Why The Trade Deficit Is Warning Of Weak GDP
With the recent release of the trade deficit numbers there is an indication that 2nd quarter GDP will be coming in weaker than economists current estimates. Most likely this is why Bernanke was a little quick on the trigger of announcing another round of stimulus which will most aptly be named after the previously diminishing effect programs "Quantitative Easing 1 & 2" or "QE 3".
Remember that the basic equation of GDP is:
GDP = C + I + G + (X-M)
Where: C= Consumption
I = Investment
G = Government Spending
(X-M) = Exports minus Imports or Net Exports
I have highlighted the last piece of the equation as it is specifically what we are interested in as it relates to today's release from the BLS.
The BLS reported that import prices declined by 0.5% in the month of June, slightly less than the 0.6% predicted by the consensus. This was a substantial drop from the revised 0.1% increase in May and was the biggest monthly drop since June 2010's -1.2% drop. There are two factors at work here the biggest and most obvious is the drop in oil prices in the last month. Oil makes up 40% trade deficit so it plays an very pivotal role in the monthly release. The other factor is that consumers are consuming less. Demand has been falling over the last couple of months as the economy shows signs of weakness and the unemployment situation darkens.
More importantly, as you will see in the chart the declines in the year-over-year changes in both exports (companies are shipping less meaning lower revenue) and imports (consumers are purchasing less) is probably one of the factors that led Bernanke to pre-announce QE 3. The chart tells the tale that so goes the direction of the year-over-year change in exports and imports so goes the economy
The real take away here is that most likely second quarter GDP is softer than the 1st quarter read of 1.9%. As stated previously this data is likely the reason that the Bernanke went ahead and made the shot across the bow about QE3 to try and get ahead of some possibly ugly numbers. In their FOMC statement they noted that:
"Participants also discussed the medium-term outlook for monetary policy. Some participants noted that if economic growth remained too slow to make satisfactory progress toward reducing the unemployment rate and if inflation returned to relatively low levels after the effects of recent transitory shocks dissipated, it would be appropriate to provide additional monetary policy accommodation."
First of all economic growth is running at well below normal historical levels and we are just a smidge above a recessionary level for the economy. The reason is that the monetary policies that have been applied to the markets for the last 30 years have created a credit-sourced boom that has led to malinvestment which has resulted in weaker and weaker economic output. The current level of output is insufficient to absorb the current labor pool which is keep unemployment at high levels which also has a dampening effect on economic growth.
It is highly unlikely that QE 3 will have much of a net positive effect on the economy as most of the future consumption that boosted the economy during QE 1 was pretty much completed during QE 2. There is little to drive the economy currently with the consumer and small businesses retrenching and taking defensive positions. QE 3 may drive asset prices higher once again, especially in the area of commodities, but another decline in the dollar combined with rises in food and energy prices is almost guaranteed to further extinguish any potential long term organic economic growth.