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Backward, March: The Economy Is In Much Worse Shape Than We Thought

The key takeaways from today's dismal numbers on the state of the U.S. economy:

  1. The recession caused by the financial crisis was far worse than previously thought (although not for everyone)
  2. Hopes for a strong recovery in the second half of the year are fading
  3. Washington's embrace of fiscal austerity is likely to make things worse
Simply, the economy has hit a wall in 2011. The biggest shock out of the Commerce Department is that GDP growth in the first quarter was only 0.4 percent, not 1.9 percent as originally forecast. Second-quarter growth wasn't much healthier, at 1.3 percent.

Keep in mind that the economy needs GDP of 2.5 percent simply to keep unemployment from rising. Instead, over the first half of the year it grew by roughly 0.9 percent. Not surprisingly, that has resulted in unemployment surging from 8.8 percent earlier in the year to 9.2 percent. If the anemic growth continues through December, unemployment is likely to top double digits by year-end. Says one expert:

There's nothing that you can look at here that is signaling some revival in growth in the second half of the year, and in fact we may see another catastrophically weak quarter next quarter if things go wrong next week," said Nigel Gault, chief United States economist at IHS Global Insight.
The spending lesson
The report has many lowlights, but let me highlight three that are critical in understanding what's happening to the economy.
  • Consumer spending rose only 0.1 percent in the second quarter, with car purchases taking an especially big hit in diving nearly 23 percent
  • Government spending fell 1.1 percent, less than the 5.9 percent decline in Q1 but still enough to reduce GDP by 0.23 percent
  • Business investment in computers and other equipment fell to 5.7 percent, down from 8.7 percent in the first quarter and the slowest rate of growth since capital spending started flagging in early 2009
The moral of the story: Shutting off spending while economic demand is slack, as Congress is preparing to do, is like choking a drowning man.

Conversely, the latest government data underlines that the injection of stimulus two years ago worked. After shrinking 7.8 percent at the end of 2008 and early the following year, GDP fell only 0.7 percent in the second quarter of 2009 and grew 1.7 percent the following quarter. And since the stimulus spigot was turned off? We've gone backwards. Says economist Josh Bivens of the Economic Policy Institute:

All of the signs in this report point to an economy that remains below potential because it lacks sufficient spending. Furthermore, the revisions make clear that this dearth of spending has actually driven the economy further away from its potential levels than we had previously thought. The first six months of 2011 saw the too-slow but relatively steady progress since late 2009 in lowering the unemployment rate stop and then actually reverse.
What could boost consumption? Wage growth, for one. But that grew only 1 percent in the second quarter. Unfortunately, I have yet to hear Rep. John Boehner, R-Ohio, or Sen. Harry Reid, D-Nev., the authors of the two leading deficit-reduction bills, wax eloquent about the threat to the economy posed by falling personal income.

Dangerous ground
As I noted up top, one sector of the economy has done just fine over the last few years: big companies. According to the government's revised data, corporations recorded sharply higher profits for 2008-10. The biggest winner? The financial services industry, which economist Dean Baker notes is generating nearly 32 percent of corporate profits, compared with 10 percent in the 1960s.

By contrast, small businesses continue to suffer. One in four smaller companies, which collectively account for roughly half of GDP, report weak sales, according to the National Federation of Independent Business.

Time to start worrying about double-dipdom again? Yes and no. Numerous economists and market analysts continue to predict a modest economic rebound over the rest of the year. But that assumes everything goes right. With the debt ceiling threatening to cave in, sovereign-debt woes still plaguing Europe and our political leaders in denial, plenty could go wrong. Even a mild shock to the system -- a temporary downgrade to U.S. credit, say, or an outbreak of anti-austerity rioting in Madrid -- could send the economy tumbling back into recession. We're skating a very thin edge.


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