U.S. economy lost steam in Q2, slower growth looms

When the first quarter ended, many analysts projected the subsequent months would bring even stronger gains in Gross Domestic Product. But the high hopes of economy watchers for acceleration in growth were dashed by reality when the U.S. Bureau of Economic Analysis released the revised second quarter report on GDP (August 27). The earlier advance report for the second quarter estimated the increase at 2.4 percent, but this was revised sharply downward to 1.6 percent growth in the latest release. Compared to the first quarter growth figure of 3.7 percent (seasonally adjusted and annualized), the economy in the second quarter slowed to less than one-half the pace of a few months ago.

When the first quarter ended, many analysts projected the subsequent months would bring even stronger gains in Gross Domestic Product. But the high hopes of economy watchers for acceleration in growth were dashed by reality when the U.S. Bureau of Economic Analysis released the revised second quarter report on GDP (August 27).

The earlier advance report for the second quarter estimated the increase at 2.4 percent, but this was revised sharply downward to 1.6 percent growth in the latest release. Compared to the first quarter growth figure of 3.7 percent (seasonally adjusted and annualized), the economy in the second quarter slowed to less than one-half the pace of a few months ago.

And now, Q3 growth is shaping up to be equally modest, as the recovery appears to be losing steam. Many analysts tend to believe that GDP increases in the 1 to 2 percent annualized growth range are inadequate to bring down unemployment rates by any appreciable amount in the near term.

Rising imports create a drag on GDP

The major sources of expansion in GDP for the second quarter are shown in the accompanying table. While the items in the table add to a healthy growth rate of more than 4 percent, the positive impacts on GDP must be adjusted by those elements of the economy that are still a drag on growth.

The single largest negative force was imports. As imports increase, GDP actually declines, since import spending benefits foreign economies. In the world of GDP accounting, the net effect of exports and imports — or net exports — is what counts.

In the latest GDP report, imports were up by more than 30 percent (annualized) in the second quarter, and the resulting impact on net exports amounted to a deduction of 3 whole percentage points from GDP growth. Imports have surged, particularly from Europe, the UK, South Korea, and Taiwan, as domestic firms have added to inventories of goods.

Business equipment and software spending rose

Spending by businesses for equipment and software tops the list of positive contributors to GDP growth, adding 1.53 percentage points to the 1.6 percent overall gains. Equipment and software spending increased by more than 20 percent in each of the past two quarters as businesses started to spend some of their healthy cash reserves on modernization and expansion.

Consumer spending in Q2 was a disappointment for many analysts. In March, retail sales were up by 2.0 percent, leading to an expectation that perhaps consumers would begin to loosen the grip on their wallets into the second quarter. Instead, retail sales were weak in April and fell in May and June.

Outlays by consumers in Q2 contributed 1.38 percentage points to GDP, little different from the 1.33 percent contribution in Q1. The second quarter annualized rate of growth for consumer outlays was 2.0 percent, still well below the average annual pace of 3.3 percent recorded over the past 25 years.

With consumer spending accounting for some 70 percent of annual GDP, the hesitancy to spend by consumers continues to inhibit growth. Meanwhile, the savings rate for the second quarter was 6.1 percent, three times greater than the 2.1 percent savings rate during the high-flying times of 2007, before the recession began. Consumers remain cautious, postponing spending and reducing borrowing.

Exports contributed 1.08 percentage points, down slightly from the previous quarter, but still an important source of growth for the economy. However, the negative 4.45 influence of imports led to the overall negative net export effect on GDP, subtracting 3.37 percentage points from Q2 growth.

Additions to inventories are winding down as a source of gains for the economy. In the two previous quarters, inventory rebuilding was responsible for more than 2.5 percentage points of GDP growth. In Q2, the contribution slipped below one percent to 0.63.

Construction spending up in Q2

Optimists sifting through the advance GDP report could find a few highlights to raise their spirits. Annualized spending on residential construction was up by 27.2 percent, thanks to the final surge of the first time homebuyer tax credits program.

This was the largest increase in residential spending since the mid 1980s. But outlays on nonresidential structures were flat, basically adding zero to GDP. However, nonresidential building has declined for seven consecutive quarters, so the decreases appear to have at least hit a temporary bottom.

Looking ahead

The recovery has turned more fragile. The outlook for a double-dip decrease in quarterly GDP remains remote but not impossible. Growth in the second half will be even slower than expected a short while ago. The W. P. Carey Round Number Forecast for GDP has been reduced for 2010 and 2011. Growth is now pegged at 2.5 percent for each year.

Consumer spending is expected to increase by only 1.5 percent in 2010, about one-half the pace of its long term average, and not nearly enough to drive the recovery. Double-digit growth in 2010 will be recorded in spending on equipment and software, and exports will be up by more than 10 percent. But neither residential nor nonresidential structures will be a source of growth in 2010.

As the influence of the stimulus program moderates, there are no readily discernable drivers on the horizon in 2011. Consumers will remain cautious as long as job growth is weak and credit is tight. Businesses additions to inventory will continue to slow down. State and local governments, usually a source of stability, will be a nonfactor due to budget problems.

A new unemployment record?

Weak economic growth means that unemployment is likely to hang over the economy like a cloud, well into 2011. According to a recent survey of economists that contribute to Blue Chip Economic Indicators newsletter, the consensus unemployment rate projected for December, 2011 is 8.7 percent.

The longest previous spell of unemployment above 8 percent was the 27 months from December 1981 through January 1984. If the consensus holds for unemployment above 8 percent all through 2011, that will be a string of 35 months, beginning in February 2009, a somber new record of economic distress.