Good economic sign

Gross domestic product is formally calculated as follows:

C + I + G + X = GDP

• In that formulation ‘C’ stands for consumer spending. That number is traditionally around 70% of GDP. As we all know consumer spending of all kinds is flat to down. We are each learning to save for things rather than use credit to buy things. And even more importantly, many consumers are taking a breather all together and only buying essentials. Monies saved are being used to pay down consumer debts. So how can we emerge from recession if 70% of spending is flat to slightly down? The remaining components then take on greater importance.
• The ‘G’ part of the equation is government spending. Clearly the government under Barack Obama is spending like never before. Think: cash for clunkers. Think: bank bailouts. In my opinion, these dollars, while misspent, have likely propped up the economy and kept it from entering a depression. Unfortunately, these dollars are not real economic growth of the sort we have discussed so often on the blog. These dollars are life savers thrown to victims of a crashed ship.
• The ‘X’ part of the equation is net exports. If we have a positive trade balance then it serves as an additive to GDP. If we have a trade deficit we have a subtraction from GDP. While the net export situation is improving, it is still a brake on the economy.
• So that leaves us with ‘I,’ or investment on the part of businesses. As I predicted on the blog last summer, the emergence from recession was going to have to be led by the ‘I’ component because consumers were not spending. How are we doing in the ‘I’ category? Let me quote a few passages from today’s Wall Street Journal to tell the story…

“Big companies that sell to corporate customers are growing more bullish about their prospects for 2010, a sign that a revival of business investment could buoy the sluggish U.S. economy in coming quarters…

“An upturn in spending by businesses or indications that companies are raising investment plans would be significant. Business spending on equipment, software and structures accounted for 9.5% of U.S. economic demand in the second quarter — far below the 68.2% accounted for by consumer spending but still a potential catalyst for recovery.”

While the numbers are tepid at this point, they are growing faster than consumer spending. This is a very important trend to watch. Recovery in ‘I’ will serve create backbone for the economy. But because this component of GDP is so much smaller than the (C)onsumer portion of GDP, the recovery will be a slow one. Also as we have discussed on the blog, I believe that this is a good thing. The “spend more than you make” culture of the U.S. had to be derailed at some point. Better that reckoning be now rather than later.

This increase in ‘I’ is a trend that I will be watching very closely.

Be well everyone!

Jason