When Higher GDP Growth Isn't a Welcome Sign

When is higher GDP growth not a welcome sign? When what's unimportant is growing, and what's important is shrinking.

That's exactly what happened when the Bureau of Economic Analysis revised fourth-quarter 2009 GDP growth numbers.

In January, Q4 GDP growth was reported to be 5.7% -- a staggering improvement from the 5.4% decline a year earlier. Last week, that growth was revised up to 5.9%. Even better, right?

Crazy as it sounds, not really.

The headline number in a GDP report isn't important; it's the makeup of the individual components that matters. Some GDP components are more sustainable than others, so what looks like a strong growth number can be misleading. That was the case last quarter, when more than three percentage points of the original 5.7% growth were attributable to changes in inventory levels as big sellers like Wal-Mart (NYSE: WMT  ) , Best Buy (NYSE: BBY  ) , and Ford (NYSE: F  ) ceased the all-out fire sales of the year before.

A shift in inventory is real, legitimate GDP growth that naturally comes at the end of recessions. But it isn't sustainable, sticking around for a few quarters if we're lucky. There's a reason you don't hear talk of countries building national prosperity off changes in inventory drawdowns. You need things like manufacturing, personal consumption, and net exports to fuel sustainable growth.

The bad news is that, in the revised 5.9% figure, more growth came from inventory changes while less came from personal consumption and net exports.

Component

Original Version

Revised Version

Personal Consumption

1.44%

1.23%

Gross Domestic Investment

3.82%

4.63%

Inventory Changes

3.39%

3.88%

Net Exports

0.50%

0.30%

Government Spending

(0.02%)

(0.23%)

Total

5.7%

5.9%

Source: Bureau of Economic Analysis.

So even though the revised headline number is higher, the components that need to grow in order to sustain recovery (personal spending, net exports) were revised down, while components that provide fleeting relief (inventory changes) were revised up. That's when higher GDP growth isn't necessarily a welcome sign.

To be fair, not all the change in gross domestic investment came from inventory changes. Investments in "information and processing equipment and software" increased in the revised edition. That's great news for companies like IBM (NYSE: IBM  ) and Oracle (Nasdaq: ORCL  ) , but it accounted for less than one percentage point of the 5.9% total growth.

In January I asked, "How is this economy going to keep growing?" Even with an upwardly revised blowout number, the question remains.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Best Buy and Wal-Mart Stores are Motley Fool Inside Value picks. Best Buy and Ford Motor are Motley Fool Stock Advisor selections. The Fool owns shares of Best Buy and Oracle, and has a disclosure policy.


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