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January 30, 2013 7:16 pm
To predict a US recession based on the 0.1 per cent fall in annualised output for the fourth quarter is a bit like expecting rain because somebody threw a bucket of water out of the window.
Consumption, business investment and construction, the core areas of private sector demand, were robust and collectively added 2.7 percentage points to growth. That suggests the outlook for the economic weather is still fairly clear.
Most of the damage came from two categories that are notorious for their volatility – business inventories and federal defence spending – which each knocked 1.3 percentage points off total growth.
That is unlikely to continue – but is a warning of what could happen to the US economy if Congress decides to dump water out of the window every month, via across-the-board “sequester” cuts to spending that are due to take effect at the end of February.
“Inventories and federal defence spending subtracted heavily from GDP, but the data indicates that the underlying recovery remained intact – both consumer spending and business investment expanded robustly,” said Kevin Dunning, US analyst for the Economist Intelligence Unit.
The consumption and investment data are broadly encouraging: they suggest that businesses shrugged off the end-of-year fiscal cliff. That picture is backed up by a range of other data, from the labour market to confidence surveys, none of which suggests that the US economy is headed into recession.
The weakness was elsewhere. Inventory growth had added 0.7 percentage points to growth in the third quarter. Over the long run, inventories should remain broadly stable on average, so any big rise is often followed by a big fall.
Defence spending also jumped in the third quarter and so some of its decline was probably payback as well. The US fiscal year ends on September 30 and seasonal effects seem to have been especially pronounced in recent years. In both 2010 and 2011, defence added to US growth in the third quarter, and subtracted from it in the fourth.
But there was also reason to suspect that the drop in defence spending – the biggest quarterly decline since the early 1970s – was partly due to the looming threat of “sequestration”.
Unless Congress can agree to replace or suspend them, $1.2tn in automatic spending cuts over a decade are due to take effect beginning March 1 – with half of the reduction to come from the Pentagon budget.
With the fourth quarter of the calendar year marking the first quarter of the fiscal year, the Pentagon had every reason to spend carefully, especially as it knew sequestration might bring a big cut in its budget.
“They know they are in store for some big cuts, it’s much easier to spread it out over the whole fiscal year,” said Mark Zandi of Moody’s Analytics.
The defence spending number in the first GDP release comes from monthly cash statements published by the Treasury department. They show the cash flowing out of different government departments.
Defence spending in those statements looked fairly normal, which is why the output drop took Wall Street by surprise, but the Bureau of Economic Analysis makes several adjustments when it calculates the GDP numbers.
For example, it spreads out lump sum pension payments across the year in the national accounts. Doing that this time revealed lower spending in areas such as operations, procurement and research.
The drawdown of two wars in the Middle East and the impact of budget cuts already in place may also have hurt defence spending. But so far, there is mixed evidence that this has had a major ripple effect across the private sector.
Chad Moutray, chief economist at the National Association of Manufacturers, says this will certainly take a more negative turn if the sequestration cuts do in fact morph from threat into reality.
“We are hearing from a lot of our member companies, they don’t know how to go,” Mr Moutray says. “Some of them are being forced into pulling back – not knowing what’s going to happen with their contracts,” he says.
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