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Thursday morning, the government came out with its first stab at the second quarter GDP numbers, as well as revisions to past periods. While the headline growth of 1.9% (all percentages are annual rates) was a bit less than the market was expecting, it was far from recessionary. However, there appears to be far less to the number than meets the eye, and the revisions were generally to the downside.

Each of the last three full years was revised down. Growth in 2005 is now seen as having been 2.9% rather than the previously reported 3.1%, for 2006 it was 2.8% not 2.9% and for 2007 it was 2.0%, not 2.2%. Within 2007, there was an upward revision to the second quarter, but a big downward revision to the fourth quarter. Growth in the fourth quarter was actually -0.2% rather than the plus 0.6% number that had been in use up until now. The first quarter was revised down to growth of 0.9% from 1.0%.

Within the second quarter numbers, there was some good news. The change in private inventories actually subtracted 1.92 percentage points from growth. Usually declines in inventories are made up in later quarters, so one might be tempted to argue that the second quarter was much stronger than the headlines let on. Real final sales were up 3.9%, which is a fairly healthy showing.

What were the drivers of GDP growth in the second quarter? Personal Consumption Expenditures (PCE) added 1.08 points to GDP growth (i.e. 57% of the 1.9% total growth), largely due to strong showings for Non-Durable Goods and Services, while Durable Goods sales were a drag on growth, most notably vehicle sales which subtracted 1.07 points from growth. The PCE growth was much more significant than in the first quarter when it added only 0.61 points to growth.

Building was a big help, as Investment in Non-Residential structures was up 14.4%, adding 0.51 points to growth. Residential Construction continued to be a drag on growth, but less of one than in the first quarter (or the fourth quarter for that matter). It fell 15.6%, subtracting 0.62 points of growth, which was not as bad as the 25.1% decline subtracting 1.12 points from growth in the first quarter.

International Trade was the real hero of the quarter, Exports surged 9.2% adding 1.16 points to growth while imports fell 6.6%. Falling imports add to growth in the GDP calculations and that decline added 1.26 points to growth in the second quarter. Thus taken together, net exports added 2.42 points to growth, or significantly more than the total growth of 1.9%. This was a big improvement over the first quarter when net exports added 0.77 points or the fourth quarter when they added 0.93 points to growth.

Higher government spending also added to growth. Overall Federal spending grew 6.7% adding 0.48 points to growth, of which 0.36 came from defense and 0.12 came from increased Non-Defense spending. In the first quarter Federal Spending added 0.41 points to growth while in the fourth quarter it actually slightly subtracted from growth (0.04 points). Increased State and Local spending added 0.20 points to growth.

Ok, now that we have gotten all those numbers out of the way, what does it mean? Well clearly the stimulus checks helped with PCE, but it is interesting to mote that most of that went for non-durable goods like food and energy, not to durable goods like autos. Second debasing the currency can help growth at least in the short term, as the weak dollar is clearly a factor in the strong net export showing.

The debasing the currency part brings us to the real fly in the ointment in this release, and a reason that every one of the numbers cited above should be taken with a few pounds of salt. We are talking about real GDP here, not nominal, which grew at a very low 3.0% following 3.5% growth in the first quarter. Real GDP depends pretty critically on the implicit price deflator used to translate nominal GDP into real GDP.

The government would have you believe that inflation in the second quarter, at least the inflation measure used to calculate GDP, was running at just 1.1%, down from 2.6% in the first quarter and 2.5% in the fourth quarter. That is a very hard number to believe.

Now, I don't like to say bad things about the ref -- it usually is just an excuse used by a bad coach. But really now folks, this simply does not pass the smell test. Every other measure of inflation was far, far higher than this, and was accelerating in the second quarter. The CPI rose at an annual rate of 10.3% in the second quarter and was up 5.0% on a year over year basis, the PPI was up at a 14.3% rate in the second quarter and was up 9.1% year over year.

I know there are technical differences in how the indexes are constructed, and that the implicit price deflator is designed to measure domestic inflation and much of our inflation has been imported, but these are HUGE differences. Plug in any realistic measure of inflation and the growth vanishes. I expect this number will be revised down over the course of time.

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