Courtesy : Joshua Zumbrun for Forbes
Friday's GDP data shows the economy is on the mend. Can it last?
What's the story with the economy?
Optimists see the current stabilization as a spurt, likely to be followed by years of slow but steady growth. Pessimists see it as a mere pause before continuing to tumble down the stairs. Few see the foundations for a return to the long expansions in the '80s and '90s.
On Friday, new government data on America's gross domestic product showed the economy shrank by 1% in the second quarter, according to the initial estimate from the Bureau of Economic Analysis.
Though still negative, this was the best GDP statistic in a year--compared with shrinking by 2.7% in the third quarter of 2008, 5.4% in the last three months of 2008, and by 6.4% in the first three months of 2009, according to the newly adjusted data.
Although improvement from previous months was widely anticipated, a Bloomberg survey of economists projected the economy would shrink at a 1.5% rate in the second quarter of 2008. (Forecasts were complicated because of a twice-a-decade statistical adjustment that coincided with this release.)
The trends are in place for growth in the third quarter. More confident consumers, a stabilizing housing market, a better outlook for businesses and a big (but temporary) boost from the government help in the short term. Indeed, it may eventually be determined that the recession has already ended (though not everywhere). (See: "Where Unemployment Has Hit Hardest.")
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What's harder to see is how the economy keeps up its strength. "Recessions come to an end, indeed, but the transition phase to the next sustainable bull market and economic expansion following a post-bubble credit collapse is treacherous. If there is anything we have learned from history, that would be it," said David Rosenberg, former economist for Merrill Lynch and now the chief economist for Gluskin Scheff, before Friday's release. "So long as credit continues to contract, any recovery is going to be fraught with deflation pressure and double-dip recession risks along the way."
A look at some major components of the economy show why he's worried:
Consumption: Personal consumption makes up over 70% of the U.S. economy. In the second quarter, consumers regained some of their confidence as fears of a Depression eased, and consumption fell by just 1%. John Canally, economist for LPL Financial, points to the savings rate, now at about 7%, as a positive sign since a hefty chunk will get spent. But still more will be needed to reduce debts and fix family balance sheets. And that could constrain growth.
Meanwhile, borrowing will get more expensive. Though Federal Reserve Chairman Ben Bernanke says he's got inflation in hand and he'll keep interest rates low for the foreseeable future, in time the Fed will have to raise interest rates to stop the money printed during the recession from flooding the economy.
Investment: Investment in equipment, software and building for businesses fell by 9%. In the first quarter it fell by 39%, so the number is not nearly as bad. The huge reduction in investment will reverse simply because businesses have to replace old equipment, but with an uncertain outlook for consumers, many businesses will be reluctant to invest for the long term.
Housing: Investment in housing fell 29%, still an ugly number but not as bad as the 38% in the first quarter. Reports this week from the Census Bureau and the Case-Shiller Home Price Index show signs of stabilization in both prices and sales. But housing activity normally picks up going into the summer only to slow back down during the winter months (who buys a home in December?). Prices could fall again, and many potential sellers have been waiting out the bad market. Their return will keep a cap on prices, and all the homes going up for sale will reduce the incentive for homeowners to build new homes.
Trade: In the second quarter exports fell, but imports fell even more. This means the trade gap again narrowed. Larry Summers, the president's top economic adviser, envisions a future for the U.S. built more on exporting. The trade gap has long reduced the country's GDP (by about 3% now, but by about 5% in 2008, before global trade collapsed), since the U.S. imports more than it exports. If this trend reverses, it could add to growth. Exports have helped lead the country out of the last two recessions, notes Canally of LPL Financial.
But with so many economies around the world damaged, who will buy American exports? Climbing oil prices could also drag on growth.
Government spending: Government spending is 21% of GDP and growing fast. Government spending increased by 5.6% due to an increase in defense purchases and the spending portion of the $787 billion stimulus package kicking into effect. In coming quarters, the $787 billion stimulus package (which got off to a slow start) will further increase the size of the government in the economy and contribute to GDP growth.
But by the end of 2010, the bulk of the stimulus will have been spent. If the government shrinks back down, it will provide less GDP growth. Another stimulus? Perhaps. But can the government really afford to grow any more than it already has in the last six months?
