Fourth-Quarter GDP: Reality or Myth, Sustainable or Unsustainable?

In the midst of a near-constant stream of bad news about the US economy, there was some recent good news; gross domestic product grew at a 3.2% rate in the fourth quarter.

Though this was below the consensus estimate for 3.6% growth, it was an improvement from the 2.6% pace in the third quarter and 1.7% in the second quarter.

Much of the growth was attributed to consumer spending, which grew at a 4.4% rate. So, at first blush, it seems US consumers have returned from their hibernation.

But before you get too excited, let's explore a few important facts.

First, there are roughly 15 million unemployed Americans at present. And 17.3% of American workers were either unemployed or under-employed, meaning they can only find part-time work even though they are seeking full-time employment.

Second, due to the Christmas season, the fourth quarter is typically the most robust for retailers. According to the National Retail Federation, for some retailers, the holiday season can represent anywhere between 25-40% of annual sales.

Additionally, real income rose a paltry 1.7% in the third quarter. Which leads us to ask, where did consumers find all that extra spending money?

Well, savings dropped by a notable 0.5% in the quarter. And, according to Investment Company Institute, investors withdrew a whopping $33.12 billion from domestic stock market mutual funds in first seven months of 2010.

So, the draw down in savings accounts and mutual funds allowed for increased spending, even though wages and incomes were so tight.

Consumer activity comprises the bulk of the US economy — some $10 trillion of the roughly $14 trillion total. To put this into perspective, that $10 trillion is approximately half of the entire global consumer market. The combined BRIC nations — Brazil, Russia, India and China — account for less than one-third of that amount.

While consumer spending averaged 64% of GDP between 1950 and 1980, it has now reached 70% of GDP. Most of this was, and is, funded by debt.

Household debt in the US grew from 69% of our gross domestic product at the end of 1998 to 97% of GDP by the end of 2009.

We can see that the US embarked on a decade-long debt binge. And now the question is, how much longer can this last?

After the financial collapse in the fall of 2008, and the subsequent recession that lasted for six consecutive quarters, it seemed as if all that rampant consumer spending — and the debt that fueled it — had finally come to an end.

The Great Recession — which officially lasted 18 months, from December 2007 through June 2009 — was the longest since World War II. Its effects are still bitter and enduring for millions of Americans.

According to the American Bankruptcy Institute, 1.53 million US consumers filed for bankruptcy protection from creditors in 2010, up from 1.4 million in 2009. Consumer bankruptcies rose 9% in 2010, and the ABI expects that filings will keep climbing this year given high debts and weak incomes.

With all of this in mind, it's reasonable to ask if the initial fourth quarter GDP number was in fact accurate, or if it will later be revised downward, as so often happens.

And even if the 3.2% reading is ultimately found to be accurate, can it hold up in the first quarter of 2011? Now that the Christmas spending binge is over, can consumers continue to carry the US economy at that same pace?

My guess is no.

It's important to remember that the government is facing a massive and rapidly expanding debt exceeding $14 trillion. The last election was largely about the economy and the debt.

Consequently, the new Republican majority in Congress has pledged to slash government spending. Though long overdue, such spending cuts will create a major drag on the economy.

If consumers feel the hangover of all that Christmas spending — reflected in their recent credit card statements — and decide to tighten their purse strings as a result, the combination could be devastating.

When government and citizens attempt to pay down debt at the same time, the result is depression and deflation, which would make our debt problems even worse.

We'll know more in April, when the initial first-quarter GDP figure is announced. But it will hardly be surprising if the pace dips below the fourth quarter level, which was celebrated by many media pundits and talking heads.

At this point, everyone is desperate for good news. But we shouldn't fool ourselves. This kind of GDP growth will have to become a trend before I become a believer.