Baumohl By the Numbers: Uh Oh

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Well, at least itís growth. The Commerce Department reported Friday that GDP growth for the just-finished second quarter was a barely perceptible 0.7 percent, lower than analysts expected (though higher than the zero number some were forecasting a few months ago) and the lowest number in eight years. And though new home sales for June stayed strong, rising 1.7 percent, the University of Michiganís final July consumer sentiment index edged down to 92.4 from 92.6 in June, according to a Reuters report.

Is this the low point of the slowdown — or the edge of the cliff? TIME senior economics Bernie Baumohl says Fridayís numbers are the worst batch of news heís heard all year. What do you see thatís troubling in the Q2 GDP report?

Bernie Baumohl It looks like weíve barely detected a heartbeat in the U.S. economy for the second quarter. The 0.7 percent growth number is the lowest in 8 years — on the one hand, thereís some relief that itís not negative, on the other, itís a sign of real weakness that could raise some concerns for the rest of the year.

Business spending, for example, is non-existent. It actually dropped — 13.6 percent, compared with a drop of 0.2 percent in the first quarter. Thatís the steepest drop since the spring of 1982, when the U.S. was in its worst recession since the Great Depression. And consumer spending growth has also slowed, the lowest increase in four years.

With the University of Michigan numberís slight decline, weíre seeing signs that what everyoneís been fearing has begun to happen — the consumer is starting to retrench. They may be beginning to reassess their financial situation, given the rise in unemployment and the buildup in debt, and they may have begun to spend themselves out.

Is there hope?

The good news is that $40 billion in tax-rebate stimulus is on the way, and thereís a lot of monetary stimulus in the pipeline as well, from the six interest-rate cuts from the Fed. Thatís hopefully going to put a floor underneath consumer spending, and keep it up long enough until business can start to lead the recovery late this year or early next year.

And although home sales — new home sales rose 1.7 percent in June to a seasonally adjusted 922,000 annual pace — have started to plateau, itís a plateau at a very high level. Housing is an umbrella industry that carries other sectors, from appliances to construction to electronics, along with it, and itís been tremendously important in the consumer-driven growth thatís been keeping the economy going this year. But as the year continues, there are a lot of trouble spots.

Such as?

For one, housing tends to cool in the fall and winter. For another, OPECís decision this week to cut production could show up in energy prices, like home heating oil, this winter. And that could cut into consumersí discretionary spending.

Besides that, thereís the rest of the world. I see an 80 percent chance that Argentina will have to default in some way on its bonds, and thatís a contagion that could spread to the rest of Latin America and other emerging markets. That — and the almost-equally-good possibility that Japanese Prime Minister Koizumi wonít be able to follow through on the necessary economic reforms — is likely to drive even more investors to the U.S., making the dollar even stronger. And thatís bad news for manufacturing, which is already in a recession and has lost something like 800,000 jobs so far. A strong dollar — which makes imported goods more competitive — is only going to delay that sectorís recovery.

Whatís down the road economically?

Right now, weíre looking at two or three quarters of very weak growth — and thatís if the tax cut and the interest-rate cuts provide that floor for consumer spending, and nothing else goes wrong. At worst, the economy is very vulnerable right now to shocks at home and abroad, and still totally dependent on consumer spending to stay above water. If spending weakens significantly and businesses donít see that demand for their products, we could still get a recession that starts in the fall or winter and ends who knows when.

This does mean that the Fedís rate-cutting regime is not over. Inflation is still apparently contained, and in the meantime Greenspan is still waiting for the cuts so far to have an effect. The number to watch for the next quarter or two will be consumer spending and confidence — although itís only slipping slightly, itís a trend you donít want, and one this expansion wonít be able to survive for long.