Smith Faculty Opinion Article	November 29, 2006
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

GDP Increases 2.2 Percent in Third Quarter
Housing Sector, Trade Deficit Contribute to Slower Growth

Today, the Commerce Department reported that GDP grew at a 2.2 percent annual rate in the third quarter, down from 2.6 percent in the second quarter.

The housing sector and the growing trade deficit were the main culprits. The falloff in residential construction subtracted 1.2 percent from growth.

Although the trade deficit was revised downward from the October advance estimate, ballooning imports subtracted 0.9 percent from growth.

Consumers continued to hold up the economy, but with housing and auto sales dropping, it remains to be seen how much longer consumer spending can stave off recession.

Consumer spending grew 2.9 percent, faster than the 2.6 percent second quarter pace. Considering rising gasoline prices in July and August and conditions in the housing market, this was a reasonably strong showing. Despite a fall off in new home sales and sluggish auto demand, durable goods sales were up 6.0 percent, after falling 0.1 percent in the second quarter.

Homeowners still have considerable equity to finance more spending. Even with the decline in existing home values, home equities are still up nearly 50 percent over the last five years. The question comes down to: Will the moderate pullback in housing prices set off a wave of pessimism and kill the economic recovery?

Overall, private investment was flat in the third quarter, as compared to a 1.0 percent gain in the second quarter, because of cutbacks in residential construction.

Residential construction contracted 18.0 percent, while business investment in new structures, equipment and software was up 10.0 percent. Commercial construction was a bright spot, increasing 16.7 percent. Investment in equipment and software was up 7.2 percent, after retreating 1.4 percent in the second quarter.

The trade deficit continues to drag down growth. Real imports grew 5.3 percent, even after adjusting for the higher price of oil, while exports expanded only 6.3 percent. Overall, the real trade deficit grew 0.8 percent.

An undervalued yuan continues to drive growth in China by stealing manufacturing jobs and growth from the United States and Europe. Low wages account for less than half of Chinas price advantage, while currency manipulation, export tax rebates, domestic production subsidies, and other mercantilist policies do more to drive up Chinese exports. Meanwhile, steep tariffs and other trade barriers continue to limit U.S. and EU exports to China, India and other fast growing Asian markets.

The U.S. trade deficit with China now exceeds net petroleum imports, and the overall trade deficit with East Asia, excluding oil rich Indonesia and Malaysia, accounts for half the U.S. trade deficit. The hole must be plugged to rekindle rapid productivity and GDP growth.

Looking forward, fourth quarter growth should be about 2.1 percent in the fourth quarter and pick up to about 2.6 percent in 2007. This is sub par, and the U.S. economy will continue to under-perform its potential until the Bush Administration finds the courage to deal with Chinese mercantilism and the protectionist epidemic sweeping across Asia.

Wall Street expresses few concerns about this morass. Most large U.S. companies earn a good deal of their profits abroad; hence the combination of strong growth in Asia, coupled with moderate growth in the United States is good for their bottom line.

Good corporate profits growth and improvements in household savings performance should sustain the stock market. With housing prices leveling off and in some places declining, homes are no longer viewed as a good near-term speculative investment. Household savings should improve, and much of those savings will find their way into equities.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.