The first estimate of US Q3 GDP growth came out at a dismal 1.6% but, as reported by Bloomberg, the actual correct figure would have been 0.9% if the production of motor vehicles in Q3 had been measured correctly:

U.S. Statistical Fluke Exaggerated Growth, Will Be Reversed
By Carlos Torres

Oct. 27 (Bloomberg) -- An unexpected increase in auto production last quarter was a statistical fluke that will be reversed, making current U.S. economic growth even weaker, according to a former Commerce Department economist.

Last quarter's annualized 26 percent increase in auto production shocked Joe Carson, now director of economic research at AllianceBernstein LP in New York. Without the gain, the economy would have grown at an annual rate of 0.9 percent, not the 1.6 percent the Commerce Department reported today.

The increase in output came despite cutbacks announced by General Motors Corp., Ford Motor Co. and others. A drop in the wholesale price of SUVs and light trucks as the automakers cleared leftover 2006 models made production look stronger than it actually was, said Carson. The economic fallout from the auto-industry cutbacks will instead come this quarter, he said.

``Last quarter was weak even with the benefit of this mismatch and the fourth quarter will now also be weak because it's going the other way,'' Carson said. ``Whatever output you have this quarter, which will probably be down, will be discounted by a likely rebound in prices.''

The mismatch can be explained by looking at how the government adjusts the figures for price changes.

Commerce Department economists use wholesale light truck prices, from the Labor Department's producer price report, to eliminate the influence of inflation on investment and inventories for that category. A 5.5 percent drop in price of SUVs and other light trucks last quarter made output look stronger when adjusted for inflation.

Growth Pessimism

``Whatever output you have this quarter, which will probably be down, will be discounted by a likely rebound in prices,'' Carson said. He currently forecasts the U.S. economy will grow at an annual rate of 1.4 percent this quarter and said he wouldn't be surprised if growth came in at half that pace. AllianceBernstein is an asset management firm.

The median forecast of economists surveyed by Bloomberg News earlier this month was for fourth-quarter growth of 2.5 percent.

``We are looking into it to see if we can better understand the reasons for the large decline'' in prices, said Brent Moulton, associate director for national economic accounts at the Bureau of Economic Analysis, part of the Commerce Department, which produces the report on gross domestic product.

Carson wasn't the only economist shocked by the auto- production figures.

`Unbelievable Detail'

Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut, called the output numbers ``the most unbelievable detail'' in the GDP report.

The composition of growth last quarter, which included an unexpectedly large accumulation of inventories, also prompted other economists to reduce estimates for fourth-quarter growth. An increase in inventories overall suggests manufacturers may need to trim production this quarter.

The economy will probably grow at an annual pace of 1 percent from October through December, down almost a full percentage point from his earlier estimate, according to Joseph LaVorgna, chief U.S. fixed income economist at Deutsche Bank Securities Inc. in New York.

``A relatively large inventory build last quarter will need to be worked off and that will produce a negative hit to production, employment and income,'' LaVorgna added.

This mismeasurement of motor vehicle production in Q3 is highly suspicious coming about ten days before the US mid-term elections. It is also highly suspicious as it is not clear how the Bureau of Economic Analysis (BEA) at the Department of Commerce could have made such a gross mistake when seeing an alleged 26% increase in auto production that was patently at odds with many facts. During Q3 all the major US automakers - Ford, GM, Chrysler - announced production cuts for both Q3 and Q4. So, how could the folks at BEA argue and estimate that production went up by a whopping 26%?  These data also do not make any sense as the Federal Reserve  Board data on automotive production in Q3 show a sharp fall in production of motor vehicles of 12% (see http://www.federalreserve.gov/releases/g17/Current/g17.pdf, Table 1).

So how come the FRB data show a -12.0% sharp drop in production while the BEA estimates show an incredible 26% increase in production in Q3? This is altogether fishy. If one wants to give the benefit of the doubt to the usually non-partisan statisticians at BEA one would have to conclude that they were clueless about estimating motor vehicle production and they used a wrong price index to deflate the value of auto sales. How could they make such a gross mistake and believe in their estimate 26% growth figure - when all news headlines for months have been presenting the bad news about the plight of US automakers - is anyone's guess? The alternative hypothesis is that the Q3 GDP growth number was "massaged" upwards less than two weeks before the US mid-term elections. While a 1.6% is bad and dismal enough, a 0.9% would have been an altogether awful headline.

When I brought up the issue of the wrong estimate of the Q3 GDP number during my interview at Kudlow & Co. on Friday, even the conservative host Larry Kudlow was forced to ask one of the other guests - David Malpass of Bear Stearns - whether the GDP growth figure had been manipulated upward because of the election. And Malpass agreed with me that the motor vehicle figures looked fishy and that actual motor vehicle production in Q3 was lower than officially estimated.

Personally I prefer to give to BEA -  a respected and independent government agency - the benefit of the doubt  before claiming political and electoral manipulation of the most sensitive macro indicator before the election. But now BEA urgently owes the public a rapid and clear response on how it estimated motor vehicle production, why its +26% growth estimate is at odds with the -12% estimate of the Federal Reserve Board, and what it is planning to do to correct such incorrect estimate. Statistical measurement is always an art rather than a science but this is such a gross and obvious mismeasurement that BEA owes the public a clear and open answer. The fudged answer that Brent Moulton of BEA gave to Bloomberg for this first estimate will frankly not do.

I myself had predicted in July that Q3 GDP growth would be as low as 1.5% but, during the last few weeks, I had revised my growth estimate to "at most 1.5% and most likely closer to 1%" (see also another earlier blog of mine making the same point). My even greater recent pessimism was based - in part - on the awful news and data that were coming out of the US auto sector. Indeed several other private sector forecasters had recently downgraded their Q3 growth forecasts below 1% (for example Goldman Sachs down to 1%). That is why many observers, including Carson and Stanley, found the actual first estimate of Q3 GDP growth at 1.6% as highly suspicious.

We thus expect BEA to provide a rapid clear and open explanation of this gross mismeasurement. The issue is serious enough to require an explanation: both for markets and investors as the reaction of major asset markets to a 0.9% estimate of growth would have been even poorer than the reaction on Friday to the 1.6% estimate; and for the public in general as this episode leaves the suspicion - until otherwise clarified - that the first estimate of growth was actually manipulated for other purposes.