GDP Sinks Like A Stone: Part Two

After having a few days away from the news it would be nice to return to some good tidings. But no. Last week’s GDP announcement shows that all our worst expectations are correct. Here’s the government press release: GDP Declines Sharply

There is not much to say about this since it is self evidently awful.

There are on or two points to be made however.

The fourth quarter of 2008 saw GDP decline at a 6.2% rate. To put that in perspective, if that rate of decline was maintained throughout 2009 we would expect the economy to shrink by about $900 billion. Also assuming that the recovery, when it finally arrives, manifests itself as a slow quarterly climb – which is the most likely case – the total loss of GDP looks as if it will comfortably exceed $1.5 trillion. Keep this figure in mind when you are thinking about the stimulus package and the cost of debt to pay for it. Depending on the actual disbursement of the stimulus money, and a lot of it will leak into 2010, the gap in demand is still enormous. Even if all the money were to be spent this year, the gap is still going to be on the order of $300 billion this year alone.

This is why I have said from the beginning that the stimulus package was too small compared with the problem being solved. We need another shot in the arm of maybe $400 to $500 billion.

The second interesting point is that a major contributor to the collapse of GDP was the sharp contraction in trade. Exports dropped 23.6%, while imports only dropped 16.0%. Both these numbers are huge compared with earlier last year and show that the weakness of demand worldwide will not be a sufficient power to pull our economy back up. The recovery has to be self-generated.

This is stark contrast to the Japanese experience in the 1990’s, when their economy was able to recover, albeit very slowly, through an export led drive. Japanese domestic demand stagnated for years throughout the 1990’s, it was only this drive for exports that created growth during those years. So our recovery will have to have a very different dynamic.

Both these points are worth keeping mind as we watch the debate over economic policy. We cannot afford to misjudge the extent of our problem because we don’t have the luxury of foreign consumption to pull us out.

That’s why the political discussion is so important and so urgent.

We’ll probably need more stimulus within the next year. Curing this demand gap will be extraordinarily expensive. We had better get used to that.