow down a bit. Otherwise commonly accepted macro economic theory would indicate that you run the risk of overheating.

Some people argue that the Fed knows something that it is not telling us and it is running scared. Maybe this is true. But if there is some kind of secret knowledge, it did not convince all the Fed governors. One of them (Thomas Hoenig) publicly dissented. That almost never happens.

If there is anything clear in all this it is that nothing is clear. Cowen is right to point out that things have not been unfolding the way Bears thought they would. But he is wrong to single out the Bears. If the Bulls were to be believed a few short months ago, all the problems were going to stay contained in sub-prime. No one believes this any longer.

Now a lot of people who used to be bulls (including most of the fed board of governors apparently) are worried about serious problems cropping up as a result of problems in housing. But why haven’t they already started taking their toll? And where did all of last quarter’s spending come from?

Don’t get me wrong, I did not expect GDP growth to turn recessionary last quarter. Employment is still too good for that to happen. But I did expect to see GDP growth slow down, not speed up. If housing is going to cause problems down the road, it just does not make much sense for GDP growth to speed up just as the housing problems are taking their toll.

How do we account for the fact that financial companies are losing billions of dollars and the Fed is taking extraordinary steps to reassure the markets and yet nobody else seems to be having any problems? Is there really no connection between the financial world and the real world?

Maybe this story from the Baltimore Sun can help us figure the problem out…

But cards are now the bank growth product and consumer lender of last resort. Some households are almost certainly meeting mortgage obligations by borrowing against their credit cards, although it’s impossible to tell how many, says banking analyst Bert Ely of Ely & Co. Millions of mortgages issued at low, teaser rates will reset over the next two years, adding to pressure on household finances.

“I wonder how many people are out there right now getting new credit cards and just preparing for that day,” says Ely.

As growth in home equity balances has fallen almost to zero, credit-card balances have increased at a 17 percent annual rate over the past six months, according to a report by Merrill Lynch economist David Rosenberg. And the trend, he writes, “is clearly accelerating.” A year ago card balances were shrinking.

A 17 percent growth in credit card balances over the last 6 months could certainly help explain why consumer spending was so strong last quarter. But it does not resolve all the mysteries. If consumers were being forced to turn to their cards because of economic distress, the rise in credit card balances should have been neutral in terms of GDP growth. In other words, if consumers turn to their cards to replace income streams that they lost when they stopped being able to withdraw from money from real estate then there should have been no net rise in consumer spending.

On the other hand, if consumers were not hurt by the fall in the real estate markets, how come they decided to pile on the credit card debt all of the sudden? It just does not make any sense.

Life is full of mysteries.

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