Government consumption and investment expenditures declined by 1.8 percent, driven by a 3.8 percent decline in State and Local Government. Federal Government expenditures, both defense and non-defense, were up modestly. (State and Local Government expenditures are 60 percent of Government spending.)

Exports grew about six percent while imports grew about nine percent.

This press release is based on preliminary data and will be revised. However, it appears to indicate a few things:

• Residential real estate investment is not out of the woods yet
• Commercial real estate investment is also not out of the woods yet
• The strength of consumption and the weakness in disposable personal income imply that the savings rate is falling. This has at least a few implications:
o If the household sector does not rebuild its balance sheet future spending will be weak
o The decline in the quantity of loanable-funds, other factors being equal, would contribute to a rise in interest rates. This does not necessarily imply that rates will rise, as this is just one of many factors impacting interest rates at this time.
o Household default rates and personal bankruptcies will remain high
• In contrast to the fourth quarter of 2009 where trade boosted the economy, trade was a drag on the economy in the first quarter of 2010
• It is difficult for the Federal Government to spend enough to offset the declines in State and Local government spending, thus negating the Federal Keynesian-style fiscal expansion policy

New unemployment claims also rose to 444,000, again exceeding “consensus expectations.”

There was also a report that will receive much less attention, but it is important. Inventories increased in November, the most recent month for which data are available. If inventories were increasing over the Christmas shopping season, and sales were declining, retailers ended the year with excessive inventory. That means reduced production in the first and second quarters of 2010.

2009’s third quarter output (GDP) growth was positive, and many expect a very impressive positive number for the fourth quarter, some as high as five percent. If the fourth quarter does come in with a strong GDP growth rate, it will be hailed as the harbinger of a soon-to-be-realized vigorous recovery.

Don’t buy that, and you won’t be disappointed.

That vigorous recovery may eventually come, but it is unlikely to come in 2010. Whatever growth generated in second-half of 2009 was government-supported consumption, ephemeral, not a solid foundation for economic growth, certainly not the basis for sustained vigorous job growth.

A vigorous recovery will be a result of investment, technological growth, and improved productivity. Recent productivity numbers have been encouraging, but in large part, they are probably the result of firms downsizing. Technological growth and solid job growth require investment, and that is the problem.

Our banks are in no condition to fund any vigorous expansion. Indeed, bank loans have been declining since October 2008. Businesses and consumers remain over-leveraged, unable to increase spending on consumption, unable to invest, desperately trying to reduce debt.

We won’t see a vigorous recovery until balance sheets are improved and banks can lend.

Government programs haven’t helped. Most of the spending programs have been consumption based instead of investment based. Some have been outright counterproductive, programs such as foreclosure-delay, paying interest on bank deposits at the Fed, and cash for clunkers. Even worse, the banking problem has been ignored, and now new taxes on banks are being discussed. That is as bad an idea as I’ve heard in a long time.

Our mid-November United States forecast for fourth quarter real GDP growth was for a fall of 2.6 percent, driven by the advance estimate, so if we ran our model with the new information, our fourth quarter forecast would fall a bit. The economics news on all fronts continues to confirm ongoing weakness. In particular, data releases on the housing market continue to be discouraging. Today, a report was published that stated that 10.7 million United States homeowners were “under-water”, indicating that they owed more on their mortgage than the estimated current market value. In addition, recent economic indicators continue to lead us to believe that the Holiday shopping season will be weak. Our fourth quarter forecast for the seasonally adjusted annualized growth rate of the United States economy, to be published December 16, will likely be in the range of a fall of 2.5 percent to a fall of 3 percent.

While it is possible that GDP growth will be positive in the 3rd quarter, we believe that the private economy will be weak for some time to come. The evolution of this recession could look like a “W” or an “L”. GDP growth rates will be small, sometimes negative or near zero, with occasional bounces that will be driven by temporary household and/or government expenditures. If GDP is recalculated without foreign or government influences, then 2009 quarter 2 economic activity declined by 4 percent, see my August 5 blog on this topic. Real estate delinquencies and foreclosures continue at historically high levels. It appears that the tide of commercial foreclosures will continue to rise. Foreclosures hit the economy hard, having serious negative consequences for both Main Street and Wall Street. US economic growth might be positive in 2009 quarter 3, but the factors driving economic activity may conspire to reduce GDP growth in late 2009 or early 2010.

That may be a bit premature. Dan discussed the GDP numbers yesterday, but there are more issues. Deutsche Bank thinks that half of U.S. mortgages will be upside down by 2011 and retail is suffering. Tomorrow’s jobs data could bring more bad news.
The fact is that after the housing crash and financial meltdown, financial institutions, businesses, and consumers were over-leveraged. After months of recession, consumers and businesses are in even worse shape. And now, the government is also over-leveraged. Where does the recovery come from?

Some are hanging their hats on inventory rebuilding, but that is a one-time shot, especially if the holiday season is as weak as we expect. Some are hanging their hats on the housing market, but at best that will only stop the bleeding.

The problem with claiming victory now is that the administration risks ridicule and losing citizens’ confidence. I don’t see how that helps the administration or the economy.