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August 1, 2008

Prepare for More Bad News on the Economy

More GDP Revisions Likely to Point Downwards

Yesterday, the government released second quarter GDP and revealed that the economy had grown by 1.9 percent in the second quarter. Despite being up from about 1% in the first quarter, yesterday’s numbers did not meet Wall Streets expectations and later caused a selloff in the stock market. Unfortunately, when it comes to GDP, we can expect more bad news in the near future.

To start, 4th quarter GDP was revised down from .6% to -.2%. That means if first quarter GDP would eventually be revised down to a negative (and it could happen), we would have had a recession, without realizing we were in one until after it happened! (Alternatively, we may not know we are in a recession until nearly one year after it started!) I believe that a great deal of these downward revisions have to do with higher than expected inflation.

Remember, the GDP is determined by taking the actual growth (9.8%) and deducting inflation (7.9%). The result is the real GDP. Now, I do not know if the above numbers are correct, but I am basing my hypothesis on the 7.9% three month annualized inflation figure from the second quarter. With inflation likely to increase, I believe that will eat into the growth of the economy.

While inflation may drive up the nominal growth rate of GDP (and therefore have no perceived effect on real GDP), higher inflation causes consumers to buy less, business costs to rise, manufacturers to lower productivity and employment, which therefore lowers economic growth.

Despite an apparently unchanged revision in first quarter GDP (I did not see a new number), the government could still revise it downward in each of the next two Q2 revisions or the first look at Q3 in late October. Today’s higher unemployment data also shows that economic growth could be worse than expected this quarter, next quarter, and for the first half of next year.

I am beginning to believe that all of these actions we are taking to avoid a recession are only delaying the inevitable. Whether the future recession created by “proactivity” is deeper as a result, only time will tell.

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