South By North Strategies, Ltd.

Advance estimates from the U.S. Bureau of Economic analysis show that real gross domestic produce (GDP) grew at a 3.5 percent annual rate between July and September 2009.  This is the first quarter of positive GDP growth since the second quarter of 2008.

Real GDP is driven by four broad factors: personal consumption expenditures (PCE), gross private domestic investment, net exports, and government spending in investment.

Last quarter,  PCE and gross private domestic investment were the main contributors to real GDP growth, adding 2.36 and 1.22 percentage points (annualized) respectively. Government spending, primarily at the federal level, added 0.62 percentage points. Because America imports more goods and services than it exports, the trade gap subtracted 0.53 percentage points from GDP growth.

Many observers will look at the positive GDP report — which is subject to two further revisions — and claim that the recession has ended. This is a misleading claim. Although positive GDP growth is welcome news, it is unclear if this path is sustainable, as so much of the growth is tied to public spending — both direct spending on things like military purchases and indirect spending through tax breaks.

For instance, the single largest contributor to PCE growth was automotive purchases, which were fueled by the “cash for clunkers” tax credit program. In the same manner,  investment in residential structures linked to the homebuyers tax credit was the major driver of gross private domestic investment.

Now that public programs like cash for clunkers have ended and given that other elements of the recovery package are soon will start to expire, it is unclear whether the economy will be able to maintain robust real GDP growth. High levels of unemployment suggest that PCE will contract while weaknesses in residential and nonresidential real estate likely will retard activity in those areas. The trade deficit will continue to subtract from GDP growth, and the expiration of federal aid to the states and weak revenue collections likely will restrain state and local government spending.

One other clear finding contained in the report is that inflation remains subdued. Core market-based PCE (meaning expenditures excluding those for food and energy) grew at an annualized rate of 1.2 percent in the third quarter, down from a rate of 2.3 percent in the second quarter. This is the lowest rate recorded over the last 16 quarters.