GDP Drop Not As Bad As Expected But….

The good news….

While the US economy declined at the fastest rate for 26 years, the fall was less severe than many on Wall Street had expected, with some economists forecasting a 5.9 per cent drop.

Now the bad news…

In a short-term sweet but probably long-term bitter turn, inventories rose at the end of 2008. The inventory increase was troubling because it was likely unintended — the result of companies getting stuck with unwanted merchandise because demand has tailed off in the recession. Excess inventory will have to be worked off down the road and that signals production cuts, which in turn could mean layoffs that hamstring the economy even more.

“With inventory investment jumping in (the fourth quarter), there will be inventory liquidation in (the first quarter),” Insight Economics analyst Steven Wood said. “This suggests that (first-quarter) GDP will also contract, probably more sharply than it did in (the fourth quarter).”

Inventories increased by $6.2 billion in the fourth quarter, after going down $29.6 billion in the third quarter and $50.6 billion in the second quarter. The climb added 1.32 percentage points to GDP. Real final sales of domestic product, which is GDP less the change in private inventories, decreased 5.1% in the fourth quarter, after falling by 1.3% in the third quarter.

“Obviously, with final demand declining at a 5.1% annualized rate, an increase in inventories is hardly good news for future economic conditions,” MFR Inc. analyst Joshua Shapiro said. “It signals that businesses were unable to reduce inventories to desired levels as demand evaporated. This means that orders and production will sink even more as inventory control and final demand both weigh on activity.”

In other words, GDP only dropped by 3.8% but demand dropped by 5.1%. The difference is made up by the fact that inventories increased. No wonder factories are cutting production so sharply.

Edit: LA Times puts some numbers on on the inventory build up….

Swonk and other economists who analyzed the underlying data noted that about 1.3% of the economy’s output went into inventory — showing that companies produced more than their customers were purchasing.

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