The largest economy in the world grew even larger in the second quarter as the US Commerce Department reported GDP growth from April through to June of 4.2 percent. This was better than expected and was built on improved activity on "Main Street", improving corporate profitability and underlined the fact that the recovery has taken hold and is secure in its fifth year (second chart).
Source: Department of Commerce
This has to be taken as a positive and will serve to underline the economic optimism that is colouring the outlook for the second half of this year. On Main Street where American corporations make the bulk of their income record, profits have been booked in the second quarter as the Commerce Department reported that after-tax corporate profits pre-inventory valuations and adjustment for capital consumption came in at a seasonally adjusted annual rate of USD 1.84 trillion.
• That is its highest level on record.
• It is a six percent increase over the first quarter.
• Q3 and Q4 2013 saw declining profitability.
When the components of GDP are tabulated, one can see that in the second quarter the share of corporate profits rose against the first quarter, although at 10.6 percent it was just a little shy of an all-time record.
The banking system still has its days when it hogs the headlines for the wrong reasons especially as the Fed and Federal Deposit Insurance Corporation are of a mind that the largest banks still do not have enough capital to protect themselves in the event of a systemic crisis or failure. However, let us give them their day in the sun. The major US banks booked near-record profits in the second quarter as they were able to enjoy the bounty of soft money and rising asset prices.
What is even more encouraging is that corporations are no longer just sitting on cash. The GDP report showed that business spending on new buildings, machinery and research and development grew in the second quarter by a larger degree than had initially been estimated. Non-residential fixed investment rose 8.4 percent in the quarter up from the initial estimate of 5.5 percent. In contrast inventories were seen to be a lower contributor to growth than first believed.
The consumer was no slouch either as retail spending grew on a seasonally adjusted basis at a 2.5 percent annual rate and added 1.69 percent to GDP growth. This was in line with the Commerce Department's initial estimate.
Net foreign trade was negative factor to growth, albeit by less than was originally expected. Net trade reduced GDP growth 0.43 percent cf. the first estimate of 0.61 percent.
Choppy waters
The first chart illustrates that although the recession ended in June 2009 on a quarter on quarter basis, the recovery has been a choppy affair. However, even after the bad winter that hit the economy in the first quarter as GDP fell 2.1 percent, the bounce back has been impressive.
Certainly the data for Q2 will negate the gloom and doom merchants that have been forecasting a new slowdown. However, we cannot claim that the economic seas are calm waters for the Fed last December was predicting GDP growth of 2.8 percent to 3.2 percent in 2014. This optimism was dimmed slightly in June as they decided to pare back the forecast to just 2.1 percent to 2.3 percent.
Of course the Fed officials have a greater access to raw and complete data than I will ever have, but I am not so gloomy and I expect the gains of the second quarter to catapult the US to achieve GDP growth this year in the region of 2.6 percent.
My optimism is based on the following. A key focus for Federal Reserve Bank chair Janet Yellen is the level of lasting job creation in the private sector. The labour market has enjoyed a period of robust gains as the last six months have seen nonfarm payrolls book the best number of gains since 2006. In in July 2014 employers added over 200,000 new positions for the first time since 1997. The national level of unemployment is now just 6.2 percent against 7.3 percent last year.
The Fed has been activity tapering its bond-buying program and this will be concluded in October this year. This has not knocked the economy out of kilter as all along the Fed has given transparent communication as to its intentions. The market is comfortable with the prospect of the first rate rise in Fed Funds coming somewhere near the middle of 2015.
Conclusion
There have been many economists and market analysts from both the United States and overseas that have criticised the policy of the Fed, when run by Bernanke and then Yellen.
Some opposed the extraordinary measures that were taken to flood the system with liquidity so as to save the banking system and thereby stave off the threat of depression. Others have warned that an extended period of low rates would herald rampant inflation. Indeed at the extreme, the most radical laissez-faire thinkers wanted the troubled banks and corporations to go to the wall as raw capitalism showed no mercy and staved off moral hazard.
Dealing with future behaviour and conduct is for the politicians and regulators at both a national and global level to design a simple yet co-ordinated approach. What is clear is that had we followed the extreme view, the US economy and financial system would have been dead in the water, belly-up. The interconnectivity of the world is such that had the US slipped into depression then so would the rest of the world.
Thankfully, wise minds applied all the lessons of past economic trials. The beauty of the capitalist system is that it does allow for the organs of state to be engaged as and when appropriate. Thank goodness the Fed was involved. The system has been soothed by abundant liquidity and it has followed Schumpeter’s rules of creative destruction to become leaner and sharper. The economy is growing at a good clip, there is no inflationary risk and the Fed will smoothly retreat from the extreme level of accommodation and the economy will take it in its stride.