'We May Be in a Contraction Right Now'

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It's okay: Fed chairman Alan Greenspan speaks to the Economic Club of New York

A lot of numbers Friday, and none of them good. The Commerce Department said U.S. GDP in the first quarter (January to March) didn't really grow 2 percent, as previously estimated — the new Q1 number is 1.3 percent. Orders for durable goods — cars, computers and the like — fell an ugly 5 percent in April after rising a revised 2.2 percent in March. And existing home sales, which make up 80 percent of the housing market, fell 4.2 percent to an annual rate of about 5.2 million last month, the National Association of Realtors (NAR) reported, — a day after new home sales in April notched their first drop in three months.

Well, one good one: The University of Michigan's final May reading of consumer sentiment about the economy rose to 92.0 from 88.4 in April. Finally, that trend may be on the way up, and consumer spending may well follow with a recovery form its recent slip. It had better — in a TIME.com Q&A, TIME senior economics reporter Bernie Baumohl says the numbers indicate that the U.S. economy is shrinking in the second quarter — meaning, right now. And where it goes in the third quarter will again be up to those consumers.

TIME.com: How about that GDP revision?

Bernie Baumohl: I think everybody expected that 2 percent was too high, and wasn't going to hold up. These numbers confirm that business spending and especially consumer spending was down a little more in the first quarter than we'd thought.

And now, for the last six months that we have numbers for — the fourth quarter of last year and the first quarter of this one — the economy grew at something like a 1 percent rate. You can't get much lower than that without being in a recession — and what that says is we've spent the second quarter bumping along the bottom, and the monthly economic numbers we've seen lately are actually worse than what we saw during the first quarter.

So where's that leave us?

I think the odds are better than 50-50 that we're in a contraction right now — negative economic growth.

A contraction, not a recession?

Remember, home sales may be down, but April's low would still have been a record in 1998. A lot of these numbers are like unemployment — historically not so bad but bad in relation to the recent past. So even if we've entered a contraction it's likely to be temporary. Most economists, at the Fed and elsewhere, feel quite confident that after the second quarter, things will start to turn around.

A recession is technically defined as two quarters of negative economic growth. I think the second quarter, if it's negative, will be isolated — the third quarter will be back in positive territory, and the record economic expansion of the last decade will probably remain uninterrupted.

So we're looking ahead to the third quarter.

The third quarter will be the inflection point. Alan Greenspan, in his speech to the Economic Club of New York last night, indicated that he thought the worst was probably over. The economy still has soft spots, and he didn't rule out further rate cuts. But his message was that the rate cuts he's done already will have a stimulatory effect at least by the end of the year.

Could he be jawboning a little?

That's a possibility, and certainly he's talking up the work he's already done. He's telling the business community, essentially, to lay off the layoffs — things will pick back up soon enough. And to consumers, he's saying keep those spirits up — 4.5 percent unemployment still isn't that high, he's on the job, and the turnaround is coming.

Who'll lead the turnaround?

Consumers still have to carry us through until the interest-rate cuts — which are all still in the pipeline — make their way into the economy. With the Fed acting aggressively and the stock market having stabilized to some degree, there's a good chance that consumers will keep spending. Americans are notoriously slow to adjust their lifestyles when the economy slows — they'd rather borrow more to keep living the good life they've been living. So we could see the small falloff in spending reverse itself without too much prodding.

But here's what consumers are up against: First, layoffs are still being announced at a rate of 6,000 every business day. And second, Americans have looked at their household savings and said, "Oh my God." The fall in the stock market has hurt my portfolio and my 401(k) — the average 401(k) is below $40,000 right now — do I have any savings at all?'

And we know what happened to savings the last few months. What we could get right now is an uptick in savings, back from negative territory to 1 or 2 percent — and that's something Greenspan and everyone else is in favor of. But every 1 percent of savings takes $70 billion out of the economy — so a savings boom right now could come at a very bad time.

Like St. Augustine — give me chastity, just not yet.

Right. To prevent a second quarter of contraction — and thus, technically, a recession — consumers will have to spend more over July, August and September than they did in the second quarter. I expect they will, mostly because unemployment still isn't that high and the Fed is still on the job and cutting rates. There are plenty of reasons to be optimistic about the future, and that should be enough for them to keep spending and borrowing enough to start to bring businesses back into the game some time this winter and next spring.