The Economy Is Weak and Getting Weaker

When the current quarter numbers come in, back-to-back contraction will confirm that a recession is under way.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

October 30, 2008

By the time the federal government has all the statistics it needs to decide how the economy performed last quarter, the figure is likely to be worse than what the Commerce Department said on Oct. 30, when third-quarter gross domestic product (GDP) declined 0.3%, the government's first crack at estimating economic growth for the three-month period. And the economic growth is almost certainly going to contract the next two quarters.

Economists are bracing for at least a 2% contraction in the fourth quarter of 2008 and about as bad as this in the first quarter of next year. Even if economic growth begins to pick up later in 2009, economists expect GDP growth for the year as a whole to be near zero, which hasn't happened since 1991.

The last negative GDP quarter was a decline of 0.2% in the fourth quarter of 2007, a blip during what had been a healthy expansion. Before that, the last time the economy shrank was a steep 1.4% drop in the third quarter of 2001, amid a mild recession.

"Things are going to get worse in the fourth quarter. Consumer spending won't fall 3% (as happened in the third quarter), but it will contract again," says Jay Bryson, an economist with Wachovia Corp. Since consumers account for about 70% of GDP, a 3% decline shrinks overall GDP growth by more than two percentage points.

Consumer spending last actually contracted in the final three months of 1991, shortly after a recession had ended, although no one yet knew it at the time. Despite the recent plunge in gasoline prices, consumers are feeling strapped. Rising layoffs are hitting more households. And many are shut off from further borrowing by credit card companies and by struggling banks, which are freezing home equity lines of credit.

Exports, which had been a key source of strength, are now a concern. After increasing 12.3% in the second quarter and helping fuel GDP's 2.8% growth, their gain slowed to 5.9% in the most recent quarter. With reports of the credit market crisis spreading to the U.K., Japan, Australia and other countries overseas, a further slowdown in U.S. exports is likely.

House construction and remodeling continued to fall, down 19.1%, which compares with a 13.3% drop in the previous quarter. Business investment, which accounts for about 11% of GDP, fell 1% in the third quarter. Companies slowed spending on new buildings and reduced equipment and software purchases.

The sole source of strength was government spending, mostly at the federal level, which saw an increase of 13.8%. Defense spending soared, up 18.1%. Spending by state and local governments slowed but still posted a gain of 1.4%.

Officials at the Federal Reserve acknowledged across-the-board weakness in a policy statement that they issued with a half point rate cut on Oct. 29. They added that "the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit." We don't expect that banks and other lenders will make credit easier until next spring or summer.

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