It is now obvious to say that the US economy is going through one of the worst periods in its history, due to the developments of “Covid-19” epidemic and its repercussions on consumers and investors.

But the recent economic performance data caused confusion among some. With one of the highest recorded magnitudes of Gross domestic product [GDP] contraction in the second quarter, the contraction reached more than a third of the size of the economy.

Confirmed deflation and stagnation

The US Bureau of Economic Analysis announced that the gross domestic product of the United States shrank at an annual rate of 32.9% in the preliminary reading for the second quarter of this year, in the largest quarterly decline in the country’s history.

The US economy contracted by 5% in the first quarter of this year, officially entering a state of recession after shrinking GDP for two consecutive quarters: the traditional definition of a recession.

Even on a monthly basis, the national lockdown and social distancing measures brought an end to the longest economic expansion in American history that lasted for 128 months in a row that ended in February.

The biggest blow to the US economy in the second quarter was represented by a decline in consumer spending at an annual pace of 34.6% and a decrease in private investment by 49% amid the uncertainty of the “Covid-19” epidemic.

While government spending was the only positive development, with a 2.7% increase after the strong rise in federal spending to offset the virus’s impact on the economy.

But does this really mean that the US economy lost 32% or more than a third of its value in just 3 months? In fact, that did not happen!

GDP and its measurement

To decipher this ambiguity and remove the confusion that some may have, we must first explain what GDP is and how it is measured.

The size of a country’s economy is measured by the value of its gross domestic product or GDP in a period, often one year.

GDP is the total of all goods and services produced and is measured either by face value or fixed value which excludes the effect of price change over time.

In the United States, the value of gross domestic product at constant prices reached the level of 19.254 trillion dollars at the end of the 4th quarter of last year.

In the first three months of this year, the US economy contracted due to its vulnerability to the virus crisis, starting from February, bringing the GDP to an annual pace of $ 19.010 trillion, losing $ 243 billion.

In the second quarter of this year, the gross domestic product continued to decline to an annual pace of $ 17.205 trillion, which means that the value of the goods and services produced declined in the second quarter compared to the first three months of 2019 by about $ 1.805 trillion.

If you deduct the size of the economy by the end of the second quarter from its recorded value in the first three months of the same year, you will find that the GDP contracted by only 9.5% on a quarterly basis.

So, what is the correct number: quarterly shrinkage of 9.5%, or annualized contraction of 32.9%?

In fact, both are correct and used in the official data, but the first shows the actual volume of change on a seasonal basis, while the second highlights the decrease if the current rate of contraction continues throughout the year.

Thus, the annual or annualized rate of GDP contact is calculated on a 12 month period.

The aim of using the annual pace is to find an easy way to compare economic numbers over different periods of time.

The annual pace provides a forecast of overall performance over an entire year in case the same situation continues throughout the other quarters.

Of course, this method of presenting economic data can be tricky and a little misleading for many followers, especially in exceptional times, as is the case now.

For example, if a person gets a 500 riyal financial bonus in a month, then it would not be logical to consider this increase as an annual pace of 6000 riyals, because he knows that this is an unexpected thing not to repeat in the same way.

Consequently, presenting data across the annual frequency leads, in some unusual cases, to “extreme” values ​​that depart far from normal or logical performance.

In fact, the United States is not only presenting economic figures at the annual pace of GDP, but even data on sales of homes, cars, etc. is presented in the same way.

For example, US data released on the 22nd of July showed that existing home sales in the United States rose 20.7% to 4.72 million units in June compared to the previous month.

Is it logical for a country to see more than 4 million homes sold in just one month? Of course not, but the annual pace here expresses an overall expectation of what will be sold if the same performance continues for 12 months.

In short

The American economy suffered a historic blow in the second quarter of this year due to the repercussions of the national closures and the efforts to control the outbreak of the epidemic.

But whether it is measured at or without the annual pace, the recorded contraction in the US economy is the worst since at least 1947 when the quarterly data was first announced.

Just as the numbers were large and perhaps puzzling in the second quarter using the “annual pace”, the expected recovery in the third and fourth quarters may yield a similar result, however, on the positive side this time.

This data should not be considered as the final, as the US GDP is evaluated 3 times through initial data, then a second reading, followed by a final third. This data should be used in conjunction with the other 30 economic data points, released quarterly, to create a more wholistic view of how the US economy is doing.

The second reading of US 2nd quarter GDP data is scheduled for August 27.

Mohamed Shraka

Head of Business Development (EMEA)
mshraka@tvmarkets.com