The Expansion Is Accelerating
Second quarter GDP could be very impressive indeed.


David Malpass

The U.S. economy is not only doing pretty well these days — it’s accelerating. In the first quarter, GDP growth was 4.2 percent, with each month stronger than the previous. So, with April and May building on very strong March results, second-quarter GDP could be very impressive indeed — something like 5.2 percent.

Higher oil prices and the impending interest-rate increases will weigh on the expansion, but they won’t block it as some pundits insist. The positive economic factors are stronger than the negative ones today. The near-term economic drivers include an improvement in business sentiment (which a second dip of uncertainty leading in the April 2003 Iraq war) along with indications of stronger growth of inventories, business investment, and payrolls (employment, of course, has surged in recent months).

As a growth factory, inventory building is important because it has not yet made a significant contribution to overall GDP in the current expansion. Inventory “after burners” should kick in during 2004, providing a significant boost to an already accelerating expansion.

Demand for commercial and industrial loans typically coincides with an increase in business inventories. And what do you know — demand for loans is up. This growth in loans and inventories makes sense given the “get it while you can” nature of today’s super-low interest-rate environment.

Corporate profit growth accelerated beginning in 2002, reaching the highest percentage of GDP since the late 1960s. However, while investment spending on plant and equipment (capital spending) began to revive in 2003, it remains below the level of aggregate cash flow, reflecting both the extent of the investment excess in the late 1990s and the subsequent bust.

But CEOs have become significantly more optimistic of late, which should reduce their risk aversion and lead to increased jobs, inventories, and business investment. If you combine confident CEOs and strong profits, you get pent-up investment demand contributing to the economic acceleration of 2004.

There are some out there who hold that the excess capacity out there will place a low limit on investment growth. The Institute for Supply Management’s capacity use measure is rising much faster than the Fed’s. [See Larry Kudlow on this development.) One explanation for this is that private-sector executives are “moth balling” uneconomic capacity much faster than the Fed assumes, suggesting that business investment will grow faster than expectations in the coming quarters.

Finally, the consumer sector provides even more acceleration signs. Consumption growth has accelerated despite relatively low consumer confidence and continuing concerns about the international situation. Retail sales were down 0.5 percent in April from March. However, the March-April total was 2.2 percent (13.9 percent annualized) over the January-February total. If the April sales level simply holds, second quarter retail sales will be 1.3 percent (of 4.6 percent annualized) above sales for the first quarter.

Some see blocks to the expansion where others see challenges that can be overcome. But there’s simply no reason to think this durable economy can’t handle some (overdue) interest-rate hikes, a mild piece-by-piece inflation process, and a run of higher energy prices.

– David Malpass is the chief global economist for Bear Stearns.