GDP Slide Continues

Surely no one was surprised by the release this morning of the first quarter GDP results. The sharp contraction that began lat the end of 2007 continued unabated with the economy shrinking at an annual rate of 6.1%. This was the first time in three decades that we have experienced back to back quarterly declines of over 5%, and, obviously, was a very poor performance.

Inside the numbers, however, are nuggets that can support everyone’s argument, pessimists and optimists alike. Usually this kind of split or ambiguous message is the first sign that the decline is beginning to moderate, so all eyes turn to the current quarter where most ‘experts’ are predicting a much slower rate of fall, possibly a drop of 2%, before we arrive at the third quarter which may well be flat or even a tiny uptick.

Let’s look at the details:

• Trade. The difference between exports and imports, the balance of trade, played a major role in the first quarter. It added 2% to growth. Or rather, it prevented the decline from being 2% steeper. Under normal circumstances this would be cause for a little celebration: the US has run a considerable trade deficit for far too long. This time, however, our celebration should be severely muted. The reason the trade balance improved was simply due to a drastic cut in imports as American consumers stopped buying foreign goods. Imports fell at an annual rate of 34.1%, an extraordinary decline. Unfortunately exports also dropped like a stone, only not quite as much as imports: the drop was a ‘mere’ 30%. Taken together the trade gap shrank. But for all the wrong reasons. I see no joy in this. The global collapse of trade is an alarming feature of this recession and is an indicator of how difficult it will be to restore strong growth. There is no way any country can export their way out of the crisis. That’s a very big deal for export driven economies such as Germany and Japan, but it also removes one of our potential sources of recovery.
• Consumption. The optimists will love the fact that consumer spending rose 2.2% in the first quarter. They will look at this number and immediately proclaim an end to our woes since our economy is driven in large part by consumer spending. I am a little more skeptical. Just this week consumer confidence improved dramatically: it jumped from a very low mid 20% to a high 30% range. But it remains really low. So, while I agree that there is an obvious improvement: consumption had fallen at annual rates of about 4% in each of the previous two quarters, I would not declare an end to the crisis on the back of this evidence. There is still a very long way to go, and the shadow cast by unemployment will linger well into next year. My position remains cautious: let’s see how the monthly data tracks over the coming months before getting too giddy. We are not cable TV hosts, so we can be realistic. Having said that it is equally evident that consumers stepped up more than expected in the first quarter. The combination of larger tax refunds and slashed prices had the desired effect. Let’s see if that effect carries over and sets a sustainable pace for the rest of the year.
• Business Investment. Here’s the real rogue last quarter. Business investment plummeted: investment in buildings fell 44.2%, and investment in equipment and software fell 33.8% for an overall drop in business investment of 37.9% at annual rates. That’s ugly. Really ugly. Companies are slashing not just jobs but anything else they can lay their hands on in order to preserve cash flow. This is the biggest cut back since 1958 and has now reached a level that is probably unsustainable. Simultaneously businesses also kept on cutting back inventories: by some $103.7 billion in the quarter. At some point businesses will have eliminated all the expenses they can. When we arrive at that moment the only way is up and investment will increase again, no matter how small the increase is it will help end the recession. Of course being able to predict when the turning point has arrived is impossible, but with declines of that magnitude in the first quarter I have to believe we are very close to it. This is one major reason why I see the decline in GDP ending at the end of this year.
• Investment in Housing. There can be no surprise here. Investment in housing continued its steep decline for the 13th straight quarter. It fell at an annual rate of 38%, the sharpest decline since 1980. Given the news earlier this week that home prices are still falling, I think it is fair to call the outlook for residential investment grim as far as the eye can see.
• Government Spending. This data is weird. With all the fuss over deficit spending and stimulus plans you would think that government spending boomed in the first quarter. You’d be wrong. It fell at a 3.9% annual rate. State and Local government was one part of the cause: cut backs at those levels also were at a 3.9%, which is the sharpest drop since 1981. The surprise is that Federal spending fell at a 4% rate, with most of the decline coming from a 6.9% drop in defense spending, which is notoriously volatile and will therefore most likely jump back later this year. Clearly the stimulus has yet to kick in. When it does government spending will help lift the economy out of recession. Again this seems as another likely candidate to end the recession later this year.

So for those of you keeping count, we had a decline of 6.1% overall. When you adjust all the factors I just mentioned for their impact on the total economy here’s the scorecard: Consumer spending added 1.5% and trade added 2%. So on the positive side we had 3.7% gains in two sectors. The downside came from: business investment -4.7%; government spending – 0.8%; inventories -2.8%; and investment in housing -1.4%. Yes I know that only adds up to a drop of 6.0%, but that’s accounted for by sundry small stuff and rounding off the figures!

The message? The economy continues to tank. A 6.1% decline is awful in anyone’s book. But there are very slight signs the rate of decline will now start to moderate. We should even grow a little later this year.

None of this is controversial. The really big question remains: what is the shape of the eventual recovery? Will it be a sharp upturn? Or will it be a long slow slog?

The answer to that depends heavily on the health of our banks. But that’s probably not what you wanted to hear.