Despite a Lousy GDP Report, U.S. Economy Is Primed to Expand

Photograph courtesy Lockheed Martin via Getty Images

The U.S. economy shrank by 0.1 percent in the fourth quarter of 2012, its first contraction since the recession ended in 2009. Although the figure could eventually be revised into positive territory, for now this marks the end of 13 straight quarters of economic growth. Not bad, America. While economic contraction is never good, there’s a lot to like about this gross domestic product report—unless you’re in the defense industry. The report is actually riddled with good news.

First, the bad. One of the drags on fourth-quarter growth was a slowdown in inventory spending. It’s not as if we didn’t see this coming. Businesses spent big on inventory during the third quarter, restocking for the holidays. That wasn’t going to last, and it’s now clear that third-quarter spending stole growth from the end of the year. At least it happened. Remember, the economy grew by 3.1 percent from July through September.

The biggest shocker is the 22 percent decline in defense spending. According to Neil Dutta, head U.S. economist at Renaissance Macro Research, there have been only seven quarters since 1947 in which defense spending fell that far. That makes it a 3-in-100 event, he wrote in a note on Wednesday. Again, just like business inventories, this is an example of spending being pulled forward—probably for fear over federal budget sequestration—and thereby stealing from future growth. During the third quarter, defense spending jumped by 13 percent. Back in October, BNP Paribas chief economist Julia Coronado likened that surge to a “use it or lose” mentality within the Pentagon. Looks like they just used it before October: After surging from $807 billion to $834 billion in the third quarter, the annual rate of defense spending crashed to $787 billion in the fourth quarter.

Now the good news. While businesses were cutting back on inventory spending, total business investment surged by 12.5 percent as companies spent on capital goods such as computers and trucks and machinery. That’s very good news, especially for a recently beleaguered manufacturing sector.

Here’s another nice stat pointed out by Dutta: Consumer spending rose at 2.2 percent and the savings rate increased to 4.7 percent, up more than 1 percentage point from 3.6 percent in the third quarter. When people have more money to spend and they save at the same time, that’s a very good sign. Real disposable income grew by 6.6 percent, more evidence that wages are starting to inch higher.

Economic growth isn’t always smooth. Sure, it’s much better when it is—being more predictable and whatnot. But considering all the uncertainty that Congress injected into the economy over the last several months, it’s not surprising that growth and spending have been so choppy. Also, this is the kind of growth that happens when you shrink government. Total spending by the federal government fell by 15 percent. Given such a dramatic decline, it can be considered heartening that the private sector was able to pick up so much of the slack.

And while the dismal quarter ends a run of consecutive growth, the recovery did not die in December 2012. This is not the beginning of a new recession. Growth will probably be slow through the first quarter, as the 2 percent payroll tax increase slims workers’ paychecks and we get our heads around the framework of new federal taxation. The prospect of a government shutdown won’t help either, as congressional Republicans and President Obama spar over spending.

The U.S. economy is still primed to expand, though we’ll have to make do with a smaller contribution from Uncle Sam. Remember, the biggest immediate threat to the U.S. economy right now is Congress, which controls so much of the spending and taxing that filters into Americans’ everyday economic decisions.  Sad as that may be, there are worse problems to have.

    Before it's here, it's on the Bloomberg Terminal.